fmp vs fd

A PROJECT REPORT ON

“FIXED MATURITY PLAN V/S FIXED DEPOSIT”

AT

UNIT TRUST OF INDIA

SUBMITTED TO

MR. PRASENJIT BHATTACHARYA (CHIEF MANAGER)

SUBMITTED BY

LALITA KUMARI

(MARKETING)

BALAJI INSTITUTE OFMODERN MANAGEMENT PUNE

2011-2013

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TABLE OF CONTENT

S. No. TOPIC PAGE

1 Declaration 2

2 Acknowledgement 3

3 Executive summary 5

4 Objective of the project 6

5 Introduction to Mutual Funds 7

6 Introduction to Fixed Maturity Plans 19

7. Risk & return of FMPs 21

8. Comparison between FMP & FD 25

9. Indexation benefit 28

10. Tax efficiency of FMPs 31

11 Future perspective of FMP in India 34

12. Comparison between FMP & FD 35

13 Comparison between different investment avenues 36

14 Conclusion 37

15. Project findings & Recommendations 38

16. Bibliography 39

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ACKNOWLEDGEMENT

At the very outset I would like to express my heartfelt gratitude to investors of Pune for allowing & contributing in making this project a success.

My thanks are due to those investors who were very kind in explaining us the challenge that lay ahead of me & also for allowing me to make liberal use of their knowledge, resource & patience.

My deepest sense of gratitude, profound respect & sincere thanks to Mr. Prasenjit Bhattacharya (Chief Manager-UTI AMC,Pune) our company guide who has been there us throughout the entire project. He always had the answers to our queries, be it regarding any concept related to mutual funds. His support ,practical guidance & easy explanations not only regarding the project matters but others too add to the success of my project.

My special thanks to Mr. SANTOSH SINGADE (Relationship Manager-UTI AMC, Pune) our project guide & mentor for his valuable assistance, keen interest & constant motivation at each step of project. I would like to thank my institute for providing me with a chance of

having such exposure.

I would like to express my gratitude towards my parents from whom I inherited all the desired virtues. Last but not the least I would like to pay obeisance to the almighty god for bestowing on me his blessings & also being on my side when the challenge seemed

insurmountable.

DECLARATION

I LALITA KUMARI hereby declare that the project work entitled “Fixed Maturity Plan v/s Fixed Deposit” submitted to BIMM Pune, is a record of original work done by me under the guidance of Mr. Prasenjit Bhattacharya (chief manager UTI AMC).

This project is submitted in the partial fulfillment of the requirements of the MBA exam. the results embodied in this project have not been submitted to any other university or institute for the award of any degree or diploma.

Date-

LALITA KUMARI

MARKETING

BIMM-MM1113121

EXECUTIVE SUMMARY

The project titled “FIXED MATURITY PLANS VERSUS FIXED DEPOSITS” being carried out for UNIT TRUST OF INDIA (AMC)

UTIAMC has a well-qualified, professional fund management team, which has been fully empowered to manage funds with greater efficiency and accountability in the sole interest of the unit holders.

UTI FMP scheme and plans launched there under is to seek regular returns by investing in a portfolio of fixed income securities normally maturing in line with the time profile of the

respective Plans, thereby enabling the investors to nearly eliminate interest rate risk by remaining invested in the Plan till the maturity / final redemption.

Banking Sector has been given more emphasis for the study of project as comparison could be done only by knowing the real facts about investments from the depositors at various banks.

The area of project work is pune

OBJECTIVE OF THE PROJECT

This project provides better understanding to the reader by giving insights on Fixed Maturity Plans & its detailed analysis in terms of returns generated. It also highlights how FMPs are tax efficient in different maturity periods.

It also seeks to make a comparative study between Bank Fixed Deposits & other investment avenues.

The project concludes by drawing a picture of the viability of the Fixed Maturity Plans in India suggesting how investments could be done so that predictable and stable returns could be generated like those of Fixed Deposits.

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Chapter-1

Introduction ,detail of the organization

1.1 INTRODUCTION TO THE COMPANY

UTI MUTUAL FUNDS

VISION

“To be the most Preferred Mutual Fund.”

