Revisit: Time Value of Money

Time for Exercise on Estimating

your retirement needs and
savings for retirement
 Exercise-1
• If Mr. Ahuja who is 30 years old, is planning to invest for his
post retirement life. He is expecting his retirement at the age
of 65 years and his life expectancy is 80 years. He requires Rs.
24,00,000 per years to meet his all expenses after retirement
and this amount is expected to go up due to average inflation
rate of 5% p.a.. He can earn 7% p.a. on investments after
retirement:

– How much he should invest every year from now till he retires?

– Expected rate of return is minimum12 % p.a. (SIP in HDFC Top

200 Fund)

– If he has savings potential of Rs 10,000 p.m. (Rs 120,000 p.a.),

than how much money p.a. he will get after retirement under same
conditions for meeting his expenses.
 Exercise-2
• Suresh is planning for funding higher education of
her daughter. His daughter is 7 years old and she
is expected to join higher education at the age of
20 years. Present cost of higher education is Rs.
20,00,000 and average inflation is 5% in cost of
higher education.

• How much he should invest every year so that he

can fund her education. On an average a equity
growth fund is expected to generate 12% p.a.
 Exercise-3
• Naina is 22 years old. She has recently started her work. Naina is
working with an educational institute and she has been trained to counsel
students. Day in and day out, she talks to young people about the careers
and goals and where they want to be in life. This set her thinking in terms
of her future. Her aspiration levels increased and she herself wanted to
study further. She knew her potential and she was getting educated on the
job market and her areas of interest. After doing the initial research, she
concluded that she wanted to study abroad. However, as is well known, a
22 year old doesn’t have a lot of money in her kitty. Also she knew that
her parents could not take the burden of such a loan. She decided that she
would need to plan for fulfilling this dream of hers. She calculated the
amount to be Rs. 15 Lakhs. She wanted to have saved up Rs. 15 Lakhs in
8 years time. The average market return is about 10%pa. How much
would she need to invest to get Rs. 15 Lakhs in 8 years? Also, if Naina
invests in yearly instalments rather than a one time proposition, how
much will she have to invest each year, so that she will have Rs. 15
Lakhs corpus at the end of 8 years at a 10% rate of return.
Cash & Saving Management
(Managing Monetary Assets)
 Objective of Cash Management
• Cash includes liquid assets
• Cash/Savings management to meet the personal financial
goals
• Liquidity to meet requirement for transactions and
contingencies
• Saving programs to meet financial objectives
• Investment in appropriate instruments to generate return
• Cash Budget to estimate inflows, outflows and
surplus/deficits
 Cash Management Products
• Saving Account
• Fixed Deposits
• Recurring Deposits
• Smart Account – deposit linked saving account
• Mutual Funds (FMPs, Liquid Funds)
• Money Market Instruments
 Saving Account
• Saving Account with a commercial bank
– Cheque facility
– Interest – 3 -4% per annum
– ATM card/ Debit Card
– Phone Banking
– Internet Banking
• Bill Payments
• Account Information
• Fund Transfers
• Other services
 Saving Account
• Choosing a Bank
– Services
– Minimum Balance
– Cost
– Access and Reach
• Handling a saving account
– Taking care of cheque book/ ATM Card/ Debit Card/ PIN
Number
– Stop Payment
– Monthly Statement & Reconciliation
 Deposit Accounts
• Fixed Deposit/ Time Deposit with commercial bank or post office
– Higher rate of interest
– Facility to pre-mature withdraw
– Cumulative
• Recurring Deposit with a bank/ Post Office
– A predetermined sum is invested every month
• Smart Account/ Deposit linked saving account
– Term deposit is linked to a saving account
– Deposit carries higher rate of interest
– In case saving account is overdrawn, appropriate sum is transferred from term
deposit to the saving account
What are Money Market Instruments ?
 Money Market Instruments
• Treasury Bills
– Issued by Government to meet short term needs
– In the form of Promissory Notes
– Highly liquid and credit risk free
– RBI acts as an Issuing agent for the Govt.
• Minimum of Rs.25,000 and in multiple thereof
• Issued at a discount/ redeemed at par
• Duration – 91 days and 364 days
 Treasury Bills
• Yield
– (FV/Purchase Price - 1) *365/Days to maturity
• Traded on the Retail Debt Segment of NSE
– Screen based
– Order driven automated order matching system
– Price-Time priority
 Commercial Paper
• Used by corporate to raise short term finance
– Minimum Net worth Rs.4 crores
• Unsecured promissory note issued at a discount
• Maturity – 15 days to one year
• Size – minimum Rs.5 lakhs and multiples thereof
• Cheaper and less cumbersome for issuer
• Liquid and high yield for the investor
• Credit rating
 Commercial Paper
• Yield
(Par Value – Purchase Price) X 360
Par Value Days to Maturity

• Secondary market – endorsement and delivery

 Certificate of Deposits
• Issued by bank/FIs as promissory notes
• Negotiable
• Issued at a discount for up to one year
• Registered or bearer or demat form
• Size – Minimum Rs.5 lakh and thereafter in
multiples of Rs. one lakh
 How Good is the Idea of Keeping
Money in and Saving Deposits & FDs
 Fixed Deposits vs. SENSEX
• Excel Sheet
Fixed Maturity Plans vs. Fixed Deposits
 What is FMP ?
• A fixed maturity plan (FMP) is a closed-ended debt scheme, wherein the
duration of debt papers is aligned with the tenure of the scheme.

