A strengthening Indian Rupee

For the first time in more than 9 years, the Indian Rupee crossed Rs. 40 mark against US Dollar!

The Indian Rupee has been on a rally that had put many a companies, especially IT and other export oriented ones, on fire. The Big Four of Indian IT industry (TCS, Wipro, Infosys, Satyam) had already lost almost 75,000 crore of market capitalization. So is the story of textile, jewellery and drugs sectors. This article which came on rediff.com explains the side effects of Rupee appreciation.

While an appreciating Rupee is the sign of a strong economy, it may not be good for one that depends heavily on exports and outsourcing. As far as exports go, the back firing happened because they charge clients in dollar terms. Had they charged foreign clients in Rupee terms, they wouldn’t have been affected by Rupee strengthening. But India needs dollars and exporters need margins. So there is no option but to get dollars from foreigners. I was wondering, what if we had charged them in Rupee terms? When will we become strong enough to do that? One’s wildest dream may be, but it’s sweet to think about such a situation. May be, its not too far...

Endowment Policies – when it comes to maximizing returns

“Back in July 2002, I took an endowment policy. I was in my first job and for the first time in my life I was submitting investment proof to claim the munificent tax rebate. I had heard from someone that taking an endowment policy would be a better option as the higher premiums I pay would take me near the magical, tax rebate figure of One Lakh and to top it, I would get good returns on policy maturity! I didn’t think twice; called up an insurance agent. All he told me was about endowment policies. Finally, for an annual premium of around Rs. 21,000, I took an endowment policy with a policy term of 25 years. The rest I managed with National Savings Certificate.”

“It’s been three years and having diligently paid all the premiums, now I am a loyal customer of the insurance company. But some of my colleagues who had invested in stock markets that time, directly or through Mutual Funds, have already tripled or quadrupled their savings. Some had made even more. That’s when I started thinking about my endowment policy and the kind of returns it gave me with respect to the investment I made in the form of premiums. Is my endowment policy actually giving me good returns?”

I’m sure most of us who own an endowment policy would have thought like this at least once. This post succinctly examines the same. In the due course, we will find out how endowment policies don’t give much returns or insurance cover vis-à-vis some of the other investment opportunities.

Let’s have a closer look at Endowment Policies. Endowment Policies by definition agree to pay a lump sum on maturity while giving a small insurance cover during the policy term. Thus it’s a combination of both insurance and investment. The policy holder pays premium (this is the investment) reasonably higher than a term-insurance policy and gets yearly bonuses from the insurance company that get accrued and added to the lump sum. On the event of death or on maturity he gets the sum assured plus the accrued bonus (both constitutes the return on investment), which according the insurance company or the agent, is a formidable amount.

Thus, on policy maturity, the policy holder gets money in two ways.

Every year,
a) Reversionary Bonus: Distributed from company profits, based on plan, term and sum assured.
b) Terminal Bonus: Distributed from company profits for customer loyalty, based on plan, term and sum assured.

On maturity
a) Sum assured

So that the Total Amount on maturity = Sum Assured + Accrued Annual Bonuses.

Now let’s study an endowment policy in detail to calculate the returns from it. The policy under study has the following parameters.

  Annual Premium = Rs. 21,000
  Policy Term = 25 years
  Premium Paying Term = 25 years
  Sum Assured = 5 Lakh

Bonus declared by the insurance company for this particular policy during the years 2003-04, 2004-05 and 2005-06 were Rs. 53, Rs. 47 and Rs. 44 respectively, for every thousand rupees sum assured, i.e., an average of Rs. 48. Though I understand that the bonus amount would vary from year to year and may increase in the coming years, I take this average value for the calculations. Also, please to note the decreasing trend in bonus amount.

Thus for a sum assured of Rs. 5 Lakh, the bonus would come out to be Rs. 24,000 per year which is Rs. 6 Lakh for 25 years.

The terminal bonus is usually not made public by the insurance company. Hence we have no other way but to assume it to be on the range of Rs. 4 Lakh.

That makes the total amount the above policy holder would get after 25 years to be Rs. 15 Lakh. And the total premium he would have paid during the policy term would be Rs. 5 Lakh [21,000 X 25]. Thus the policy gives him an annualized return of 12%. [((15 / 5) X 100) / 25]

In this way you can calculate the returns you get from your endowment policy.