MISSION :

The most trusted brand, admired by all stakeholders

The largest and most efficient money manager with global presence

The best in class customer service provider

The most preferred employer

The most innovative and best wealth creator

A socially responsible organisation known for best corporate governance

UTI Asset Management Company Ltd. (UTI AMC)

Unit Trust of India was created by the UTI Act passed by the Parliament in 1963.For more than two decades it remained the sole vehicle for investment in the capital market by the Indian citizens. In mid- 1980s public sector banks were allowed to open mutual funds. The real vibrancy and competition in the MF industry came with the setting up of the Regulator SEBI and its laying down the MF Regulations in 1993.UTI maintained its pre-eminent place till 2001, when a massive decline in the market indices and negative investor sentiments after Ketan Parekh scam created doubts about the capacity of UTI to meet its obligations to the investors

Jan 14, 2003 is when UTI Mutual Fund started to pave its path following the vision of UTI Asset Management Company Limited, who has been appointed by the UTI Trustee Company Limited for managing the schemes of UTI Mutual Fund and the schemes transferred from the erstwhile Unit Trust of India.

ABOUT MUTUAL FUNDS

INDUSTRY BACKGROUND:

The mutual fund industry started in india in a small way with the UTI Act creating what was effectively a small savings division within the RBI. Over a period of 25 years this grew fairly successfully & gave investors a good return, & therefore in

1989, as the next logical step, public sector banks & financial institutions were allowed to float mutual fund and their success emboldened the govt to allow the private sector to foray into this area. The initial years of industry also saw the emerging years of the Indian equity market,when a number oof mistakes were made and hence the mutual fund schemes which invested ain lesser known stocks in very high levels,became loss leaders for retail investor. From those days to today the retail investor for whom the mutual fund fund is actually intended has not yet returned to the industry in a big way. But to be fair the industry too has focused on bringing in the large investor,so that it can create a significant base corpus,which can make the retail investor more secure.

The mutual fund industry started in 1963 with the formation of Unit Trust Of India, at the initiative of government of India & Reserve bank of India. The history of mutual funds can be broadly divided into four different phases.

The phases of growth-

First Phase(1964-1987) – UTI all the way

1964-87 Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of assets under management.

Second Phase (1987-1993)– Enter public sector mutual funds

1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks and Life Insurance Corporation of India (LIC) and General

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Insurance Corporation of India (GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987 followed by Canbank Mutual Fund (Dec

87), Punjab National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov

89), Bank of India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC established its mutual fund in June 1989 while GIC had set up its mutual fund in December 1990. At the end of 1993, the mutual fund industry had assets under management of Rs.47,004 crores.

Third Phase(1993-2003) – Private players enter the scene

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996. The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets under management was way ahead of other mutual funds.

Fourth Phase(since Feb 2003) –UTI’s restructuring and beyond

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs.29,835 crores as at the end

of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes. The Specified Undertaking of Unit Trust of India, functioning under an

administrator and under the rules framed by Government of India and does not come under the purview of the Mutual Fund Regulations. The second is the UTI Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund

Regulations. With the bifurcation of the erstwhile UTI which had in March 2000

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more than Rs.76,000 crores of assets under management and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund Regulations, and with recent mergers taking place among different private sector funds, the mutual

fund industry has entered its current phase of consolidation and growth.

TYPES OF MUTUAL FUND SCHEMES IN INDIA

Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position, risk tolerance and return expectations etc. thus mutual funds has Variety of flavors, Being a collection of many stocks, an investors can go for picking a mutual fund might be easy. There are over hundreds of mutual funds scheme to choose from. It is easier to think of mutual funds in categories, mentioned below.

Overview of existing schemes existed in mutual fund category:

1. Open - Ended Schemes:

BY STRUCTURE

An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is

liquidity.

2. Close - Ended Schemes:

These schemes have a pre-specified maturity period. One can invest directly in the scheme at the time of the initial issue. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. Investors can transact (buy or sell) the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand and supply situation, expectations of unitholder and other market factors. Alternatively some close-ended schemes provide an additional option of selling the units directly to the Mutual Fund

through periodic repurchase at the schemes NAV; however one cannot buy units

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and can only sell units during the liquidity window. SEBI Regulations ensure that at least one of the two exit routes is provided to the investor.

