This article is specific to india and Indian tax laws.
Mutual Funds are allowed to launch Fixed maturity plans (FMP) which by their name shall be clear to investors. The maturity, whether 1 month or 1 year shall be made very clear to investors in the offer document of the Mutual fund along with the indicative returns expected. (FMP) are closed-end debt funds that aim at generating returns that are indicated at the time of launching the scheme. Mutual funds are not allowed to launch assured return schemes. FMPs, therefore, only indicate the likely returns. FMPs can generate predefined returns because of the way their portfolio is constructed. They invest in debt securities which mature around the tenor of the fund. Since the instruments are held to maturity, there is no risk of the value of the security being affected by interest rate movements and fund managers are able to give returns indicated at the time of investing.
FMPs come with various maturities at which time the money with the returns are credited back into the investor’s bank account. The popular tenors are of one month, three months and a little over a year. As closed-end funds, FMPs cannot accept any fresh investment once the NFO is over. To help investors deploy their available funds and reinvest money from maturing FMPs, mutual fund houses launch a continuous series of FMPs. The NFO is usually open for two to three days and the minimum investment is kept at around Rs 5,000. Since investors cannot withdraw their money till the maturity of the scheme, they need to choose a fund with a tenor that matches their investment horizon.
Why FMP?
FMPs are similar to bank fixed deposits (FD) in features such as fixed maturity period and indicative return. But they do not guarantee returns like FDs do.
So, why should an investor choose an FMP over an FD?
The answer lies in the tax efficiency that FMPs bring to their returns.
a) The example given in the table below shows that while FMP attracts the dividend distribution tax (DDT), FD attracts income tax. Since DDT is lower than the income tax rate, FMP gives a higher post-tax return than FD.
b) FMPs with maturities of greater than one year provide capital gains efficiency by structuring the tenor in such a way that investors benefit from double indexation. For example, an FMP holder holding the FMP launched on 30 March 2007 for a little more than a year (375 days) till it matures on 9 April 2008, an investor gets to use the cost of inflation index applicable for the years 2006-2007 (year of purchase) and 2008-2009 (year of redemption). The tenor of the fund and the date on which it is launched allows double indexation, thus reducing the capital gains tax applicable on the returns.
FMPs suit investors who have a fixed investment horizon and would like to know the likely returns. The tax advantages make them superior to FDs. The only caveat is that investors need to evaluate the credit risk involved in the securities that the FMP is likely to invest in.
FD vs FMP: Effect of Taxation
FD FMP
Investment (Rs) 5,000 5,000
Rate of interest (% p.a.) 9 9
Amount at the end of 1 year (Rs) 5,450 5,450
DDT1 (%) ( Div Distbn Tax ) Nil 14.1625
Tax on interest (%) ( Income Tax rate) 33.66 Nil
Net amount2 5,298.53 5,386.28
Post-tax return (%) 5.97 7.72
1Dividend distribution tax
2Assuming the FMP distributed the entire Rs 450 as dividend
From the above example it is clear that
- Even if an investor holds an FMP less than a year, he/she is better off in the post tax yield. The above example shows that the FMP yield is 7.72% vs the FD yield of 5.97% for an investor in the highest Income tax slab of 33%.
- If the Investor holds the FMP for 375 days as mentioned in b) above, that is between 30th March 2007 till 9th April 2008, then only an indexed capital gains tax apply. The steps to arrive at the tax is as below.
- First find out the indexation factor. Assuming the inflation index for 2006 -07 is 100, for 2007-08 it is 105 and 2008-09 is 110. The indexation factor for this investment is 110/100 which is equal to 1.1.
- Then multiply the actual investment with the Indexation factor. In this case, it is Rs 5,000 multiplied by 1.1 which shall be Rs 5,500/-.
- Now look at the actual return provided for 375 days at the rate of 9% for 365 days. It is approximately Rs 450.
- Calculate the total principal plus interest and subtract it from the indexed investment. This is the gain received. Which is Rs 5450( total receivable) minus Rs 5,500 (indexed cost ). Which is minus Rs 50. As there are no gains, the capital gains tax of 20% on gains need not be applied. So, the post tax yield in this example is 9% vs the post tax yield of 5.97% the FD yields.
Hence, be wise – always invest in FMPs offered by Mutual Funds as against the bank FDs. If you hold it for above 365 days ( across 2 financial years) , the returns are still better.
