OUR INVESTMENTS Today, there are a number of investment opportunities that galore through news papers, television channels,

websites, SMS on mobiles, agents and so on. These sources of information on investment opportunities bother you almost every day about financial and non-financial investments of various companies with different nature and characters. Following are some of the examples of investments in the Indian context: Ms Akhila who joined as front office executive in a bank noticed that Rs 3,500 is deducted as provident fund (PF) from her first month salary. Mr Rakesh who is an IT Professional bought an apartment for Rs 30 Lakhs in Bangalore Dr Bangar deposits Rs 1,00,000 in SBI Tax Savings Scheme Ms Swathi bought 40 grams of gold on the occasion of Akshaya Tritiya Mr Jagadeesh, Finance manager of Lakshmi steels parked their companys surplus cash in a liquid plan of HDFC mutual fund. Mr Rama Rao, who retired recently opened a Monthly Income Scheme (MIS) in Post Office worth Rs 10,00,000, which he received through provident fund. Mr Aakash, who is an MBA student is saving his pocket money and depositing it in ICICI Banks Recurring deposit account.

You would have heard or experienced about all or some of the above financial transactions or commitments in your life at one point or the other. These are some of the investment alternatives for an individual or a company who would like to make some investments from surplus funds which is the residual of income after expenses. We will now look at investment alternatives and understanding them in detail. INVESTMENT ALTERNATIVES In todays world, there are a plenty of opportunities for an investor, be it an employee who has little monthly savings to companies who have several crores as surplus in their current accounts. These investment opportunities range from a traditional banks term deposit to risky derivative instruments leaving the choice to the investors based on their needs, objectives and risk appetite. Following figure 2.1 depicts the classification of investment alternatives and enables the reader to differentiate all the investment alternatives with respective segments or sectors.

Figure Figure 2.1 2.1 Types Types of of Investment Investment Opportunities Opportunities

Real Assets Real Estate Precious Stones Bullion Business Assets Long Term

Financial Assets Short Term

Equity Trading Derivatives Trading

Money Market Instruments

Arts, Antiques, Collectables

Treasury Bills Commercial Paper

Repos Certificate of Deposit

Traditional Chit Fund

Recurring Deposits

Non Traditional Shares Mutual Funds ULIPs Corporate Debt Government Securities Hybrid Instruments

Term Deposit Insurance

Provident and

Pension Fund Life Insurance

It is important to keep in mind that each and every investment opportunity is important as they have their individual advantages/disadvantages that fulfill the needs of all investors. In this chapter, we would have an aerial outlook of all varieties of investments to get a quick awareness and understanding at the introductory stage.Table Table2.12.1 Real givesAssets the classification of real assets Real Estate Other Real Assets Apartment Art work Commercial Apartment Antiques Residential Apartment Business Assets Group House Collectables: Stamps, books Service Apartment Precious Stones Studio Apartment Diamond Individual House Emerald Bungalow Ruby Duplex House Sapphire Villa Gemstone Row Housing Bullion Land Gold Residential Silver Commercial Land Platinum 2

Agricultural Land Industrial Unit Following is the description of individual investments in brief. A detailed discussion on individual investment opportunity in terms of nature, advantages, disadvantages, current trends, etc, would be dealt in later chapters. REAL ASSETS Investors invest because they have long term objectives and their prioritized needs like retirement, children education and marriage or low prioritized needs like foreign tour, premium car, etc. to fulfill. Often buying a new car, television, washing machine and other house hold articles that have a longer life are considered as investments as they become tangible assets. Buying these items would be either expense or investment also depend upon the objective of buying the same. For example buying a car for personal use is expenditure whereas, the same would be investment if the car is engaged in generating periodic or non conventional cash-flows. Long term investments can be in the form of real or financial investments matching the investors objectives and timing. The real investments usually reflect investment in tangible assets which can be classified as investment in real estate, bullion, precious stones and business. It can also be extended to other investments like antiques, art work and collectables. Let us understand more about them. a) Real Estate Land is limited and population in the world is increasing every year which implies that there would be a continuous escalation of real estate prices. Important objective of investment in real estate is wealth accumulation through capital appreciation which is escalation of prices over a long period of time. This involves commitment to long-term funds. It also generates periodic returns through rent and lease amount. Investment in real estate requires huge funds in several lakhs, long-term commitment and a deep understanding of local administrative and middlemen dynamics while dealing with real estate. India had seen a phenomenal growth in real estate in terms of prices, number of registrations, companies involved in real estate, number of intermediaries and spread of the scope o real estate business. Investment in real estate can be classified as follows depending on individual or a companys needs and objectives. Vacant Land: Investors buy land either to build a house for themselves or anticipate capital appreciation in future. Vacant land includes approved and unapproved residential plots, commercial plots, industrial units and business spaces in special economic zones (SEZ) through government or private schemes and agricultural land. Investors need to be cautious on the ownership and legal hurdles while buying the land. One has to strictly scrutinize ownership registration documents, link documents of previous ownership and take the statement from the seller that the land is free from litigations, mortgage, civil or legal disputes. Investors should thing of publishing the intentions to buy in a reputed news paper so that any litigants would address the investor. Taking legal opinion from professional consultants also serves the purpose to be safe. Apartment: Booming Indian economy and tax benefits on housing loan have boosted apartment housing in our country. Construction of residential and commercial apartments has been increasing for the past decade with increasing residential and commercial demand. Some investors feel that instead of buying a vacant land and constructing a house, it is wiser to buy an apartment as it would save time and money. An apartment in the form of a residential or commercial flat or studio apartment or service apartment would also serve the

investor in generating periodic monthly rent and capital appreciation in future. DLF is one of the leading construction company engaged in mega residential projects in big cities like Delhi, Gurgaon, Noida, Bangalore and Mumbai. Individual House : Along with residential apartment, projects construction companies are also launching row house, villa and duplex house projects to attract premium investors as it is costlier than buying a flat in a residential apartment. It is similar to the construction of a house/villa/mansion in an existing residential plot. In both the cases, the investor wants to save his monthly rent paid on his occupation or rent it out as additional income along with anticipated capital appreciation in future. b) Business Assets Doing a business in itself is part of investment process irrespective of whether the business is to sell a physical product or intangible service. In addition to that business entitites accumulate assets as pure investment option but on the name of the company anticipating a future value appreciation of the asset c) Bullion Bullion refers to investing in precious metals like gold, silver and platinum which can be bought in the form of coins, bars, biscuits, ornaments or jewelry. Similar to real estate, these precious metals are very limited which are obtained by the strenuous process of mining with increasing demand every year. India is one of the largest consumers of gold since it is important for the women in India to have gold in social ceremonies, family occasions like marriages and other social gatherings. Gold also reflects the image of an individual in the society. Though India is dominant in the demand side for gold, it may not influence the prices individually as the gold prices are globalized and are influenced by many factors across the globe, importantly in developed economies. For example Akshaya Tritiya which is an auspicious day to buy gold in India makes several lakhs of individuals to buy gold leading to a huge demand in several tons, but the prices do not necessarily escalate on the same day. Exhibit 2.1 : Top Gold Jewellery Consumption by country (in Tonnes) Change # Country 2010 2009 in % 1 India 745.70 442.37 69 2 Greater China 428.00 376.96 14 3 United States 128.61 150.28 -14 4 Turkey 74.07 75.16 -1 5 Saudi Arabia 72.95 77.75 -6 6 Russia 67.50 60.12 12 7 United Arab Emirates 63.37 67.60 -6 8 Egypt 53.43 56.68 -6 9 Indonesia 32.75 41.00 -20 10 United Kingdom 27.35 31.75 -14 11 Other Gulf Countries 21.97 24.10 -10 12 Japan 18.50 21.85 -15 13 South Korea 15.87 18.83 -16 14 Vietnam 14.36 15.08 -5 15 Thailand 6.28 7.33 -14 4