3. Interval Schemes:

Interval Schemes are that scheme, which combines the features of open-ended and close-ended schemes. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.

The risk return trade-off indicates that if investor is willing to take higher risk then correspondingly he can expect higher returns and vise versa if he pertains to lower risk instruments, which would be satisfied by lower returns. For example, if an investors opt for bank FD, which provide moderate return with minimal risk. But as he moves ahead to invest in capital protected funds and the profit-bonds that give

out more return which is slightly higher as compared to the bank deposits but the risk

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.

Thus investors choose mutual funds as their primary means of investing, as Mutual funds provide professional management, diversification, convenience and liquidity. That doesn‟t mean mutual fund investments risk free. This is because the money that is pooled in are not invested only in debts funds which are less riskier but are

also invested in the stock markets which involves a higher risk but can expect higher returns. Hedge fund involves a very high risk since it is mostly traded in the derivatives market which is considered very volatile.

Overview of existing schemes existed in mutual fund category: BY NATURE

1. Equity fund:

These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary different for different schemes and the fund manager‟s outlook on different stocks. The Equity Funds are sub-classified depending upon

their investment objective, as follows:

Diversified Equity Funds

Mid-Cap Funds

Sector Specific Funds

Tax Savings Funds (ELSS)

Equity investments are meant for a longer time horizon, thus Equity funds rank high on the risk-return matrix.

2. Debt funds:

The objective of these Funds is to invest in debt papers. Government authorities, private companies, banks and financial institutions are some of the major issuers of debt papers. By investing in debt instruments, these funds ensure low risk and provide stable income to the investors. Debt funds are further classified as:

Gilt Funds: Invest their corpus in securities issued by Government, popularly known as Government of India debt papers. These Funds carry zero Default risk but are associated with Interest Rate risk. These schemes are safer as they invest in papers backed by Government.

Income Funds: Invest a major portion into various debt instruments such as

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bonds, corporate debentures and Government securities.

MIPs: Invests maximum of their total corpus in debt instruments while they take minimum exposure in equities. It gets benefit of both equity and debt market. These scheme ranks slightly high on the risk-return matrix when compared with other debt schemes.

Short Term Plans (STPs): Meant for investment horizon for three to six months. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested in corporate debentures.

Liquid Funds: Also known as Money Market Schemes, These funds provides easy liquidity and preservation of capital. These schemes invest in short-term instruments like Treasury Bills, inter-bank call money market, CPs and CDs. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. These

schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds.

3. Balanced funds:

As the name suggest they, are a mix of both equity and debt funds. They invest in both equities and fixed income securities, which are in line with pre-defined investment objective of the scheme. These schemes aim to provide investors with the best of both the worlds. Equity part provides growth and the debt part provides stability in returns.

Further the mutual funds can be broadly classified on the basis of investment

parameter viz,

Each category of funds is backed by an investment philosophy, which is pre-defined in the objectives of the fund. The investor can align his own investment needs with the funds objective and invest accordingly.

By investment objective:

Growth Schemes: Growth Schemes are also known as equity schemes. The aim of these schemes is to provide capital appreciation over medium to long term. These schemes normally invest a major part of their fund in equities and

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are willing to bear short-term decline in value for possible future appreciation.

Income Schemes:Income Schemes are also known as debt schemes. The aim of these schemes is to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited.

Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes invest in both shares and fixed income securities, in the proportion indicated in their offer documents (normally 50:50).

Money Market Schemes: Money Market Schemes aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter-bank call money.

Other schemes

Tax Saving Schemes:

Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. Under Sec.88 of the Income Tax Act, contributions made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate.

Index Schemes:

Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. The portfolio of these schemes will consist of only those stocks that constitute the index. The percentage of each stock to the total holding will be identical to the stocks index weightage. And hence,

the returns from such schemes would be more or less equivalent to those of the Index.

Sector Specific Schemes:

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These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time.

Types of returns

There are three ways, where the total returns provided by mutual funds can be enjoyed by investors:

Income is earned from dividends on stocks and interest on bonds. A fund

pays out nearly all income it receives over the year to fund owners in the form of a distribution.