Disclaimer: These are just my views and the readers are advised to consult their financial advisors before making any investments. The readers indemnify this author against any and all eventualities which may or may not occur in the financial markets. Also, tax illustrations if any are applicable only when this article was posted and they may change subsequently thereby making any tax adjusted return calculation different.
Saturday, July 12, 2008
Credit card - FAQ 2
... this is a continuation of my previous post FAQ 1 on same topic.
What happens when my credit card payment is late?
If you don’t make the monthly repayment by the date specified on your statement, your provider may charge you a late payment fee. They might even stop your card. Late payment fees, as the term indicates are payable in he event of any delay in repayment of the out standings on your credit card after the stipulated ‘interest-free period’. These charges are very steep and card members are well advised to pay off at least the minimum amount due on out standings every month.
What does rolling over credit/ revolving credit mean?
You have two choices for making card payments. You may clear your full dues as soon as you receive your billing statement. Or you may choose to pay the minimum monthly installment mentioned on the statement (which is usually between 5-10 percent of the total amount outstanding as on the date of the statement) and avail of revolving credit on thebalance. In other words your credit amount rolls over to the next month and so on. In a majority of cases, interest will be calculated on the average daily balance method on the unpaid balance plus amounts incurred for new purchases. Average daily balance depends usually on the amount outstanding and the number of days it is outstanding for.
What is the catch with low interest balance transfer offers?
Low interest balance transfer cards can save you money on interest payments; you just need to consider all the features of the card. Some cards charge a balance transfer fee. Also, be aware that the low interest rate charged for balance transfers may not apply to purchases. So, if you start spending with your card, you could end up paying a higher interest rate.
Should I consolidate my credit card debt?
If you’ve got several credit card debts, it makes much more sense to transfer your balance onto one low interest card. Interest rates tend to be lower on balance transfers, so you’ll be saving money and making repayments easier to manage. Make sure you cut up your old cards once you transfer your balance.
What sort of tricks should I look out for when looking for a credit card offer?
0% balance transfer rates can seem very attractive but make sure you know what you’re getting into. The rate will only apply to balance transfers, not purchases and be only for a limited time like 3 months. So you could end up paying the provider’s typical rate or higher, if you make any new purchases. You can also end up paying charges if you use your card to make cash withdrawals. You’ll be charged a standard fee, however much you withdraw. Plus, you’ll start paying interest from the moment you draw your cash out.
What should I check before applying for a credit card?
- What is the interest rate for purchases?
- What is the interest rate for cash withdrawals?
- What’s the period of free credit (the maximum is 56 days)?
- Will you be charged if you miss a monthly repayment?
- Is there an annual charge?
- Are balance transfers possible?
- Are there any rewards included with the card?
- Is travel insurance included with the card and if so what cover is provided?
How many credit cards should I have?
It’s advisable to limit your credit cards to just two – one for balance transfers, and one for purchases. This is because the rate often differs according to what you’re using the card for. It’s generally not a good idea to have more than two cards – you may damage your credit rating if you have lots of credit cards. Also, it’s much easier to build up debt and much harder to keep track of repayments if you have lots of different credit cards.
What is the minimum balance you must pay on a credit card each month?
Every month you must make a minimum repayment towards your debt. Typically, this is around 5% of your balance (which will include interest).
If I pay off the full balance every month will I ever be charged interest or other fees? As long as you pay back the amount you owe before the interest rate kicks in (this varies from card to card), you won’t be charged interest. However, if your provider charges an annual fee, you’ll need to include this in your repayment.
If I don’t pay off my balance in full, how much will it cost me in interest?
If you don’t pay off your balance every month, the remaining amount will be added to your next statement. Interest charges will be backdated to when you made the purchase, so you’ll actually be paying two lots of interest on your remaining balance; for the month you made the purchase and the month you carry your balance over.
How do cash advances from a credit card work?
You can use your credit card to withdraw money from a cash machine – this is called a ‘cash advance’. Before withdrawing money, check the amount your provider charges for this service – there’s usually a fixed charge and you’ll start paying interest on this from the day you withdrew the cash.
What is a supplementary/add-on card?
An add-on card is usually for your dependents - spouse, parents or children. Any additional cards under this head come at a fee, which varies between Rs 100 to Rs 1,000. All expenses on the card are billed to you.
What does the purchase protection feature of credit cards mean?
