Fixed Maturity Plans

Fixed DepositsVs.

By:

Sri Hasa Sahil Malhotra2010193 2010195

FDs

• In an FD, you deposit an amount with the bank for a fixed duration.

• You earn a fixed rate of interest on this investment. The interest rate is fixed at the time of the investment – even if interest rates change during the tenure of the FD, the interest that you earn on your FD remains fixed. (The interest is not floating)

• Thus, you invest a fixed amount, for a fixed duration, and earn a fixed interest on it. No wonder, it is called a fixed deposit!

• A certificate of deposit is a time deposit product

FMPs• Fixed Maturity Plans are close-ended debt schemes with

a maturity horizon varying from one month to five years.• Launched with predetermined maturity date; so as the

investments are made in such securities which mature at or around the same time as the schemes do.

• Dividend or growth option• Investors are not allowed for premature redemption

during period and are warranted to stay till maturity.• However, premature withdrawals are allowed on the

stock exchanges where these units are listed and traded at market prices.

• However this route is not yet very liquid. The schemes are shut down generally once they get matured.

Indexation Under Indexation, you are allowed by law to inflate thecost of your asset by a government notified inflationfactor.• This factor is called the ‘Cost Inflation Index’, fromwhich the word ‘Indexation’ has been derived.• This inflation index is used to artificially inflate yourasset price.• This helps to counter erosion of value in the price of anasset and brings the value of an asset at par withprevailing market price.• This cost inflation index factor is notified by thegovernment every year. This index gradually increasesevery year due to inflation.

How is cost-inflation indexcomputed? ?

• The cost inflation index (CII) is calculated as shown:

Inflation Index for year in which asset is soldCII = --------------------------------------------------------------

Inflation Index for year in which asset was bought

This index is then multiplied by the cost of the asset toarrive at inflated cost.

Common features

• The investors are aware of the returns before hand.

• Both the instruments carry Credit Risk.

• However they are been assessed by credit agencies for quality.

Differences

• FMP highlights Indicative Yield where else FD is assured returns.

• FMP income, attracts the low rate of Income tax have indexation benefit which makes it more tax efficient.

Fixed Maturity Plan (FMP) Fixed Deposit (FD)Asset Class Debt DebtOffered by Mutual Funds (MFs) Banks

Safety Quite safe, but less safe compared to bank FDs Very safe, safer than FMPs

Type of investment Fixed duration Fixed duration

Comparisons…

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

Money invested in

Commercial Paper (CP), Certificate of Deposit (CD), Money market instruments, corporate bonds and bank FDs

NA

Rate of returnUsually beats inflation by a small margin, return is better than bank FDs

Usually beats inflation by a small margin, return is a little lesser than FMPs

Fixed Maturity Plan (FMP) Fixed Deposit (FD)

Comparisons…

Rate of return (at the time of investment) Indicative, not guaranteed Guaranteed

Exit Load From 1% to 3%From 0% to 1% (Penalty for breaking an FD)

Income tax (IT) treatment of returns

Dividend: Tax freeShort term gain: Clubbed with that year’s income, and is taxed as per the applicable IT slabsLong term gain: Taxed at a special rate – 10% without the benefit of indexation, or 20% with the benefit of indexation.

Interest earned is clubbed with that year’s income, and is taxed as per the applicable IT slabs

Fixed Maturity Plan (FMP) Fixed Deposit (FD)

FMP

Bank FDWithout

Indexation With Indexation

Investment Amount (Rs.) 1,00,000 1,00,000 1,00,000

Assumed Net Yield to investor (p.a) 7.50% 7.50% 7.50%Tenor (Months) 13 13 13

Amount at Maturity (Rs.) 1,08,125.00 1,08,125.00 1,08,125.00

Interest/Long Term Capital Gain 8,125.00 8,125.00 8,125.00

Indexed Cost of Acquisition(CII = 10.25%)

N.A. N.A 1,10,250.00

Indexed Gain/ (Loss) N.A. 8,125.00 (2,125.00)

Tax Rate 30% 10% 20%

Tax on Interest on FD/ Capital Gain on MF 2,734.88 812.50 –

Post Tax Income 5,390.13 7312.50 8,125.00