Now we got an idea about the returns from an endowment policy. Going ahead, let’s think about the next question. Is there any other way for us to get more returns and more insurance cover from the same investment amount? Is there a way to maximize our investments without compromising on the insurance cover?

So, let’s look at another investment option; say Mutual Funds. Over the years, mutual funds have been giving very good returns, in the range of 40% per year. But if we assume an average return of even 15%, an investment of Rs. 21,000 per year for 25 years would give the above person a return of Rs. 51 Lakh, had he invested the same amount in Mutual Funds every year! Quite amazed?

Unlike endowment policies, mutual funds don’t give any insurance cover. So how do we take care of the insurance part? Well, one way to do that would be to cut down the investment amount a bit and take a term insurance using that. Just to give you a hint, for an annual premium of around 6,000 rupees you will get a term insurance of about Rs. 25 Lakh for the same time period of 25 years! Hence splitting the endowment policy into term insurance + mutual fund combination would be an intelligent way to get more returns and insurance cover. When you play around with such a combination, probably you would end up with a better investment, having more returns and more insurance cover for the same investment amount.

Now one may ask, with endowment policies he will get a return for sure but if he invests in mutual funds, isn’t there a risk of losing money? Well yes, since the mutual funds invest in shares there is a risk of losing money. But mutual fund companies maintain a portfolio of shares to reduce this risk, due to which the downfall may be less. Also, for the less risky, there are balanced funds which invest only half the amount in shares. By the way, the bonus amount of an endowment policy is based on the insurance company’s profit. What if the company made a loss?

Thus there are better ways to invest than taking an endowment policy. Though I haven’t told you how to plan your investment or what to take, I hope that this post would have helped you to think a bit before going for an endowment policy.

Back Slash: An insurance agent gets commission for every premium you pay. For an endowment policy, you will pay premium for longer time periods; 25 years may be, possibly the reason why he may persuade you to go for an endowment policy and may not tell you about the more essential, term-insurance policies.

Entrepreneurship, the next Indian way?

I was reading an article that came on rediff which talked about a few young entrepreneurs who started something that they were passionate about and then succeeded in it. A techie who started a restuarant, a gamer who started a gaming company, another techie who started a resort; great and inspiring stories!

I have always felt that India is a land of family owned businesses. Almost all the big business names in India have the same story behind it. I know, there are a few Infosyses out there, but then, when you take the larger picture the names you would hear would be nothing but the Tatas, Birlas, Ambanis, Wadias, Bajajs, etc. Okay, when they all started they did it through the entrepreneurship way, but the point is there isn't enough entrepreneurial ventures in India being started these days, not to the extent that the country can produce.

Is it because of the lack of availability of funds? If it was 10 years ago I would have definitely considered this sentence, but now, with a lot of Venture Capital Funds operating in India, I would not agree to that. During this year's placement at IIMA, along with companies, a few VC Funds also visited the campus to hear whether the bright minds in the country have got any bright ideas with them so that they can pour the required money to let those ideas see the light of the day. Now, that was a welcome change. Hmm.. India is not only shining but changing too!

I hope the talents in our country would get inspired by the stories such as those posted by rediff and do some thing substantial to take our country towards the next era.

India and her perpetual debt

I read this on Economic Times and I couldn’t but write a post on it.

The piece says, India was by far the largest borrower from two World Bank institutions, accounting for $3.75 billion, or 15 percent of their total lending as the bank group globally committed $34.3 billion in fiscal year 2007.

It’s not under my proficiency to criticize and say why India is the largest borrower despite showing a tremendous economic growth rate, surging capital inflows and increased earnings through taxes. At least from the taxes front, I know for sure that it’s more streamlined than ever. In such a situation, I thought India have had reduced her borrowings in the recent times and would have been making it to zero over a period of time; 2020 may be!

But one may not forget that due to the trickling effect (!) only less of these funds reach the needy poor, for eradicating poverty, for providing basic infrastructure, education etc. Majority of which end up in the deep and ravenous pockets of the needy rich, politicians, middlemen! Well, that could be one of the reasons why more such funds are encouraged to flow from organizations such as World Bank to India every year, even today.

I also read experts saying 15% GDP growth will eradicate poverty in India.

Which one India should adopt to eradicate poverty? Working hard to make the GDP grow 15% or working hard to borrow from World Bank and make our debt a perpetual one?