• FMPs are usually offered for tenures varying from 30 days to five years.
The most commonly offered tenures are 30 days, 180 days, 370 days and
395 days.

• So a one-year FMP will invest in debt instruments that mature in one

year or just before this period

• This synchronised maturing completely eliminates the interest rate or

reinvestment risk

• The FMPs invest largely in certificates of deposit (CDs), commercial

papers (CPs), money market instruments, corporate bonds, even in bank
fixed deposits

• Example FMP
 What is FMP ?
• As said earlier, FMPs are somewhat similar to bank
FDs, in that the money invested is locked in for the
tenure of the scheme.

• FMPs are debt funds that invest in government

securities and company debt. FMPs typically have no
equity component, unless you invest in an FMP that
chooses to have a limited equity component

• FMPs are ideal for all investors wanting steady returns

across different parameters, such as lower market risk
and tax efficient returns.
 Features of FMP
• Fixed tenure
• Investment strategy.
• Closed ended funds
• Low interest rate sensitivity
• Low credit & liquidity risk
• Portfolio balancing
• Tax benefits
• Growth and Dividend options
 Disadvantages of FMP
• Unlike FDs difficult to withdraw before
maturity

• FDs have deposit insurance

• FMPs may have credit risk, if invested in low

quality papers (Always buy FMPs from
reputed houses)
 Current relevance of FMP
• More suitable in high inflation, high interest rate
and high growth scenario

• In an environment of high prevailing rates, and

with other asset classes not adequately
performing, it makes sense for investors to invest
in FMPs
.
• FMPs are an ideal platform to capitalise
prevailing high yields, without assuming the
volatility risk of investing in a duration product.
 Taxation: FMPs vs. Bank FDs
• FMPs are usually tax efficient. Here is a simple tax
calculation that demonstrates the tax efficiency of FMPs vs
FDs.

• FMP offers single indexation benefit if it is maturing in

one financial year (For indexation benefit investment
should be for more than one year)

• FMPs also offer double indexation benefit, which comes

into play when the scheme purchase is made in one
financial year and the maturity of the scheme is after two
financial years. Indexation (for tax purposes) allows returns
generated on FMPs to be adjusted for inflation so that
investors are taxed only on the real returns

• Example FMP vs. FD Example

Liquids funds – A supplement to
your savings bank account
 What are liquid funds?
• Funds which do not invest any part of assets in
securities with a residual maturity of more than 91
days are liquid funds.

• Currently, the average portfolio maturity of this

category ranges between four and 91 days. These
funds invest in short-term debt instruments with
maturities of less than one year.

• Investments are mostly in money market instruments,

short-term corporate deposits and treasury. The
maturity of instruments held is between 3 and 6
months.
Liquid funds provide better returns than savings account

• Investments made in liquid funds offer better returns

for retail investors than parking money in savings
bank account

• A study conducted by CRISIL Fund Services has

found that liquid funds not only offer higher post-
tax returns but also provide a reasonable degree of
safety in terms of the principal invested

• Over the last 5 years, liquid funds rated by CRISIL

have given an annualised post-tax return of 5.78
per cent, compared to 3 per cent given by a
savings bank account
 When to use
• To create an emergency fund which can be
withdrawn any time

• To temporarily park any lump sum you may have

received

• To save for short-term goals such as saving for an

impending vacation or for short-term obligations

• To park money and systematically invest in other

high yielding schemes such as equity funds
 How to plan
• Segregate the money in your savings account
into two:
• one, the sum that you need for your day-to-day
operational cash flows and
• the rest for contingencies (emergency fund) or for
a short-term goal.

• Let the first part remain in your savings

account as you need this for your daily
expenditure. Shift the rest to a liquid fund.
 Being Tax Efficient
• Did you know that you need to pay tax on the interest that your
savings account balance fetches?

• Such interest income is taxed at the tax slab in which you fall –
10%, 20% or 30%. Liquid funds too, are taxed (as capital gains) in
the same rate if held for less than one year (indexation benefits are
available for holdings greater than one year)

• But you can plan to reduce the impact of capital gains tax in liquid
funds. Here’s how: if you are in the high tax bracket of 30% opt for
dividend payout or daily dividend reinvestment. This will reduce or
nullify your capital gains. If you are in the lower tax bracket, you
can instead take the growth option since the tax rate is anyway low.
Corporate houses have been using liquid funds to park their daily
surpluses and derive some returns. As retail investors, you can take
also benefit from these schemes
 Some Popular Liquid Funds
• Birla Sun Life Floating Rate Short Term Plan
• DSP BR Liquidity and
• HDFC Cash Management Savings Plan
• Reliance Money Manager

• Performance of Liquid Funds

End of Session 3