1,805.6 1,508.7 0 0 Other Countries 254.00 251.60 2,059.6 1,760.3 World Total 0 0 st Source Wikipedia as on 31 Dec 2011 Total

20 1 17

In todays modern world, gold can be purchased not only in physical form but also in some derived forms like gold futures in derivative markets, E Gold in Spot exchange and gold Exchange Traded Funds (ETFs) in stock markets. We will learn about gold futures in the chapter on Derivatives Markets. Here, it is only important to understand what Gold ETF is. Gold ETFs are a kind of mutual fund units traded in a stock exchange. In India National Stock Exchange (NSE) offers Gold ETFs. These ETFs are notional assets linked to the value of an underlying asset (Gold) and have all the feature of underlying asset in terms of price, quantity and so on. The price of gold ETFs changes according to the changes in the prices of physical gold. Some of the actively traded gold ETFs in NSE are UTI Gold ETF, Reliance Gold ETF and Kotak Gold ETF. As this is part of mutual fund, ETFs charge an annual Fund Management Fee which is adjusted to the Net Asset Value (NAV) of ETF. It means irrespective of gold appreciation or depreciation the NAV (value of gold ETF) decreases to the extent of annual management fee. The major drawback of ETF is choice of bench mark which may vary from one fund to another. Goldman sachs Gold BEES has London bullion market as the benchmark and some of the other funds have Mumbai spot market. E-Gold is different from ETF as it is not an ETF and doesnt belong to any mutual funds plan or scheme. It is similar to buying an equity share and putting the same in a demat account. Instead of buying physical gold in the market and storing in your house or a bank locker you can buy gold in electronic form and maintain it in a demat account. The price at which you buy EGold is same with market price of the physical gold. Whenever you want to have the physical gold you rematerialize E-Gold into physical gold which may incurs some expenses. So it is easy to store gold and it is also safe but it has annual cost of maintaining demat account which would less than annual Fund Management Fee. Investors have to bare some charges to see E-Gold into a physical form. Right now E-Gold is offered by National Spot Exchange Limited (NSEL). d) Precious Stones Precious stones, lead by diamonds have been the darlings of women importantly young ladies for the past many decades. Gems, Ruby and Emerald are the other stones used in ornaments and jewelry of women and to some extent men. e) Antiques, Art work and Collectables Though these are not popular in India, they are very popular and have vibrant markets in Europe and USA. The markets for antiques and art works are growing rapidly in India. Right now, it is limited only to big cities like Delhi, Mumbai, Bangalore, Hyderabad and Chennai with active auction houses and call markets through exhibitions. Collectables like out-of-print books, old coins, stamps, etc, are also of investment value provided they are well known in the investment classes and communities. Internet sources like EBay in the modern times have aggravated the speed and volume of these kinds of transactions and brought all the investors in one common plat form. Following table 2.2 provides the details of top Indian art works including the work of M F Hussain.

Exhibit 2.2 - Top Global Art Works Auctioned* # Price In $ Millions 155.30 152.50 Painting No. 5, 1948 Woman III Portrait of Adele BlochBauer I Portrait of Dr. Gachet Bal du moulin de la Galette[8] Garon la pipe Nude, Green Leaves and Bust Portrait of Joseph Roulin Dora Maar au Chat Irises Eight Elvises Portrait de l'artiste sans barbe Portrait of Adele BlochBauer II Massacre of the Innocents Triptych, 1976 Artist Jackson Pollock Willem de Koonin g Gustav Klimt Vincent van Gogh PierreAuguste Renoir Pablo Picasso Pablo Picasso Vincent van Gogh Pablo Picasso Vincent van Gogh Andy Warhol Vincent van Gogh Gustav Klimt Peter Paul Rubens Francis Bacon Year Date of sale Seller Buyer Auction House Private sale via Sotheby's Steven A. Cohen Ronald Lauder, Neue Galerie Ryoei Saito Private sale via Larry Gagosian Private sale via Christie's Christie's, New York Sotheby's, New York Sotheby's, New York Christie's, New York Museum of Modern Art New York Boris Ivanishvili Alan Bond Private sale via Thomas Ammann, Fine Art Zurich Sotheby's, New York Sotheby's, New York Private sale via Philippe Sgalot Christie's, New York Christie's, New York Kenneth Thomson Sotheby's, London 6 Sotheby's, New York

1 2

1948 1953

2-Nov-06 David Geffen 18-Nov-06 David Geffen

148.70

1907

Maria 18-Jun-06 Altmann

142.70

Siegfried 1890 15-May-90 Kramarsky family 1876 17-May-90 Betsey Whitney

135.10

Ryoei Saito

123.10

1905

Greentree foundation 4-May-04 (Whitney family) Frances 4-May-10 Lasker Brody estate Private 1-Aug-89 collection, Zrich Gidwitz family son of Joan 11-Nov-87 Whitney Payson 3-May-06 Annibale 2008-10 Berlingieri Heirs of 19-Nov-98 Jacques Koerfer 2-Nov-06 Maria Altmann

Guido Barilla?

