chapter- 1.11 Long-term Financial Instruments

1.11 Long-term Financial Instruments

Various Financial Instruments

Traditional Financial Investments

Term Deposits

A time deposit, also known as a term deposit, is money deposited with a banking institution that cannot be withdrawn for a certain ‘term’ or period of time. When the term is over it can be withdrawn or it can be reinvested for another term. The avenues for such investments include:

• Commercial Banks
• Post Office
• Non-Banking Financial Companies ( NBFCs )

Recurring Deposits

The objective of the scheme is to enable the depositor to make a financial position for his future needs by paying monthly installments for an agreed period. It will be known as a recurring deposit amount. The avenues for such investment are the same as above.

Chit Fund (Recognised / Unrecognised)

This is peculiar to India and operates by enrolment of members. The members’ pool money once in a month and the pooled amount is given to one of the members usually by draw of lots or using a chit. Hence the name chit fund. However, if members opt go for auction, their amount of profit could be more.

For example, let us suppose that you join a chit fund with 20 people, each promising to contribute Rs 2,000 per month for 20 months. At the end of your term you would get Rs 40,000. However, if in the first month somebody takes the amount by auction, say at 50 per cent loss, s/he would get in the first month 50 per cent of the whole amount i.e. Rs 20,000. Therefore the balance 50 per cent would be shared by all the other members i.e. in the next month every member needs to pay only Rs 1,000 instead of Rs 2,000.

Insurance Premiums

Life insurance in India is known to public or investors through LIC for many decades. The Life Insurance Corporation of India and other companies sell their products through a sales network called life insurance agents. There are several new players in the new millennium as insurance may now be offered by private companies as well. That means there are wide options open to customers which ensure life as well as give you a good return after maturity. In case the person availing the policy survives the period for which his/her risk of death is covered, s/he will receive a payment called a ‘survival benefit’ which is seen by many as protection plus investment. There are multiple insurance schemes and will be discussed later.

Provident Fund Schemes

These investments are available only to employees of a firm. The employees contribute to this fund through their monthly deduction in their salary. They are attractive because they also offer income tax benefits.

Pension Fund Schemes

The employee may access these funds usually after a period or 15 to 20 years or after retirement. Insurance, provident fund and pension funds have attracted investors as they offer certain income tax benefits. In India, investors traditionally invest the surplus money available to them in banks (public and private sector) despite low to modest interest rates because they consider them ‘safe’. Post offices also offer deposit schemes. They usually offer better rates of interest than commercial banks. Post offices are seen by many urban people as lacking in service (customer care) and are typically used in non-urban areas and by investors who are able to invest only small sums of money. However, the well-informed are willing to take the risk for better returns.

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Non-Traditional Financial Investments

Equity Instruments

These are documents which serve as legally enforceable evidence of the right of ownership in a firm, such as a share certificate/stock certificate. (We shall cover it in detail later).

Debt Instruments

These are documents or electronic obligations that enable the issuing party to raise funds by promising to repay a lender in accordance with the terms of a contract. It can be in the form of following (see the reference for more details).

• Corporate Securities
• Company Deposits
• Bonds
• Debentures

Bonds

It is a fixed income (debt) instrument issued for a period of more than one year with the purpose of raising capital. The central or state government, corporations and similar institutions sell these bonds. A bond is generally a promise to repay the principal along with a fixed rate of interest on a specified date, called the maturity date.

Hybrid Instruments

Generally hybrid instruments are used to refer to financial instruments that blend characteristics of debt and equity markets. For example, convertible debentures, warrants etc.

Mutual Funds

Mutual funds are investment companies that pool money from investors at large and offer to sell and buy back its shares on a continuous basis and use the capital thus raised to invest in securities of different companies. (We shall cover this extensively in the following sections).

Unit-Linked Insurance Plans (ULIPs)

A ULIP is a life insurance policy which provides a combination of risk cover and investment. The dynamics of the capital market have a direct bearing on the performance of the ULIPs.