The magic of Inflation

Business Standard reported, “Inflation based on the Wholesale Price Index (WPI) dropped to 3.79% for the week ended August 25 from 3.94% in the previous week. Inflation close to 7% few months back to 3.79% is more welcomed than ever. As one won’t be having any doubts regarding the importance of inflation to an economy and how it affects the economy, let’s see how it is calculated in India.

But before that, there are two methods to calculate inflation rate; Wholesale Price Index (WPI, introduced in 1902) and Consumer Price Index (CPI, introduced in the 1970s). In WPI, the calculation of inflation is done on the basis of the average rate of change in prices of a set of commodities in the wholesale market. Where as CPI is a statistical time-series value based on the weighted average of rate of change in prices of a set of goods and services purchased by consumers. Thus the CPI is much more comprehensive and it catches the inflation value from the end-consumer's side rather than from the wholesale seller's side. CPI is published on a monthly basis while WPI is available every week and has the shortest possible time lag of 2 weeks. India uses WPI while most of the developed countries use CPI to calculate the inflation rate.

The prices of a set of 435 commodities (such as onion, rice, dal etc.) are used for calculating WPI in India. Economists say that India should adopt CPI for inflation calculation as it is the one that shows price rise an end-consumer would experience. Finance Ministry counters it saying that in India there are 4 CPI indices (CPI Industrial Workers, CPI Urban Non-manual Employees, CPI Agricultural Labourers and CPI Rural Labour) in existence which makes switching over to CPI riskier and complex and also CPI has too much lag time in reporting. But then, the question remains how the United States, the United Kingdom, Japan, France, Canada, Singapore and China use CPI for inflation calculation?

The way in which WPI inflation rate is calculated in India can be found out in the article, How is WPI inflation rate calculated in India?.

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Bullion; much unnoticed

I was never in favor of yellow/white metals. Long past, I lost a chain and a ring to a crook during my summer internship days and that was the end of my story towards owning gold. Nonetheless, it surfaced two months back, owing to the occasion of my marriage and voila, I own a few sovereigns now!

Now coming to the point, I bought the gold at a price of Rs. 801 per gram on the 1st of July 2007 and today on the 6th of September 2007; the price of gold have gone up to Rs. 905 per gram. That translates to an out of the blue return of about 13 percent (approximate yearly return of 78 percent) in just two months! It may not be as lucrative a return as you get while investing in stock markets, but it’s not that small either.

I know that I shouldn’t go by the numbers as gold prices won’t increase like this round the year. There are times when the price falls as well. But the point is bullion also makes a great investment, provided you track the market well and put your money at the right time. While I don’t think I have done the same, like tracking and timing the market, this was an eye-opener and now I am going to track the bullion market too.

US Sub-prime Crisis

The US sub-prime mortgage lending crisis or simply sub-prime crisis has been the catchphrase in various media over the last few weeks. In this entire hullabaloo, one may want to know what this episode is all about and how it will affect the Indian economy or rather the world economy as a whole. Let’s have a look.

Sub-prime borrower
In US almost everything, right from getting a credit card to receiving various banking services, is dependent on the credit history of a person. A good credit history can be directly attributed to making payments on time, less revolving credit on credit cards, fewer payment defaults and check bounces etc. and is denoted by the FICO score or credit score of a person set by few credit rating agencies. It is easy for a person with a good credit history to get loans and other services while it’s exceedingly difficult for a person with a not so good credit history or low FICO score to avail banks’ services, let alone loans. Such poor credit history borrowers are called sub-prime borrowers. Since there is a risk of default on loans to sub-prime borrowers, US banks usually charge a higher rate of interest to them for the risk they are taking. From the bank’s side, a higher interest means a higher return, well with a risk. As a result, some banks had seen lending money to sub-prime borrowers as an opportunity.

