Page 97 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes Please note that it is not mandatory for non-finance companies to get a credit rating for
their fixed deposit schemes. Hence, it is advisable to see if the company has a credit rating
for any other debt instrument while evaluating fixed deposit schemes.
2. Diversify: Diversification across issuers of fixed-income instruments is a recommended
approach to reducing credit risk.

Notes Returns Return calculations should consider effective yield, interest rate expectations
and taxes.
(i) Calculate effective yield: Calculate the post-tax effective yield for each instrument
for comparison. Effective yield is the IRR (Internal Rate of Return) of the fixed-
income instrument.

For example for an instrument that pays 14% monthly interest, the effective annual
yield works out to 14.93%. This is definitely more attractive than an instrument that
pays 14% annually.

(ii) Consider interest rate (and inflation) expectations: Once you invest in a fixed-income
instrument, your investment is committed, more often than not, for the specified
period of time.
During this period, if interest rates increase, you will not benefit from this rise.
Hence your effective return from this investment will be lower than if you had the
flexibility to invest at a higher interest rate.
So, if you expect interest rates to increase, invest only in short-term instruments,
and vice versa.
(iii) Don’t forget taxes: While calculating your interest yield remember to include post-
tax interest receipts. For investors in high-tax brackets, tax-free government bonds/
schemes might be more attractive.

Did u know? Mutual funds present an alternative avenue to invest in fixed income
instruments at zero tax liability on the income received.

Liquidity Fixed-income instruments are normally illiquid as the secondary market for
these instruments is not yet developed in India. Make sure you carefully evaluate the
potential liquidity, exit route and penalties of the instrument before you invest.
Step 3: How to buy

Since the secondary market for fixed-income instruments is not yet developed in India, we
discuss below only the primary market options available for retail investors.
Company bonds/debentures: Companies issue bonds and debentures through public issues that
are open only for a limited period of time. Application forms for these issues are available with
primary market brokers.

Company fixed deposits: Fixed deposit schemes from companies are typically open round the
year, unless they have exceeded their collection limits. Even in such cases, companies accept
renewal from existing fixed deposit holders.

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