109.10

1932

105.00

1889

9 1 0 1 1 1 2 1 3 1 4 1 5

105.10 104.40 103.20 97.50

1941 1889 1963 1889

97.50

1912

95.20

1611

an Austrian 10-Jul-02 family

89.00

Moueix Family, Roman 1976 14-May-08 Chteau Ptrus Abramovich

Source: The Arts Trust. http://www.theartstrust.com/big_investment_image.aspx

Exhibit 2.3 - Top Indian Art Works Auctioned* # 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Price Yr Sale in Painting Artist Yr of Channel Rs Cr Sale 16.51 Saurashtra S H Raja 1983 2010 Christies 14.40 Figure on Rickshaw Tyeb Mehta 1984 2011 Christies 12.44 Bulls Tyeb Mehta 2007 2011 Christies 11.25 Birth F N Souza 1955 2008 Christies 10.88 LA TERRE S H Raja 1973 2008 Christies 9.56 Wish Dream Arpita Singh 2000 2010 Saffronart 8.88 La Terre S H Raja 1985 2010 Christies 8.20 Un titled Tyeb Mehta 1984 2008 Christies 7.24 Falling Bird Tyeb Mehta 1999 2010 Christies 6.95 Mahisasura Tyeb Mehta NA 2005 Christies 6.90 The Skin Speaks a Language Not its Own Bharti Kher NA 2010 Sothebys 6.90 Village Scene Amrita Shegil NA 2006 Osian's 6.56 Un titled F N Souza 1962 2010 Christies 6.56 Tapovan S H Raja 1972 2006 Sothebys 6.54 Un titled V S Gaitonde NA 2006 Christies 6.54 Lovers F N Souza 1955 2005 Saffronart 6.50 Battle of Ganga and Jamuna:Mahabharata M F Hussain 1972 2008 Christies 6.40 Un titled F N Souza 1950 2006 Christies 6.40 Man with Monstrance F N Souza 1953 2006 Sothebys 6.28 Un titled Akbar Padamsee 1960 2011 Sothebys Source: Wikipedia, http://en.wikipedia.org/wiki/List_of_most_expensive_paintings

Indian art works are limited to India and slowly creeping to global markets as they are pulling the attention of global investors. Compared to global art works Indian art works are lagging behind in terms of value or price and volume of the art works. Following table 2.3 is the list of top global art works auctioned in terms of value descending. Recently renowned artist Turners art work Navina Rome was sold for a record price of approximately Rs 210 crores in UK by the auction house Sothebys. It was earlier bought by a couple in 1878 which was auctioned by their heirs. In 2006 another Turners art work was sold for Rs 140 crores. Exhibit 1: SEBI Rules soon for art funds SEBI may soon frame a stringent set of rules for funds investing in art works, antiques, coins and stamps, with an aim to check black money flow into these products and safeguard the interest of genuine investors. SEBI considers investment funds focussed on art works, antiques, coins and stamps as Collective Investment Schemes, which come under the ambit of the capital market regulator. Fearing flow of illicit wealth into these funds and also a high level of risk posed by them to the general investors, Sebi is now considering framing a specific set of regulations for these funds, a senior official said. Globally, art funds are very famous as an alternative class of

investments for rich investors and have started gaining some ground in India over the past few years. However, there are no specific regulations in India for art and other such funds, which collect money from numerous investors, most of whom are high net worth individuals to invest them into art works, antique pieces as also old and rare coins and stamps. SEBI will soon begin a consultation process with various stakeholders, including the central government and RBI, with an aim to frame the specific regulations for these alternative investment vehicles this fiscal, the official added. Earlier in 2008, a time when the art funds first became visible in India, the regulator had issued a public notice to warn the investors against putting their money into art funds or schemes of entities not registered with SEBI. At that time, SEBI had said that its analysis of various art funds has found them to be collective investment schemes and were being launched by various entities without registering with it in accordance with the SEBI (Collective Investment Schemes) Regulations, 1999. As per the existing regulations, only an entity registered with SEBI as a Collective Investment Management Company is allowed to offer any collective investment fund or scheme, including those focused on art works. However, there are no specific regulations for art funds and the need has been felt now to have a distinct set of rules for such investment vehicles, the official added. Globally, alternative investment avenues are quite in vogue among rich investors, who are estimated to allocate 5-10 per cent of their investment portfolio into these products. As per the annual World Wealth Report of Capgemini and Merrill Lynch Wealth Management, alternative investments are expected to account for nearly 9 per cent of high networth individuals (HNIs) financial assets in 2011. These investments used to account for as much as 10 per cent of HNIs financial assets in 2006, but had fallen to as low as 6 per cent by 2009 due to the economic slowdown.
Source: Business Line April 2011

FINANCIAL INVESTMENTS Buying a financial instrument or asset is considered as a financial investment. This process is similar to that of buying an asset and it has similar potential of give returns in future. The investors who want to become rich and affluent by increasing the value of their wealth are inclined towards real assets. On the other hand, investors who look for safety, liquidity and marketability prefer financial investment as this fulfills their investment objectives. Financial investments can be categorized as Long term and Short Term. Long Term Investments Long term financial investments are investments that have long maturity period. Sometimes, investors himself, in this case, likes to stay in the investment for a long time depending on the nature of investments. These investments are further classified as follows in table 2.4. Now they will be discussed in detail. Table 2.2 Long Term Financial Investments Traditional Investments Not Traditional Investments Term Deposits Equity Shares Provident Corporate Debt Instruments Pension fund Government Securities Recurring Deposits Hybrid Instruments Insurance Premiums Mutual Fund and ULIP

Chit Fund

Money Market Instruments

a) TRADITIONAL FINANCIAL INVESTMENTS In India most of the surplus income went to traditional investment avenues till the time of liberalization in India in early nineties got ignited. Even today majority of the Indians importantly aged investors look for traditional investments for fixed and assured returns. Known to all, people invest in traditional financial investments for safety, security and better returns. Thank fully in India floating rates are not allowed by RBI allowing the investors to continue their traditional investments. Let us understand more about traditional financial investments with individual investment options. i) Term Deposits: These are the deposits that are offered by commercial banks, post offices and NBFCs for a fixed maturity period with a fixed rate of return. Commercial bank deposits are more attractive as they offer premature redemption providing liquidity. Most of the banks charge a pre mature penalty ranging from one to two percent. Some banks do not charge any penalty. Banks charge different interest rate for different periods and also offer higher interest rates for senior citizens and women (very few banks). Following table 2.5 gives the interest rate structure of ICICI Banks term deposits. Table 2.5 - Interest rates on Term Deposits of ICICI* Interest Rates Period of Investment General Senior Citizens 7 days to 14 days 3.75 4.25 15 days to 29 days 4.00 4.50 30 days to 45 days 5.00 5.50 46 days to 60 days 5.75 6.25 61 days to 90 days 6.25 6.75 91 days to 120 days 7.00 7.50 121 days to 184 days 7.00 7.50 185 days to 189 days 7.50 8.00 190 days 7.75 8.25 191 days to 210 days 7.50 8.00 211 days to 269 days 7.50 8.00 270 days to 289 days 7.50 8.00 290 days 7.75 8.25 291 days to less than 1 year 7.50 8.00 1 year to 389 days 8.25 8.75 390 days 8.50 9.00 391 days to 589 days 8.25 8.75 590 days 9.25 9.75 591 days to less than 2 years 8.25 8.75 2 years to 789 days 8.50 9.00 790 days 9.25 9.75 791 days to 989 days 8.50 9.00 990 days 9.25 10.00 9