If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.

If fund holdings increase in price but are not sold by the fund manager, the fund's shares increase in price. You can then sell your mutual fund shares for a profit. Funds will also usually give you a choice either to receive a check for distributions or to reinvest the earnings and get more shares.

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CHAPTER -2

Literature Review

MUTUAL FUNDS IS AN UNTAPPED MARKET IN INDIA

Despite being available in the market for over two decades now with assets under management equaling Rs 7,81,71,152 Lakhs (as of 28 February 2010) (Source: Association of Mutual Funds, India) , less than 10% of Indian households have invested in mutual funds. A recent report on Mutual Funds Investments in India published by research and analytics firm, Boston Analytics, suggests investors are holding back from putting their money in mutual funds due to their perceived high risk and a lack of information on how mutual funds work. This report is based on a survey of approximately 10,000 respondents in 15 Indian cities and towns as of March

2010.There are 43 Mutual Funds at present. The primary reason for not investing appears to be correlated with city size. For example, as depicted in the exhibit below, among respondents with a high s a v in g s ra t e , close to 40% of those who live in metros and Tier I cities cited such in v e stme n ts were very risky, whereas 33% of those in Tier II cities said they did not how and where to invest in such a s s e t s .

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On the other hand, among those who invested, close to nine out of ten res p o n de n ts did so because they felt these assets to be more professionally managed than other asset classes. Exhibit 2 lists some of the influencing factors for investing in mutual funds.Interestingly, while non-investors cite “r i sk ” as one of the primary reasons they do not invest in mutual funds, those who do invest cite the fact that they are “professionally managed” and “more diverse” most often as the reasons they invest in mutual funds versus other investments.

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ADVANTAGES OF MUTUAL FUNDS:

1. Professional Management - The basic advantage of funds is that, they are professional managed, by well qualified professional. Investors purchase funds because they do not have the time or the expertise to manage their own portfolio. A mutual fund is considered to be relatively less expensive way to make and monitor their investments.

2. Diversification - Purchasing units in a mutual fund instead of buying individual stocks or bonds, the investors risk is spread out and minimized up to certain extent. The idea behind

diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others.

3. Economies of Scale - Mutual fund buy and sell large amounts of securities at a time, thus help to reducing transaction costs, and help to bring down the average cost of the unit for their investors.

4. Liquidity - Just like an individual stock, mutual fund also allows investors to liquidate their holdings as and when they want.

5. Simplicity - Investments in mutual fund is considered to be easy, compare to other available instruments in the market, and the minimum investment is small. Most AMC also have automatic purchase plans whereby as little as Rs. 2000, where

SIP start with just Rs.50 per month basis.

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DISADVANTAGES OF MUTUAL FUNDS

1. Professional Management- Some funds doesn‟t perform in neither the market, as their management is not dynamic enough to explore the available opportunity in the market, thus many investors debate over whether or not the so-called professionals are any better than mutual fund or investor him self, for picking up stocks.

2. Costs – The biggest source of AMC income, is generally from the entry & exit load which they charge from an investors, at the time of purchase. The mutual fund industries are thus charging extra cost under layers of jargon.

3. Dilution - Because funds have small holdings across different companies, high returns from a few investments often don't make much difference on the overall return. Dilution is also the result of a successful fund getting too big.

4. Taxes - when making decisions about your money, fund managers don't consider your personal tax situation. For example, when a fund manager sells a security, a capital-gain tax is triggered, which affects how profitable the individual is from the sale. It might have been more advantageous for the individual to defer the capital

gains liability.

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INTRODUCTION TO FMP

Fixed Maturity Plans or, in short, FMPs (may also be called as FTP, FTIF etc) are debt schemes with a fixed maturity, launched by mutual funds. They run for a fixed period of time that could range from one month to as long as 3 years or more. The objective of FMP is to generate a predictable return over a fixed maturity period. FMPs invest in fixed income securities like money market instruments, government securities, corporate bonds, certificate of deposits (CDs), commercial papers (CPs), bank fixed deposits (FDs) etc, which mature in line with the tenure of the fund. Since the instruments are held to maturity, there is no risk of the value of the security being affected by the interest rate movements.