Sub-prime boom
For a crisis to happen, first there has to be a boom. There were a few things that led to the sub-prime boom. I better quote Christian Stracke of Financial Times who had explained the situation quite nicely. “It all originated with a global imbalance between the supply of credit and the demand for credit. Global Central Bank let monetary policy move to a nearly unprecedented accommodative stance, pumping money into the system. At the same time, corporate, the traditional mainstays in terms of borrowing funds to invest moved to a defensive stance, having grown much more conservative in the wake of the Enron and WorldCom fiascos. Finally, the major developed countries began to gain a measure of fiscal discipline, with budget deficits shrinking, which further reduced the demand for credit on a global basis. That imbalance between investors flush with cash and the traditional borrowers not really needing or wanting that cash meant that investors had to look for new markets to invest in. As the Asset Backed Securities (ABS) market had been taking off and coming into the mainstream, a natural target was the sub-prime borrower - borrowers who in the past had wanted to borrow but who had been locked out of credit markets. Eager lenders met eager borrowers, with the mortgage originators, ABS underwriters, and credit ratings agencies playing the role of matchmaker, and the sub-prime boom was born.” Now, let's see what the banks or mortgage originators did to target the sub-prime borrowers’ market.

Role of Banks and Hedge Funds
So there was an opportunity among sub-prime borrowers and there has to be someone who could take the money from investors and give it to the borrowers. Who could do this better than the banks? Banks gave money to sub-prime borrowers and then they bundle the loans to a package and sold securities whose value was linked to the performance of the package of mortgage loans. Investors bought these securities and thus indirectly provided the money required for sub-prime lending. These derivative instruments are called Collateralized Debt Obligations (CDOs), which is one form of Asset Backed Securities. Thus, banks did away with the role of playing a financial intermediary. The total volume of CDOs in the US market is around $900 billion and only 17% of the CDOs were created out of sub-prime mortgages. Hedge Funds hold majority of these sub-prime related securities due to the inherent nature of their business making them extremely vulnerable to sub-prime related issues. So everything was set and now let’s find out what triggered the crisis.

Sub-prime crisis
Quite obviously the sub-prime crisis occurred when the sub-prime borrowers defaulted in their mortgage loans, which affected the returns of CDOs. The main reason was the inability of sub-prime borrowers to pay back the money. Another catalyst was the rising segment of credits like Home Equity Loans through which the borrowers could take a second credit on the same mortgage. These added to their inability to payback the money. As a result, some defaulted. Some started force selling their houses due to which property prices came down, which made it more difficult for other sub-prime borrowers to refinance their mortgages into loans with lower rates. The result, more and more defaults!

Now at the securities side, the highly leveraged hedge funds, found themselves in distress due to the rising defaults by sub-prime borrowers. Investors who had put their money in these funds wanted their money back which forced these funds to liquidate their assets. And thus started a vicious spiral of forced selling of sub-prime securities! This reduced the price of these securities in the market and thus the crisis grew new bounds. Since hedge funds are highly leveraged, a small decrease in their asset values is enough to make them bankrupt. As a result several funds filed for bankruptcy. Thus the sub-prime crisis showed its red face!

Effect on global and Indian economies
Few companies in the US filed for bankruptcy which led to the loss of thousands of jobs. People who invested through hedge funds lost their money. UK and Japanese economies were affected a lot as there were a lot of money from investors belonging to these geographies that had been put into sub-prime securities through the hedge funds.

In other economies, hedge funds faced selling pressure to meet margin calls which led to the fall of various non-US stock indices, Sensex, Nifty being few of them!

Though not severe, Indian economy got affected by this in the following ways. A reduction in the investments in Indian securities/major selling of Indian stocks by foreign investors (foreign funds having CDOs created out of sub-prime loans and had selling pressure) and a subsequent melt down of Indian stock markets, IT companies losing few of their clients belonging to US mortgage industry & Hedge Funds due to cost cutting or bankruptcy are some of these.

Analysts say that the US sub-prime crisis is not over yet. Let’s see what more this disaster has in its store in the days to come. In the hindsight, one might think, had the banks been not greedy enough to put their money in riskier sub-prime borrowers and made securities out of it!

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NFOs and expansion of AMCs

Once again Mutual Fund Houses have entered into the New Fund Offer (NFO) bandwagon. With Asset Management Companies (AMC) such as Fidelity, SBI, HDFC, HSBC etc releasing their NFOs for various sectors, Reliance has also entered into the foray with their Reliance Equity Advantage Fund.

But what interests me is that Reliance MF is about to double their branch network from 300, due to an expected 25% increase in their Assets Under Management to Rs. 75,000 crore. Quite in line with the tradition of Reliance, ‘when doing something, do it big’.

Well, these are private matters pertaining to Fund houses. But, did you happen to think about the huge amount of money that would go into the hands of various mutual funds in the next few years? No wonder why the stock market is expected to touch more heights and create more records!