991 days to less than 3 years 3 years to less than 8 years 8 years upto 10 years Tax Saver FD 80C (5 year) Upto Rs.1 lac

8.50 8.75 8.75 8.75

9.00 9.25 9.25 9.25

* Source ICICI Bank website http://www.icicibank.com/interest-rates.html as on 16th June 2011 Due to the tax benefit, some investors are induced to invest in commercial bank term deposits which have lock-in period for a period of five years. Due to the increase in demand for term deposits, some banks offer less interest rates when compared to ordinary term deposits. ii) Provident and Pension Fund: Under Employee provident fund (EPF), the employee and the employer invest every month on the name of employee which offers an attractive fixed rate of nine percent. Monthly contributions take two forms of provident fund and pension fund as mentioned in table 2.6 Table 2.6 - Pension Features* Contributor % of contribution Employees contribution 12% of employees basic salary + DA Employers contribution 12% of employees basic salary + DA Total contribution 24% of employees basic salary + DA Diversion to provident fund 12% of Employees + 3.67% of Employers = 15.67% Diversion to pension fund 8.33% of Employers (In case it is more than Rs 541, it would be diverted to provident fund) 1.16% of Government Rate of Interest 9.5% Source : Employee Provident Fund organization, www.epfindia.com 16th June 2011

10

Figure 2.2 Scheme of Contribution

Central Governments

Employers

Employees

1.16%

8.33%

3.67%

12%

0.5%

Employees Pension Scheme

Insurance Scheme

Employees Provident Fund Scheme

EPF is a mandatory investment for the employees, which is beneficial for the employee after his /her resignation, retirement or death. Provident fund is claimed in lump sum where as the pension is received every month after retirement till death. Under EPF, the employer contributes a maximum of Rs 541 (8.33% of wage ceiling Rs 6,500) and Government contributes a maximum of Rs 75.40 (1.16% of wage ceiling or Rs 6,600) every month. If the employers contribution is more than the ceiling i.e., Rs 541, then the excess goes into his provident fund account. The amount of pension after retirement depends on the length of the service of the employee. Figure 2.2 gives the flow of monthly deduction of EPF transformed into provident fund scheme, pension scheme and insurance scheme iii) Recurring Deposits: Fixed monthly investments are offered by Commercial Banks, Post office and NBFCs through recurring deposits. The features are similar to the term deposits. It is not necessary to have same interest rate structure for term deposits and recurring deposits. Following table 2.7 gives the interest rate structure of ICICI Banks recurring deposits. Table 2.7 - Interest rates on Recurring Deposits of ICICI Bank Period of Investment 6 months 9 months 12 months 15 months 18 months 21 months 24 months 27 months Interest Rates General Senior Citizens 7.00 7.50 8.25 8.25 8.25 8.25 8.50 8.50 7.50 8.00 8.75 8.75 8.75 8.75 9.00 9.00

11

30 months 8.50 9.00 33 months 8.50 9.00 3 years to less than 8 years 8.75 9.25 8years upto 10 years 8.75 9.25 Source ICICI Bank website http://www.icicibank.com/interest-rates.html as on 16th June 2011 iv) Life Insurance: Life insurance includes, endowment, money back polices and ULIP Product. LIC was the dominant player in life insurance sector till late nineties. It experienced competition from domestic and foreign (through joint ventures) insurance players with innovative financial instruments that included insurance products for aggressive sales including ULIP Products. In India, traditionally investors were habituated to park their surplus money in banks (public and private sector) irrespective of the rate of the return, liquidity and service expected. Later post office deposits took some part of the banks stake, as it offered better returns than commercial banks. Due to the lack of staff and poor service, post office also could not attract potential investors and got limited to small investors. Today, mutual funds and life insurance products importantly, ULIP have attracted the investors due aggressive promotion and celebrity endorsement for the respective products. Where as provident fund, pension fund including NPS have been an induced investments as employers priorities and proved tax benefit. v) Chit Fund: This is similar to a mutual benefit scheme or a kitty party. It is also known as chitty, cheety, kuri and boli in India. It can be defined as a series of financial transactions for mutual benefit of organized members through the status of association of persons. It has an agreement between each member of the fund and the foreman who is the initiator, organizer and caretaker of the fund. Chit fund is organized with foreman as the key person in initiating, operating and settlement of funds for every month. It has a limited number of members or subscribers including foreman. The chit fund exists for a period of time usually in multiple of months. In terms of its objectives and association, it is some how similar to Rotating Savings and Credit Association (ROSCA) in USA and other countries. It is the most ancient system of lending and borrowing to meet financial needs even before banking. It is as old as agriculture in India which originated as self-help among small farmers with grains. After the development of banking system, chit fund lost its identity as a lending and borrowing tool. Modern chit fund had unique influence in south India as and alternative savings tool known to every house hold. The turnover of chit funds in India in 1986 was 81.6 billion1 and it grew in later decades. Model Chit Fund was the first company to launch one crore chit fund for companies for their funding needs. How Chit Fund Works? Chit amount, duration and number of members are pre-determined. Number of members and number of months in the chit period are the same. Chit members meet every month on day where the date and the day are mentioned for all the months. One of the members would be eligible to take the chit amount every month Chit Allotment and Lucky Draw To justify the demand for the chit fund from all the members, names of the members are written on a small piece of paper (Chit) and one chit is taken. The person with the name in the chit from the lot is chosen as the beneficiary for the month and his name, then, is not be considered for other months. As the months pass number of names in the chits every month comes down as the person who takes the chit fund earlier is not eligible to take the fund again.
1

Asian Development Banks Report

12

Bidding Winner has to Loose Auction is invited from all the members to take the chit fund. The auction is for the discount amount on the chit fund or the amount to loose. Whoever bids highest auction for the discount amount is awarded with the chit fund. For example in chit fund of Rs 1,00,000 with fifty members paying Rs 2,000 every month for fifty members if a bidder bids highest bid of Rs 10,000 then he would be awarded Rs 90,000. The bid amount would be distributed as dividend to all the members equally i.e Rs 200 for each member. In this case the member would pay Rs 800 instead of Rs 1000. What do you understand from this? Bidder looses-Members gain. Higher the bidding amount-higher the dividends. The auction sets the platform and competition for members to loose more as the highest bidder to loose is awarded. The successful bidder cannot participate in the later auctions. Bid amount is to a minimum of 5% and maximum is decided based on the nature of members and demand for the chit fund which may range from 30% to 40% of the chit value. In case there is more than one member willing to bid for more than cap percentage, lottery system is followed to pick up the successful bidder at the upper level. The bid amount is high in the initial months and low in the last months. The members who do not go for auction treat the monthly subscription as their investment, dividends and returns. Price Determination The discounted value (present value) of the chit fund for the remaining number of months with a given required rate of return of cost of borrowing should be the criteria for bidding. Required rate of return may differ from member to member and month to month. Following is the equation depicting cut-off for bidding. (Chit Value Bid Value) Present Value of remaining months subscription Or After Bid Value Present Value of remaining months of subscription Or ABV PV If ABV is less than the present value, it implies that that the borrower is paying more than his capacity to borrow or getting less than what he is supposed to get according to the required rate of return. Dividend Return on Chit Fund The bid amount is equally distributed by the chit fund company to all the members including the bidder which is known as dividend after deducting the commission which is the source of revenue for the chit fund company. This dividend is the return for the investor in chit fund. How to calculate the rate of return? Calculating return on investment in chit fund is similar to calculating return on investment in mutual fund. The difference is that investments every month in Systematic Investment Plan (SIP) of a mutual fund scheme are same whereas in the case of chit fund they are not same. We can calculate the rate of return on chit fund investment by calculating the annualized return for every month and taking average for n number of months. One has to remember that according to the current chit fund rules, the investor has to pay full amount without dividend for three months out of which two would be taken by the chit fund company. The last one is left for the investor who does not participate in any auctions. The rate of return for a given month can be computed as follows