The maturity of Fixed Maturity Plans is varied from one month to 3 years. At the time of new FMP offer the time period also disclosed and it is a close ended scheme. One can invest in FMP only at the time of initial offer and can redeem only after the stipulated

period. But most of the FMPs allowed a premature exit with an exit load.

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DIFFERENT TYPES OF FMPs

FMPs can be of different types

Based on the maturity period- FMPs can be classified into monthly plans (tenure of one month), quarterly plans (tenure of three months), half yearly plans (tenure of six months), yearly plans (tenure of one year) etc.

FMPs can have different types of investment options like dividend option, dividend reinvestment option & growth option.

WHO SHOULD INVEST IN FMPs

FMPs are more suitable for-

Investors who seek safe avenues for investment and in the process keep money in fixed deposits (FDs) with banks. They can earn tax efficient returns by investing in FMPs.

Investors who want to park money for a fixed period of time in safe instruments giving predictable returns, with a view to meeting certain financial goals.

Even aggressive investors who normally prefer equity investments should invest in a part of their funds in FMPs. As a prudent investor one needs to have a proper asset allocation in place & FMPs offer that much needed stability to the

investment portfolio.

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Rating &

Returns and Risk Aggregates

Modern Portfolio

StatVolatility Measures

Fund Rating Not Rated R-Squared-- Mean --

Fund Risk Grade -- Alpha -- Standard

-- Deviation

Fund Return

Grade-- Beta -- Sharpe Ratio --

Best and Worst Performance

Best (Period) Worst (Period)

Month 1.36 (04/03/2011 - 05/04/2011) 0.27 (31/03/2011 - 03/05/2011)

Year -- --

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Relative Performance (Fund Vs Category Average)

Trailing Returns

As of

03 Nov 2011Fund Return Category Return NSE T Bill NSE G-Sec Comp.

Year-to-Date -- 7.19 5.84 -1.02

1-Week 0.21 0.21 0.23 -0.55

1-Month 0.73 0.74 0.68 -1.79

3-Month 2.41 2.29 1.37 -1.80

1-Year -- 7.06 6.95 -0.39

2-Year -- 8.22 5.77 1.07

3-Year -- -- 5.92 3.27

5-Year -- -- 6.51 4.03

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Return less than 1-year are absolute and over 1 year are annualized

Annual Returns

2010 2009 2008 2007 2006

Fund Return -- -- -- -- --

Rank In Category -- -- -- -- --

Category Average 8.13 13.59 7.87 8.30 6.24

NSE T Bill 4.47 6.08 7.73 7.87 6.14

NSE G-Sec Comp. 2.55 -6.40 20.78 5.29 0.76

Quarterly Returns

Q1 Q2 Q3 Q4

2011 -- 2.13 2.24 --

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FMPs ARE ATTRACTIVE IN THE PRESENT INVESTMENT ENVIRONMENT

FMPs are attractive for investors who look for a certain return & investors who require their funds back after a certain period. In addition ,in the present high inflationary scenario where interest rates are rising, FMPs provide a good opportunity to earn returns than can be more or at least match the inflation. While long term debt funds are susceptible to interest rate movements, FMPs by the very nature of their structure offer a good cushion against interest rate movement.

• Fixed Maturity Plans, FMPs, are as attractive as Bank FDs in terms of interest rates. Further, on account of lower taxes on MFs, post tax returns from FMPs is far better. FMPs combine tax efficiency of MFs with the safety of

fixed deposit. FMPs generate significantly better post tax returns.

• Industry corpus of FMPs up to Dec’05 Rs 15000 Cr Jan’06 – July’ 06 collection

(In just 7 months) Rs 13000 Cr Aug’06 collection Rs 4000 Cr

• The tax implication is same here as the interest earned on Bank FDs and the appreciation earned in FMPs has to be added to the income of that year and tax

is to be paid as per your tax slab.

• The attraction increases when the term selected by you is over 365 days. Let’s consider a bank FD offering 8.00% and an FMP offering 8.00%. In a bank FD you have to pay 30% tax (if you are in the highest tax bracket). So your post tax return is 8.00% minus 30% tax on it, which leaves you with a paltry 5.60% post

tax returns.