The purchase protection feature automatically insures all items bought on the credit card from damage or loss due to fire or theft up to a certain sum of money.
What are the advantages of owning a platinum credit card?
Platinum cards often offer extra features, such as a low interest rates and rewards. However, to qualify you need to have good credit and a good salary.
What is the difference between a credit card, charge card and debit card?
A credit card allows you to pay for service or product over a period of time. Up to the first 55 days of credit come interest free. You can chose to pay your entire debt at one go or you can pay a minimum amount every month. A charge card works on similar lines as the credit card with one difference. With a charge card you have to pay the entire dues within the credit period. You cannot carry over any balances like a credit card. The most important differences between the two types of card are that charge cards charge a much higher interest rates and can usually only be used in just one merchant or brand. A debit card enables you to access your bank deposits for payment. When you make any purchases using a debit card, then your bank account is automatically and instantly decreased to the extent of the purchase amount
What happens when my credit card payment is late?
If you don’t make the monthly repayment by the date specified on your statement, your provider may charge you a late payment fee. They might even stop your card. Late payment fees, as the term indicates are payable in he event of any delay in repayment of the out standings on your credit card after the stipulated ‘interest-free period’. These charges are very steep and card members are well advised to pay off at least the minimum amount due on out standings every month.
What does rolling over credit/ revolving credit mean?
You have two choices for making card payments. You may clear your full dues as soon as you receive your billing statement. Or you may choose to pay the minimum monthly installment mentioned on the statement (which is usually between 5-10 percent of the total amount outstanding as on the date of the statement) and avail of revolving credit on thebalance. In other words your credit amount rolls over to the next month and so on. In a majority of cases, interest will be calculated on the average daily balance method on the unpaid balance plus amounts incurred for new purchases. Average daily balance depends usually on the amount outstanding and the number of days it is outstanding for.
What is the catch with low interest balance transfer offers?
Low interest balance transfer cards can save you money on interest payments; you just need to consider all the features of the card. Some cards charge a balance transfer fee. Also, be aware that the low interest rate charged for balance transfers may not apply to purchases. So, if you start spending with your card, you could end up paying a higher interest rate.
Should I consolidate my credit card debt?
If you’ve got several credit card debts, it makes much more sense to transfer your balance onto one low interest card. Interest rates tend to be lower on balance transfers, so you’ll be saving money and making repayments easier to manage. Make sure you cut up your old cards once you transfer your balance.
What sort of tricks should I look out for when looking for a credit card offer?
0% balance transfer rates can seem very attractive but make sure you know what you’re getting into. The rate will only apply to balance transfers, not purchases and be only for a limited time like 3 months. So you could end up paying the provider’s typical rate or higher, if you make any new purchases. You can also end up paying charges if you use your card to make cash withdrawals. You’ll be charged a standard fee, however much you withdraw. Plus, you’ll start paying interest from the moment you draw your cash out.
What should I check before applying for a credit card?
- What is the interest rate for purchases?
- What is the interest rate for cash withdrawals?
- What’s the period of free credit (the maximum is 56 days)?
- Will you be charged if you miss a monthly repayment?
- Is there an annual charge?
- Are balance transfers possible?
- Are there any rewards included with the card?
- Is travel insurance included with the card and if so what cover is provided?
How many credit cards should I have?
It’s advisable to limit your credit cards to just two – one for balance transfers, and one for purchases. This is because the rate often differs according to what you’re using the card for. It’s generally not a good idea to have more than two cards – you may damage your credit rating if you have lots of credit cards. Also, it’s much easier to build up debt and much harder to keep track of repayments if you have lots of different credit cards.
What is the minimum balance you must pay on a credit card each month?
Every month you must make a minimum repayment towards your debt. Typically, this is around 5% of your balance (which will include interest).
If I pay off the full balance every month will I ever be charged interest or other fees? As long as you pay back the amount you owe before the interest rate kicks in (this varies from card to card), you won’t be charged interest. However, if your provider charges an annual fee, you’ll need to include this in your repayment.
If I don’t pay off my balance in full, how much will it cost me in interest?
If you don’t pay off your balance every month, the remaining amount will be added to your next statement. Interest charges will be backdated to when you made the purchase, so you’ll actually be paying two lots of interest on your remaining balance; for the month you made the purchase and the month you carry your balance over.