13

 d * 100 UMI R = * 12 n m R = Monthly return annualized d = dividend for the month UMI = Unequated Monthly Installment n = number of months for chit fund m = number of months completed for the chit fund UMI =GMI - Dividend Where GMI is Gross Monthly Installment

Average return on the chit fund is the arithmetic mean of all annualized monthly returns. It can be expressed as follows
R =

R
n

ADVANTAGES OF CHITFUND To the Chit fund Company The first months chit amount would go to the organizer or the company without any chit process or competition or auction. The company charges organizing fee which is usually 5% of the chit value and deducted from the dividends to be paid to the subscribers. To the Members (Borrowers or Investors) Easy to borrow Flexible in terms of cost of borrowing, timing, etc,. Similar SIP in a mutual fund, RD in Commercial banks and Post offices as a saving channel Higher the bid amounts in the auctions, high are the dividends and more are the returns Safe as they are well regulated Borrowers in Chit funds More than investors, chit fund is more borrowers oriented as it fulfills the borrowing requirements. Borrowers are the members who are in desperate need for funds in a specific month and are willing to take higher cost of borrowing. Typically fifty to sixty six percent of the members are borrowers and rests of them are investors. Chit fund is a more relevant and important source of funding for SMEs. This is because all banks do not give easy loans to SMEs as they do not have a good track record or a proper accounting system. Borrowers get a full amount of the chit after bidding, without any deductions or charges. Investors in Chit funds An investor in the chit fund is the member who joined the chit fund not for borrowing by bidding through auction but to remain till the last month and take the full chit amount. In this case, there is only one investor and the rest of the members (n-1) are borrowers. In addition to the last members, the members who like to bid for the last twenty five to thirty three percent of the months are also considered2 as investors. Because these members bid for the chit amount as the bid amount is very low compared to the previous bids. This implies that instead of waiting for the last month, it is better to take the chit fund with low bid in the previous months. Investors get five percent less of the chit fund than what they are supposed to get as the chit fund company deducts five percent of the fund as the commission from dividends.
2

According to the collected views of the managers, agents, recovery officers of Margadarsi Chit fund Limited.

14

Chit Fund Regulation First enactment on chit fund was made before independence in 1914 by the Government of Travancore. Andhra Pradesh was the first state after independence to pass an act on chit fund in 1973 followed by Karnataka in 1984. Currently, all the chit funds are regulated directly by Registrar Chits in respective states. Central government introduced an act on chit fund in 1982. In addition to the Governments Acts, chit fund also comes under Transfer of Properties Act Sec 69. Chit funds are also regulated by RBI as they come under NBFC category of RBI.Joint Registrar of Chits (JRC) is a statutory body to control chit fund companies and safeguard the interests of the subscribers of the chit fund. The company should have commencement certificate from JRC to start a group. Chit operator has to file regular returns with JRC. For each fund the chit fund company has to deposit Fixed Deposit Receipt (FDR) with a bank favoring JRC as security which can be with drawn after the closure of the particular chit fund of the company. In case the chit fund company bankrupts all the FDRs, the immovable properties of the chit fund company is taken over by JRC and distributed to the subscribers of the chit fund according to the chit fund act. Misapprehensions Of Chit Fund In addition to the organized and well regulated chit fund industry, there also exits unorganized chit funds which are known for irregularities and defaults on both organizer and members point of view referring it as cheat fund. Some of the participants who are willing to take membership for their borrowing requirements through chit fund try to avoid the same as they feel the bidding in auction is manipulated and the chit fund is awarded to the influential members, which is not true. The bidding process is structured and transparent according the regulations. It is also perceived that the chit funds impose hidden costs, which is not true in reality. The only cost in chit fund is the commission the company takes from the members. In case of delay in payments, nominal charges are imposed which is stated in the legal document which needs to be produced before one becomes a member. -------------------------------------------------------------------------------------------------------------------EXAMPLE To analyze the desired expectations and results of a fifty month/ members, 25,00,000 chit fund of Margadarsi Chit Private Limited was collected from one of the members of the chit fund with following details in table 2.8 Table 2.8 Chit Fund Details3 Chit Fund Company Margadarsi Chit Fund Limited Subscriber SME Chit Value 25,00,000 Bid Cap 35% Bid Cap Months 10 Months Method of Bidding Auction Auction Day 2nd Sunday of every month Bidding And Cost Of Borrowing In our case in table 2.9 members are tend to be investors in twenty fifth month onwards as the cost of bidding fell drastically from 14.10% to 7.64%. Again in thirty seventh month borrowers took the seat as the bid amount rose to 11.62% and reached a maximum of 14.74% in forty third month. In the next month again it slipped to 9.86% and continually declined..
3

Source: Margadarsi Chit Fund Ltd, Vishakahaptnam

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Table 2.9 Cost of Bidding or Borrowing4 Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39

4

Paid Date 10-Jun-03 16-Oct-03 13-Nov-03 17-Dec-03 21-Jan-04 18-Feb-04 19-Mar-04 21-Apr-04 21-May-04 30-Jun-04 17-Jul-04 21-Aug-04 22-Sep-04 25-Oct-04 19-Nov-04 18-Dec-04 31-Jan-05 21-Feb-05 21-Mar-05 25-Apr-05 31-May-05 29-Jun-05 26-Jul-05 31-Aug-05 27-Sep-05 30-Oct-05 28-Nov-05 29-Dec-05 25-Jan-06 25-Feb-06 28-Mar-06 29-Apr-06 31-May-06 30-Jun-06 30-Jul-06 30-Aug-06 29-Sep-06 31-Oct-06 30-Nov-06

Month & Year Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04 Jan-05 Feb-08 Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06