• Whereas, in FMPs you need to pay just 10% concessional Long Term Capital

Gain Tax without indexation or 20% with indexation for investments of over a year. So your post tax return is 8.00% minus 10% tax on it, which leaves you with a smart 7.20% post tax returns. (Add 2% education cess & 10% surcharge if applicable on tax paid in both cases). In institutional plans, corporate earn

additional 0.25% – 0.40% pa returns.

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DIFFERENCE BETWEEN FMP & BANK FD-

Returns — Fixed Deposit vs Fixed Maturity Plan

FMPs are actually close-ended debt funds with fixed maturity offering an indicative yield. The keyword here is „indicative. An FD guarantees returns and investors are assured of receiving the same on maturity (assuming there is no default in payment of principal amount and interest). The difference here is that while the returns on FDs are assured, returns on FMPs are indicative

Risk — Fixed Deposit vs Fixed Maturity Plan

Fixed Deposit have top rated instruments in its portfolio would deliver comparatively less than a FMP with lower rated papers. Fixed Maturity Plan is much riskier than a Fixed Deposit as the returns are not assured.

Tax treatment — Fixed Deposit vs Fixed Maturity Plan

Interest income from Fixed Deposit is added to the investor‟s income and is taxable at the applicable tax slab for that investor. Interest from FDs is categorized as „Income from other sources‟ under Income Tax laws.

In case of Fixed Maturity Plan, the tax implication depends on the investment option – Dividend or Growth. If the investor has opted for a dividend option, investors have to bear dividend distribution tax, whereas in the growth option returns earned are treated as capital gains (short-term or long-term depending on tenure of investment)

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FIXED MATURITY PLAN FIXED DEPOSIT

Asset class Debt DebtOffered by Mutual funds BanksSafety Quite safe but less safe then bank

FDsVery safe, safer than bank FDs

Type of Fixed duration Fixed duration

Duration of 1 month to 3 years 15 days to 10 years

Money invested

in

Commercial paper, certificate of

deposit, money market instruments, corporate bonds & bank FDs

NA

Rate of return Usually beats the inflation by a Return is little lsess than bank FD

Rate of return at

the time of investment

Indicative not guaranteed Guaranteed

Exit load From 1% to 3% From 0% to 3%Income tax treatment of returns

Dividend-tax free.

Short terms gain clubbed with that years income, & is taxed as per applicable tax slab.

Long term capital gain taxed at a rate of 10% without indexation benefit &

Interest rate is clubbed with that years income and is taxed according to the income tax slab.

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FMPs OFFER HIGHER RETURNS THAN FIXED DEPOSITS

The magic lies in the tax treatment of FMPs. FMPs being debt products offered by mutual funds enjoy a different, favorable tax treatment as compared to bank FDs. In the case of a bank FD, although there is an assurance of returns, the returns in the form of interest are liable to tax at the normal tax rates (for the highest tax bracket the tax rate is

33.99%). Moreover there is also a deduction of tax at source if the interest from a bank FD exceeds Rs. 5000/- in a year. In the case of FMPs the return can be in the form of dividend or capital appreciation depending upon the option of the investor. Dividend is tax free in the hands of the investor while the fund has to incur a Dividend Distribution Tax of 14.1625% (for individuals & HUFs) & 22.66% (in the case of Corporates). In case of investments for more than a year &

under growth option, long term capital gains (LTCG) tax at 11.33% (without indexation benefit) & 22.66% (with indexation benefit) is

applicable.

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INDEXATION

Indexation is the benefit given to the investor as the long term capital gains need to be adjusted for the effect of inflation. Every year, the central government notifies the Cost Inflation Index for the year. The cost of investment is inflated by the inflation index to arrive at the capital gains adjusted for inflation.

Example: Mr. X bought certain number of units for Rs. 80000/- in the year 1997-98 & sold them for Rs. 320000/- in the year 2005-06. (Cost inflation index for 1997-98= 331, Cost inflation index for 2005-06= 497)

His capital gains without indexation= Rs. 320000 – Rs. 80000= Rs. 240000/- His Capital gains with indexation= Rs. 320000- (80000*497/331)

=Rs. 199879.15

If indexation benefit is opted for, then the rate of tax is 20% + surcharge + education cess

If indexation benefit is not opted for, then the rate of tax is 10% + surcharge + education cess.