How do cash advances from a credit card work?
You can use your credit card to withdraw money from a cash machine – this is called a ‘cash advance’. Before withdrawing money, check the amount your provider charges for this service – there’s usually a fixed charge and you’ll start paying interest on this from the day you withdrew the cash.
What is a supplementary/add-on card?
An add-on card is usually for your dependents - spouse, parents or children. Any additional cards under this head come at a fee, which varies between Rs 100 to Rs 1,000. All expenses on the card are billed to you.
What does the purchase protection feature of credit cards mean?
The purchase protection feature automatically insures all items bought on the credit card from damage or loss due to fire or theft up to a certain sum of money.
What are the advantages of owning a platinum credit card?
Platinum cards often offer extra features, such as a low interest rates and rewards. However, to qualify you need to have good credit and a good salary.
What is the difference between a credit card, charge card and debit card?
A credit card allows you to pay for service or product over a period of time. Up to the first 55 days of credit come interest free. You can chose to pay your entire debt at one go or you can pay a minimum amount every month. A charge card works on similar lines as the credit card with one difference. With a charge card you have to pay the entire dues within the credit period. You cannot carry over any balances like a credit card. The most important differences between the two types of card are that charge cards charge a much higher interest rates and can usually only be used in just one merchant or brand. A debit card enables you to access your bank deposits for payment. When you make any purchases using a debit card, then your bank account is automatically and instantly decreased to the extent of the purchase amount
Credit card - FAQ 1
This article answer some frequently asked questions here from “credit card – what ?” to “What to check before applying for a credit card?”. If you have got other questions you want answered why not ask our expert.
What is a credit card?
A credit card is a card used to pay for products and services at over 20 million locations around the world. All you need to do is produce the card and sign a charge slip to pay for your purchases. The institution, which issued the card to you, makes the payment to the outlet on your behalf and would be reimbursed at a later date by you.
Why should I own a credit card?
Credit cards are relatively safer than carrying cash. You can spend almost anywhere, any time. Credit cards enable you to other benefits like rewards and insurance cover. You also get interest free money for up to 50 days.
What are the eligibility requirements to get your own credit card?
To apply for a credit card, you need to generally: - To be at least 21 years of age and not more than 65 years. - A regular and steady source of income. - Credit card companies (or issuing banks, as they are known) have a requirement of a minimum income level, which serves as the starting point while applying for a card. This requirement varies from bank to bank and could vary between Rs 75,000 per annum to Rs 150,000 per annum depending upon your risk profile and the type of card you choose. Typically, banks issuing credit cards need to be sure whether or not you will be able to repay the expenses incurred through your credit card.
What types of credit cards are there?
There are three cards, which are available, Visa, Master Card and Amex. Various participating banks like ICICI bank or HDFC then issue these cards to end-users. Visa and Master Card are the most popular cards in India and have an almost equal market share. Amex is much smaller in India and is issued through few banks at this stage.
What is the minimum salary required for taking a credit card?
You will need a salary of at least Rs. 75,000 per annum for an ordinary card and Rs. 1,50,000 per annum for a gold card.
What are MasterCard and Visa ?
MasterCard and Visa are global organisations dedicated to promote the growth of the card business across the world. They have built a vast network of merchant establishments so that customers world-wide may use their respective credit cards to make various purchases.
What is a Global Card?
A Global Card enables you to use your credit card when you are overseas. You can spend in dollars or any other foreign currency and settle the dues in your local currency.
What should I do if my credit card is lost or stolen?
In the event of losing your credit card, you must inform the bank immediately. The bank then deactivates your card to prevent any fraud. You are protected from settling any expenses on your card the moment you inform the bank.
What is my liability when I lose my credit card?
Before you report the loss of your card, you will have to pay for all the purchases fraudulently made on your card. The lost card liability fee is payable on the expenses incurred during the period between the loss of your card and your having reported it to the bank. After reporting the loss, your liability is mostly restricted to Rs. 1,000. You may also have to pay for the reporting of the loss in the lost card list. You will be expected to pay for the issue of a replacement card.
Can I use credit cards to make payments on the internet?
Yes, payments over the internet using a credit card is permitted. When you do purchase a product over the internet, you need to be careful about recording details of the order, and reporting any inconsistencies in billing to the card-issuing institution immediately.
Will the merchant charge a service charge for using a credit card?