Bid Amount (in ) 0 875,000 875,000 875,000 875,000 0 875,000 875,000 875,000 875,000 875,000 875,000 676,100 592,000 585,000 617,000 645,000 604,000 594,000 601,500 600,000 616,000 555,000 602,100 355,000 348,000 357,000 285,100 342,000 343,500 335,000 315,000 282,000 196,000 240,000 256,000 277,000 235,000 226,000

Chit IRR Value Annualized (in ) 2,500,000 0.00 1,622,500 13.15 1,622,500 13.46 1,622,500 13.75 1,622,500 14.05 2,500,000 0.00 1,622,500 14.69 1,622,450 15.03 1,622,500 15.38 1,622,500 15.76 1,622,500 16.15 1,622,500 16.57 1,821,400 11.71 1,905,500 10.06 1,912,500 10.18 1,880,500 11.23 1,852,500 12.27 1,893,500 11.58 1,901,400 11.74 1,896,000 12.26 1,897,500 12.63 1,881,500 13.53 1,942,500 12.23 1,895,400 14.10 2,142,500 7.64 2,149,500 7.76 2,140,500 8.33 2,212,400 6.72 2,155,500 9.13 2,154,000 9.64 2,162,500 9.86 2,182,500 9.70 2,215,500 9.06 2,301,500 6.47 2,257,500 8.59 2,241,500 9.89 2,220,500 11.62 2,262,500 10.50 2,272,500 10.92

Source: Margadarsi Chit Fund Ltd, Vishakahaptnam

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40 41 42 43 44 45 46 47 48 49 50 Figure 2.3

30-Dec-06 31-Jan-07 28-Feb-07 16-Mar-07 20-Apr-07 19-May-07 28-Jun-07 17-Jul-07 31-Aug-07 28-Sep-07 31-Oct-07

Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07

260,000 235,000 215,000 195,200 115,000 85,000 45,000 15,000 5,000 4,990 0

2,237,500 2,262,500 2,282,500 2,302,000 2,382,500 2,412,500 2,452,500 2,482,500 2,492,500 2,492,500 2,497,500

14.08 14.00 14.29 14.74 9.86 8.70 5.81 2.82 1.81 3.61 0.00

Figure 1 - Bid and Chit

3,000,000

2,500,000

2,000,000
Amount

1,500,000

1,000,000

500,000

0 1 3

Bid Amount

11 13

Chit Value

15 17

19 21

23 25 27 29 Month

31 33

35 37 39

41 43

45 47

49

Figure 2.3 is the display of movement of discount and chit value after discount. The two lines always diverge which means less is the discount or bid value more is the chit value. Except for first, sixth and fiftieth months all the months have recorded discounts through bidding. The bid was same for first ten months (i.e. second to fourth and sixth to twelfth. Figure 2.4

17

Figure 2 - Cost of Bidding

18 16 14 12

Rate

10 8 6 4 2 0 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49

Month

The cost of bidding is shown in figure 2.4 which had a continuous surge from second month to twelfth month. It fell continually from forty fourth month onwards. In between there were different trends based on need for money and competition for bidding. Dividends And Return On Investment Returns on investment in the mentioned case were tabulated along with other details in table 2.8. Results were similar to the trends or patterns of cost of borrowing in table 2.10 The investors return in the form of dividends were always less than the cost of bidding in any month due to the reason that the chit fund company deducts five percent of the chit value from the dividends to be received by the members. Table 2.10 Return on Investment Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 Paid Date 10-Jun-03 16-Oct-03 13-Nov-03 17-Dec-03 21-Jan-04 18-Feb-04 19-Mar-04 21-Apr-04 21-May-04 30-Jun-04 17-Jul-04 21-Aug-04 22-Sep-04 25-Oct-04 19-Nov-04 18-Dec-04 31-Jan-05 21-Feb-05 Month & Year Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04 Jan-05 Feb-08 Amt Dividend Commission Paid 50,000 0 2,500 32,500 17,500 2,500 32,500 17,500 2,500 32,500 17,500 2,500 32,500 17,500 2,500 50,000 0 2,500 32,500 17,500 2,500 32,499 17,500 2,500 32,500 17,500 2,500 32,500 17,500 2,500 32,500 17,500 2,500 32,500 17,500 2,500 36,478 13,522 2,500 38,160 11,840 2,500 38,300 11,700 2,500 37,660 12,340 2,500 37,100 12,900 2,500 37,920 12,080 2,500 IRR 0.00 10.20 10.40 10.62 10.84 0.00 11.32 11.57 11.84 12.11 12.40 12.71 9.64 8.52 8.64 9.42 10.18 9.74 18

19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 Figure 2.5

21-Mar-05 25-Apr-05 31-May-05 29-Jun-05 26-Jul-05 31-Aug-05 27-Sep-05 30-Oct-05 28-Nov-05 29-Dec-05 25-Jan-06 25-Feb-06 28-Mar-06 29-Apr-06 31-May-06 30-Jun-06 30-Jul-06 30-Aug-06 29-Sep-06 31-Oct-06 30-Nov-06 30-Dec-06 31-Jan-07 28-Feb-07 16-Mar-07 20-Apr-07 19-May-07 28-Jun-07 17-Jul-07 31-Aug-07 28-Sep-07 31-Oct-07

Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07

38,078 37,970 38,000 37,680 38,900 37,958 42,900 43,040 42,860 44,298 43,160 43,130 43,300 43,700 44,360 46,080 45,200 44,880 44,460 45,300 45,500 44,800 45,300 45,700 46,090 47,700 48,300 49,100 49,700 49,900 49,900 50,000

11,880 12,030 12,000 12,320 11,100 12,042 7,100 6,960 7,140 5,702 6,840 6,870 6,700 6,300 5,640 3,920 4,800 5,120 5,540 4,700 4,520 5,200 4,700 4,300 3,904 2,300 1,700 900 300 100 100 0

2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500 2,500

9.89 10.30 10.60 11.28 10.39 11.78 6.91 7.03 7.51 6.19 8.18 9.10 8.82 8.72 8.22 6.00 7.87 8.99 10.47 9.56 9.95 12.64 12.62 12.92 13.36 9.14 8.08 5.35 2.39 1.20 2.38 0.00

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Figure 3 - Return on Investment