The assessee can calculate the tax under both these methods and adopt the method that is more beneficial. Indexation benefit is not available for short term capital gains.

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DOUBLE INDEXATION

When an investment is made prior to the end of a financial year & redeemed after the end of the next financial year, the investor can get a benefit of double indexation. The criterion for taking advantage of double indexation is that the investment should have been held for a period crossing

“two financial year ends i.e. 31st March”.

Example: An an investment made on 25th March, 2007 & withdrawn on 2nd april, 2008 would be eligible for double indexation benefit. In this case the amount remains invested for a period slightly greater than a year but the investor gets indexation benefits for inflationary changes in two years. This can reduce the investor‟s tax liability

substantially. Double indexation, at times, may even result in a net loss, even if there is

a profit otherwise & the investor need not pay any tax for the capital gains.

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RISKS IN INVESTING IN FMPS

The three most important risks associated with debt instruments are Credit Risk, Interest Rate Risk & Liquidity Risk.

CREDIT RISK- In the case of UTI FMPs, Credit Risk being the risk of default is minimal as the money is generally invested in risk free or highly rated debt

assets.

INTEREST RATE RISK- In the case of UTI FMPs interest rate risk which is the possibility of the scheme getting affected by changing interest rates gets

nullified by investing in securities, that mature in line with the plan period. Hence the returns are known & investors staying in the scheme till maturity are not affected by market fluctuations & can hope to realize the yield which they have been looking for when investing in the scheme.

LIQUIDITY RISK- In the case of UTI FMPs, liquidity risk being the risk of not being able to get the funds back when needed is minimal as the investor knows at the time of investment the tenure of the scheme & can invest the funds for the fixed tenure with predictable returns. However should the need

arise, the investor can exit the scheme before maturity with an exit load.

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FMPs TAX EFFICIENT FOR INDIVIDUALS

1st Possibility

Yearly FMP, Investor opts for Income option

Growth Option

Effective for yearly FMP

Yearly FMP Fixed Deposits

Yield - Pre Tax 10.00% 10.00%

Marginal rate of Income 0.00% 33.99%

Dividend Dist Tax 14.16% 0.00%

Effective Dist Tax 12.41% 0.00%

Post Tax returns 8.76% 6.6%

Assumptions:- Rate of Returns under Fixed Deposits and Indicative Returns under

Yearly FMP are same i.e. 9.00%

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2nd Possibility

Yearly FMP, Investor opts for Growth option

Growth Option

Effective for yearly FMP

Yearly FMP Fixed Deposits

Yield - Pre Tax 10.00% 10.00%

Marginal rate of Income 0.00% 33.99%

Long Term Capital Gains 11.33% 0.00%


Assumptions:- Rate of Returns under Fixed Deposits and Indicative Returns under

Yearly FMP are same i.e. 9.00%

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3rd Possibility

FMP tenure less than 1 Year, Investor opts for Income option.

Dividend Option FMP 3 Mnths Fixed Deposits

Effective for period less than Indicative Yield Bank Deposits

Net Yield - Pre Tax 9.50% 9.50%

Marginal rate of Income Tax 0.00% 33.99%

Dividend Dist Tax 14.16% 0.00%

Effective Dist Tax 12.41% 0.00%


Pre Tax Returns 12.61% 9.50%

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FUTURE PERSPECTIVE

The doubts and rumours about FMP Mutual Funds in India, have led many High

Networth Investors (HNI investors) of Mutual Funds in India to rapidly exit Fixed

Maturity Plan schemes

The question about India FMP Mutual Funds is : Are new FMP mutual funds worth investing or should one keep off fixed maturity plans completely?