No. However, with specific transactions like railway bookings they might demand a service charge of 2-3%. Before using a credit card check whether any service charge is applicable. Also, in some countries/states there could be an extra service tax applicable for transactions paid through a credit card.
Do I have to pay interest whenever I borrow?
No. Credit card issuing banks offer you an interest-free period of up to 55 days, after which the payment has to be made on purchases made against your credit card. You have the choice of carry forwarding your out standings by the payment of a ‘minimum due amount’ (generally 5% of the outstanding). If you pay off the entire amount within the interest-free period, then no charges are due. However if you choose to avail of the credit facility, then a credit charge is levied which generally varies between 2.5% to 3%. It should be noted that though the notional interest free period is for 40-55 days, billing is done monthly, so the actual interest free period could vary depending on whether the purchase was made at the start or the end of the billing period.
What is a credit card?
A credit card is a card used to pay for products and services at over 20 million locations around the world. All you need to do is produce the card and sign a charge slip to pay for your purchases. The institution, which issued the card to you, makes the payment to the outlet on your behalf and would be reimbursed at a later date by you.
Why should I own a credit card?
Credit cards are relatively safer than carrying cash. You can spend almost anywhere, any time. Credit cards enable you to other benefits like rewards and insurance cover. You also get interest free money for up to 50 days.
What are the eligibility requirements to get your own credit card?
To apply for a credit card, you need to generally: - To be at least 21 years of age and not more than 65 years. - A regular and steady source of income. - Credit card companies (or issuing banks, as they are known) have a requirement of a minimum income level, which serves as the starting point while applying for a card. This requirement varies from bank to bank and could vary between Rs 75,000 per annum to Rs 150,000 per annum depending upon your risk profile and the type of card you choose. Typically, banks issuing credit cards need to be sure whether or not you will be able to repay the expenses incurred through your credit card.
What types of credit cards are there?
There are three cards, which are available, Visa, Master Card and Amex. Various participating banks like ICICI bank or HDFC then issue these cards to end-users. Visa and Master Card are the most popular cards in India and have an almost equal market share. Amex is much smaller in India and is issued through few banks at this stage.
What is the minimum salary required for taking a credit card?
You will need a salary of at least Rs. 75,000 per annum for an ordinary card and Rs. 1,50,000 per annum for a gold card.
What are MasterCard and Visa ?
MasterCard and Visa are global organisations dedicated to promote the growth of the card business across the world. They have built a vast network of merchant establishments so that customers world-wide may use their respective credit cards to make various purchases.
What is a Global Card?
A Global Card enables you to use your credit card when you are overseas. You can spend in dollars or any other foreign currency and settle the dues in your local currency.
What should I do if my credit card is lost or stolen?
In the event of losing your credit card, you must inform the bank immediately. The bank then deactivates your card to prevent any fraud. You are protected from settling any expenses on your card the moment you inform the bank.
What is my liability when I lose my credit card?
Before you report the loss of your card, you will have to pay for all the purchases fraudulently made on your card. The lost card liability fee is payable on the expenses incurred during the period between the loss of your card and your having reported it to the bank. After reporting the loss, your liability is mostly restricted to Rs. 1,000. You may also have to pay for the reporting of the loss in the lost card list. You will be expected to pay for the issue of a replacement card.
Can I use credit cards to make payments on the internet?
Yes, payments over the internet using a credit card is permitted. When you do purchase a product over the internet, you need to be careful about recording details of the order, and reporting any inconsistencies in billing to the card-issuing institution immediately.
Will the merchant charge a service charge for using a credit card?
No. However, with specific transactions like railway bookings they might demand a service charge of 2-3%. Before using a credit card check whether any service charge is applicable. Also, in some countries/states there could be an extra service tax applicable for transactions paid through a credit card.
Do I have to pay interest whenever I borrow?
No. Credit card issuing banks offer you an interest-free period of up to 55 days, after which the payment has to be made on purchases made against your credit card. You have the choice of carry forwarding your out standings by the payment of a ‘minimum due amount’ (generally 5% of the outstanding). If you pay off the entire amount within the interest-free period, then no charges are due. However if you choose to avail of the credit facility, then a credit charge is levied which generally varies between 2.5% to 3%. It should be noted that though the notional interest free period is for 40-55 days, billing is done monthly, so the actual interest free period could vary depending on whether the purchase was made at the start or the end of the billing period.
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