16.00 14.00 Rate of Retrun in % 12.00 10.00 8.00 6.00 4.00 2.00 0.00 M onths

Similar to figure 2.3 which had the trends of cost of borrowing for fifty months, the above figure 2.5 for return on investment also had the same pattern with continual rise for the first ten months and decline in last seven months. -------------------------------------------------------------------------------------------------------------------Important issues in chit fund Unlike fixed rate and floating rate of interest offered by banking, the cost of borrowing or return on investment in chit fund declines as the number of months increase In the initial months the cost of borrowing is less than or equal to prevailing bank lending rates. In the later months the cost of borrowing is much lower than the prevailing bank lending rates Chit fund is a useful tool for savings, investments and borrowings for poor individuals as well as companies. The organizer of the chit fund provides a common platform for investors and borrowers with flexibility. It can be more profitable for commercial banks and companies as they have not explored the product of Indian financial engineering. It is applicable to them as follows: The size of the chit fund can be as low as five thousand rupees serving the minimum possible financial requirements of poor individuals. Barbers, rickshaw pullers, cobblers, street vendors, daily labor, fruits and flower vendors would be more beneficial as chit fund is twin edged tool of lending and borrowing. Banks can take an initiative to include chit funds in their portfolio of services to cater to the needs of small borrowers as a part of micro finance which would be profitable and it would enable the commercial banks to meet their social responsibility by serving the poor in a profitable manner as an alternative to micro credit. As the banks have robust infrastructure in urban and rural areas awarding the chit fund and recovering the same

20

from the members would be a child's play. Like loan sharks in rural areas were substituted by micro finance similarly banks should replace unorganized chit fund operators. Chit fund has the potential to substitute the traditional short term or medium term borrowing sources for SMEs to meet their working capital requirements as it offers lowest or competitive cost of borrowing with flexibility according the situation of the economy and has a major benefit of simple processing and borrowing. Enterprises may have to look into this traditional tool for their working capital requirements instead of the exiting sources as it has additional advantages for a borrower. It also has built in feature of Be investor till you borrow, which enable enterprises to park their idle cash in short term. Intermediaries in the debt market can play a significant role in popularizing chit fund as one of the alternative for corporate debt and short term investing. Recognized and unrecognized NON TRADITIONAL / MODERN FINANCIAL INVESTMENTS These instruments are not known to all kind of investors in the country. These instruments are different from traditional financial investments, as they require going through a well defined process which may consume time, money and little expertise through an intermediary. These instruments are also risky with different degrees when compared to tradition financial investments. 1) Shares are the equity instruments which can be issued in the form of common shares and Preferential shares 2) Corporate debt instruments are issued by companies through deposits, bonds and debentures 3) Government securities also known as Gilts are the securities issued by government in the form of bills, notes and bonds 4) Hybrid instruments which is a combination of both debt and equity. Some examples are convertible debentures and warrants 5) Mutual funds which accept money from the public and invest them in equity, debt, and money market instruments 6) Unit Linked Insurance Plans (ULIPs) is a combination of life insurance and investments similar to mutual funds. We will have a detailed discussion all the mentioned above in the later chapters. SHORT TERM FINANCIAL INSTRUMENTS Short term investments through short-term financial instruments are different from those of longterm financial investments. This is because the investment objectives, style of investment, need for investment for both these categories are different from each other. Following is the classification of short-term financial investments. 1) Stock trading/Equity trading 2) Derivatives trading 3) Money Market instruments Though we will learn about these investments in a greater detail in the later chapters let us understand them at the basic level. a) STOCK TRADING Stock markets have been volatile for the past two decades due to speculation or short term investment in stocks for few days or weeks and not due to investment for longer period. If every one considers stocks as investment and holds it for a long period of time, there would be no volatility in Indian stock markets. Often investment in stocks is referred to gambling or betting

21

because of aggressive buying and selling activities with in a day known as intraday or dayspeculation. Though it is considered to be very risky and dangerous; it is one of the short-term investment avenues for investors who would like to take more risk. b) DERIVATIVES TRADING Similar to stock trading, derivative trading volumes are increasing day by day and the size of derivative trading is much more than stock trading. This is due to the fact that the trader has to put a minimum amount as a proportion to the whole value of the underlying asset. If derivatives are considered as the only hedging tools and are bought and sold only for the purpose of hedging, then virtually there would be no derivative exchanges working in the country. Similar to stock trading derivatives, trading is also one of the short-term investment avenues which involves high amount of risk. Each one of the non-traditional or innovative and short-term financial instruments is discussed individually in a detailed manner in all dimensions in the later chapters. c) MONEY MARKET INSTRUMENTS These instruments are more relevant to institutional investors than individual investors as they require huge investments in lakhs and crores. These also and need some investment education as they are more technical. Money market instruments can be classified as follows: i) Treasury bills These are short-term money market instruments issued by Government of India (GOI) to Reserve Bank of India (RBI) to finance their short term requirements. These are discounted securities and thus are issued at a discount to face value. Further, RBI resells the securities to investors through auction. They are also known as government securities or gilts. The return to the investor is the difference between the maturity value and issue price. Transparency, Zero default risk being sovereign paper, High Marketability and liquidity are the important reasons for aggressive participation of institutional investors in treasury bills. Most of the investors in the treasury bills are institutional investors or professional investors who can invest in big amounts. It is not accessible for small investors as the minimum investment is a huge amount. ii) Commercial papers These instruments are issued by companies to meet their working capital requirements. Though these instruments are open to every one, only companies participate as minimum investment is a few lakh rupees. iii) Certificate of deposits These are similar to commercial papers and are issued by commercial banks for the cash requirements and liquidity issues in the short term. Alike commercial papers, the participants in these deposits are big investors as the minimum investment is high. iv) Repos Repo stands for repurchase agreement between Reserve Bank of India (RBI) and commercial banks to sell and repurchase the same from RBI at a later date. It is a Short-tem lending and borrowing between commercial banks and RBI. RBI buys government securities from commercial banks on a lower rate and the commercial banks repurchase them at higher rate, later. The difference between these two rates is the return for RBI. The reverse process where RBI sells government securities to commercial banks with an agreement to buy it later is known as reverse repo. FINANCIAL ASSETS VS REAL ASSETS One of the biggest challenges for investors is to compare the investment alternatives before making an investment decision. Because of the differences in nature and character of financial

22

assets and real assets, it becomes even more difficult for the investors to take a decision between financial and real assets. Comparison between gold and shares or real estate and mutual fund also puzzle investors. For instance, comparing investment in one residential flat which demands lakhs of rupees as minimum investment with investment in few shares of Infosys Technologies may not be a meaningful comparison. This is due to the factors listed in the following table 2.11 Table 2.11 Financial and Real Assets Financial Assets Real Assets Intangible assets Tangible assets Active Markets Inactive markets High liquidity Low liquidity Easy to possess Tedious process to possess Physical holding not required Physical holding Low minimum investment High minimum investment DIRECT AND INDIRECT INVESTMENTS Direct investments refer to the investments which are directly invested by the investor himself or with the help of any intermediary. Buying an apartment, agricultural land, depositing in a banks term deposit, buying few shares of a company and so on are the examples of direct investment. These investments are usually done by the investor himself or herself where the accountability for returns is in the name of the investor and the ownership too is on their names. Mutual funds, ULIP, Exchange Traded Funds (ETF) and Hedge funds are e examples of indirect investment where the investor parks the money with an investment house. This is specialized, qualified and professional in managing investments on behalf of the individual investors. These intermediaries or investment houses charge investors for managing their money and take the responsibility and accountability for rate of returns. Here, the investor does not have the ownership. INVESTMENT MATRIX Analysis of investment alternatives at one place gives the investors an opportunity for relative comparison based on return, risk and other related factors to investment. An investment matrix helps the investors to identify comparative risk and return parameters with in a given set of investment opportunities. Following is the investment matrix covering all the available investment opportunities (Financial and Non-financial) and their individual features in the Indian scenario in table 2.12 Table 2.12 Matrix of Investments and their relative comparison Tax Market Features/ Investment Return Risk TDS Liquidity Benefit ability Real Estate High Low No No Medium Low Bullion High Low No No Medium Low Antiques Medium Low No No Low Low Bank Deposits Low No Yes No* No High P O Deposits Low No Yes No* No Medium** Government Bonds*** Low No Yes No Low Low Mutual funds Debt Low Low No No High High Mutual funds Equity High High No Yes* High High