SEBI „s actions regarding India FMP Mutual Funds have been ambivalent

Given the liquidity crisis in MFs following panic redemptions in India FMP Mutual Funds, SEBI had instituted some urgent steps to prevent the collapse of MF houses and rein in the panic in

India FMP Mutual Funds

Some of SEBI‟ s actions regarding FMP Funds

SEBI offered a line of credit to Mutual Fund Houses so that the panic withdrawls from India FMP Mutual Funds should not be left to affect the liquidity of the MF houses. This,of course, was an excellent move from SEBI

SEBI started some serious regulation of India FMP Mutual Funds. One of the SEBI

proposals suggested that Fixed Maturity Plans in the future should not have an option of allowing withdrawls premature to the tenure of the FMP. This SEBI move regarding India FMP Mutual Funds was a controversial step that seemed to focus on supporting the Mutual Fund Houses that were not doing a good job of handling the Fixed Maturity Plan Fund portfolios rather than supporting the cause of investors in these FMP Mutual Funds

As a sop to investors in India based FMP Mutual Funds, SEBI has regulated compulsory listing of all close-ended debt funds such as Fixed Maturity Plans in stock exchanges. While, in principle, SEBI „s move regarding compulsory listing of close ended funds such as FMP Mutual

Fund Schemes seems to be a good idea, the expected absence of trading of these FMP debt securities makes SEBI‟s intentions unviable.

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COMPARISON

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FUTURE OF FMP MF IN INDIA

FMP vs FDs again

One has to put the current problems of FMP funds in perspective to the success of

Indian FMP Mutual

Funds and the current situation in the equity market. Given the current popularity of bank FDs and debt options, one really cannot deny the inherent tax benefits of FMP mutual funds in India even compared to FDs. Given the tax benefits of India FMP mutual funds compared to FDs, some investors in India will always prefer FMP mutual funds to bank Fixed deposits.

Also, given the current equity market recession,the debt based FMP mutual funds vs equity funds comparison may favor Fixed Maturity Plans for some HNI investors.

SEBI „s regulatory focus on India FMP mutual funds may encourage investors in Fixed

Maturity Plans.

SEBI‟s recent involvement with regulations regarding India FMP mutual funds may actually suggest to investors that close ended funds such as FMP Mutual Funds are being seriously monitored by SEBI. Also, SEBI‟s actions to insist on transparency in FMP Mutual Fund portfolios is a step in the right direction and will mollify investors in fixed maturity plans and suggest that FMP investments are quite safe

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CONCLUSION

•

Given the fact that returns from a FMP are not assured, FMP s are generally considered riskier than a FD.

But FDs also have their own share of risks as they are usually rated. credit rating of an FD is an indicator of the degree of

risk associated with it For instance, a rating of AAA/FAAA

‟offers the highest level of safety. So, an FD carrying a credit rating lower than this carries higher risk.

•

For investors looking at a competitive return at a minimum risk , both FMPs and

FDs are viable investment options .

To choose between them, investors need to take into account their risk profile and investment objective among other factors.

For instance, while FMPs may appeal to investors willing to take a little risk for that extra return FDs will find favour with investors who are satisfied with a lower but assured return.

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RECOMMENDATION

FMPs work well when the macro-economic scenario is unfavourable, i.e. when interest rates are on an upward trajectory due to inflationary concerns, and the liquidity in the system is negative. In the case of an improvement in the scenario FMPs should not be preferred by the investors.

From, the time SEBI prohibited the fund houses from declaring indicative yields and portfolios, the investors have no information except than the name and the tenure of the product. In this case, we advise the investors to look at the

portfolios of the FMPs that have already been launched. This would give them an idea of the instruments into which the investor money has been allocated. The investors should also look at the pedigree of the fund house and their strategy in managing short-term funds.

Although, SEBI has made it compulsory for fund houses to list the FMPs so that investors who want to go for premature withdrawal can do so. However, we believe that this option is not as liquid as it is considered to be; as a premature exit from an FMP would also prevent the investor to take advantage of the rising interest rate scenario. Hence, only those investors who do not require money for a stipulated time period should go for this product.

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BIBLIOGRAPHY

h t tp : / / am f i i nd i a .c o m

h t tp : / /u t i m f . c o m

h t tp : / / mu t ua l f u nd i n d ia . c o m

h t tp : / / v a lu e res e a rch on l in e .c o m

h t tp : / / in v e st o p ed ia . c o m

h t tp : / / a pp u on l i n e .c o m

h t tp : / / g oo g le . c o m

AMFI Workbook

Fact sheet UTI