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Mutual funds Money Market Equity Shares

Very Low High

Low High

No No

No No

High High

High High

* Bank deposit with lock-in period of 5 years, ELSS in mutual fund and NSC in PO Deposits gives tax benefits ** Some of the post of deposits like NSC have lock-in period till maturity showing poor liquidity *** These bonds include bonds issued by government or government sponsored and associated bodies like RBI Marketability refers to the product to be able to find a buyer and the buyer willing to pay the market price but not the price less than the market price

Above table gives comparison of all investment alternatives available in Indian context in terms of risk, return, tax issues, marketability and liquidity. Each investment alternative has got its own relative merit and de-merit depending on investors needs and priorities. For example, a retired person would choose risk free investments like bank term deposits or post office deposits where as an individual or company looking at wealth accumulation would be inclined to real estate, bullion, equity shares, mutual fund and even arts and antiques. SUMMARY Investors have a huge choice of investments from risky to non-risky, tangible and intangible, financial and non-financial and short-term and long-term. With in the class of assets each one of the investment avenue has a unique feature and character in terms of its nature, returns, risk and other related factors. One should be very careful while comparing different alternatives before investing. Investment matrix helps investors to get a fair idea on which investment to pick-up based on his or her investments needs and priorities. KEY WORDS Certificate of Deposit, Commercial Paper, ETF, Gilts, Mutual fund, Precious metals, Prioritized needs, Provident Fund, Surplus funds, ULIP, Vibrant markets, Wealth accumulation SELF TEST QUESTIONS 1) Employees usually invest in a. Equity share b. Provident Fund c. Pension fund d. both b and c 2) Insurance premium is a a. Real asset c. Financial asset b. tangible asset d. Non Financial asset

3) Post office recurring deposit is a a. Direct investment b. Indirect investment c. Real investment d. Risky investment 4) Investment in equity is a. Direct investment c. Real investment 5) Return on a bank deposit is a. Fixed c. Both b. Indirect investment d. Risky investment b. Floating d. None 24

6) Which one of the following doesnt have tax benefit a. Mutual fund b. Equity Share c. Bank Deposit d. Post office Deposit 7) Equity trading is a ___________ Investment Option a. Short-Term b. Medium-Term c. Long-Term d. Very Long-Term 8) The participants in treasury bills are a. Institutional investors b. Small investors c. Companies d. All 9) Money market instruments, Equity trading and Derivatives trading belong to a. Short-term investment b. Long-term investment c. Non-financial investment d. Real investment 10) Investment in antiques and art works are a. Real investment b. Long-term investment c. Non-financial investment d. All CONCEPTUAL REVIEW QUESTIONS 1) 2) 3) 4) 5) Why should we know about all the investment alternatives and choice Differentiate investment in real assets and financial assets How are traditional investments superior to modern investments? Differentiate direct and indirect investment and which one would you prefer? Can you differentiate long term and shorter financial instruments for investments? If yes do it with relevant examples

CRITICAL THINKING QUESTIONS 1. Based on the investment matrix which single investment or combination of investment you would like to do? Give reasons 2. What would be investment alternative for an investor who is just retired and looking forward for income less life and unavoidable medical expenses? 3. How do you differentiate investment priorities of two individual with same income, family, age and other related but engaged in profession as job and business? What kinds of investments are suitable to them according to their priorities? LIVE PROJECT ASSIGNMENTS 1) Prepare an investment matrix of your own investments done till now in different investment alternatives (traditional, non traditional, physical and financial investments) on a piece of paper or in an excel sheet with following specifications as the column heads in a logical manner. Investment Instrument

25

Name of the Company / Bank / Post office / Insurance company / any other issuing body Date of investment Rate of return Maturity date Current value Certificate / folio / registration / receipt number If you dont have any investments, then track your parents or any other known individuals (Friends, Colleagues and Relatives) investments like bank deposits, mutual funds, residential plot, apartment, gold, corporate deposits, etc. 2) Approach a financial planner or investment advisor and ask for an investment plan for yourself or prepare a best choice of investments from the investment matrix for yourself under his guidance based on your Investment objectives Size of investment Risk taking capacity Liquidity 3) Look at advertisements of various companies offering investments which fall under one of the categories of investment alternatives or matrix. Document all the features of their offer. Compare their offer with the actual product and observe deviation/s if any. 4) Visit websites of Indian and global auction houses and understand facts of arts and antiques in terms of price, process of auction, legality, etc. MINI CASE Mr Anup, 35 years old and Mr Chetan, 32 years old are good friends. Both are working in different companies drawing a similar salary of Rs 50,000 per month out of which they save 50% of their income. Though they have a lot of things in common. they are completely differ in terms of their investments. This is because they have different characters in terms of risk and return on investments. Mr Anup is a risky investor willing to take any investment option that can maximize his returns whereas Mr Chetan is a more cautious investor who looks for assured returns that are diversified in nature. Now assume that they have similar life styles, liabilities, expenses and other factors related to money. The only factor dividing them is their investment style or objective. In addition to this, Mr Anup has never taken a loan and does not want to take a loan in future also. In contrast to Mr Anup, Mr Chetan is prepared to take a loan for any size and for any length of period, provided his salary permits him to repay. Considering the investment opportunities discussed in this chapter, we need to assess and analyse individual investment decisions. In this regard, answering the following questions can help us in analyse the above. 1) What could be the investment objectives for Mr Chetan and Mr Anup. 2) What could be the investment constrains and considerations for Mr Chetan and Mr Anup. 3) Select investment alternatives for both the investors. FURTHER READINGS

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Frank K Reilly and Keith C Brown, Investment Analysis and Portfolio Management, 8th Edition, Thomson, Pages 79-90,8131503747 Charles P Jones, Investments Analysis and Management, 9 th Edition, Wiley, Pages 24-46, 9812531386 Donald E Fischer and Ronald J Jordan, Security Analysis and Portfolio Management, 6th Edition, 2005, Pages 18-26, ISBN 8178088797

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