What are Forwards and Futures

Introduction

Fundamentally, forward and futures contracts have the same function that both these types of contracts allow people to buy or sell a specific type of asset at a specific time in future, at a previously agreed price. The contracts, however differ in specific details.

Forwards & Futures Contract Features

A forwards contract or simply a forward is a non-standardized private contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today.

- As the name suggests, we look forward ahead of time to predict a price and decide the value of the Forward.

- Non standardized contract means that that the terms and conditions of the contract are not standard and would vary with each contract and the kind of asset being sold or bought.

- Future time means that the actual change of hands and payment of the asset would not happen now and would happen sometime in future.

- Price is agreed upon today between the seller and the buyer and is committed as a part of the contract

How a Forward / Futures contract works ?

Let us assume that you want to buy a house a year from now. At the same time, suppose that your friend, Ramesh currently owns a Rs. 50 Lacs house that he wishes to sell a year from now. Both parties could enter into a forward contract with each other. Suppose that they both agree on the sale price in one year's time of Rs.55 Lacs (a 10% appreciation assumed in one year). At this stage, both you and Ramesh have entered into a forward contract.

At the end of one year, suppose that the current market valuation of the house is Rs. 65 Lacs. Then, because Ramesh is obliged to sell this house to you for only Rs.55 Lacs,  you can easily make a profit of 10 Lacs. To see why this is so, one needs only to recognize that you can buy the house from Ramesh for Rs. 55 Lacs (as per the Forwards contract) and immediately sell to the market for Rs. 65 Lacs. In contrast, Ramesh has made a potential loss of Rs. 10 Lacs and an actual profit of Rs. 5 Lacs.

What is the purpose of Forwards / Futures contracts ?

Forward contracts offer users the ability to lock in a purchase or sale price without incurring any direct cost. This feature makes it attractive to many corporate treasurers, who can use forward contracts to lock in a profit margin, lock in an interest rate, assist in cash planning, or ensure supply of a scarce resources. 

Speculators also use forward contracts to make bets on price movements of the underlying asset. A very common example to hedge risks  is in cases like currency rate fluctuations. In currency forwards, one party opens a forward contract to buy or sell a currency to expire/settle at a future date, as they do not wish to be exposed to exchange rate/currency risk over a period of time. As the exchange rate fluctuates between the trade date and the earlier of the date at which the contract is closed or the expiration date, one party gains and the counter party loses as one currency strengthens against the other.

Comparison of Forwards Vs Futures

a) Futures contracts are exchange-traded and, therefore, are standardized contracts. Forward contracts, on the other hand, are private agreements between two parties and are not as rigid in their stated terms and conditions.

b) Because forward contracts are private agreements, there is always a chance that a party may default on its side of the agreement. Futures contracts have clearing houses that guarantee the transactions, which drastically lowers the probability of default to almost never.

c) For forward contracts, settlement of the contract occurs at the end of the contract. Futures contracts are marked-to-market daily, which means that daily changes are settled day by day until the end of the contract.

d) Settlement for futures contracts can occur over a range of dates. Forward contracts, on the other hand, only possess one settlement date.

e) Because futures contracts are quite frequently employed by speculators, who bet on the direction in which an asset's price will move, they are usually closed out prior to maturity and delivery usually never happens. On the other hand, forward contracts are mostly used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the asset or cash settlement will usually take place. 

f) In contrast to forward contracts in which a bank or a brokerage is usually the counter party to the contract, there is a buyer and seller on each side of a futures trade.

Cheers

Manoj Arora

Start organising your life

It is strange but true. In pursuit of achieving things in life, we sometimes forget to enjoy the results of what has been achieved.

When it comes to one's financial life, we truly work very hard to make sure that we earn more money, or we get the next progression or get the next client deal, or impress our boss, or at least make sure that we continue to earn what we are earning today. Well, all that is fine and it is always good to strive forward in life.

However, what startles me is the fact that hardly any of us have any time to manage the money that we have earned after sacrificing our health, family and peace ? Isn't that strange ? You might disagree with me and say that you manage it pretty well. You might also supplement this with the fact that you have invested in good fixed deposits, mutual funds, insurance policies, stocks etc. If you are doing it, then its fine. But i want to ask you some very fundamental and important questions and leave it to you to take a decision whether you and  your life is well organized or not.

- Do you have a documented plan for your life with clear goals / dreams with specific dates written on it ? The most common answer is that i have it in my mind. Well, yeah, that's good but that's not going to help you achieve anything as long as it stays in your mind and does not come down on paper. imagine a big 40 year project plan being executed through a plan which is just in some engineer's mind. alas, it does not work that way.

- How many of these goals ( i am assuming you know the number of goals - whether in mind or on paper) you have already achieved?  Let us assume that you have consumed 40% of your life span, so have you achieved at least 40% of your life goals ?

- Do you know exactly what are your total assets ? (Dont start calculating now. I am just poking.)

- Do you know how much is the exact total Return on investments you received last year on all your investments?, and a year before that? Please don't give me a rough figure or a figure that you "think" is the answer. Is this calculated anywhere?. I want this up to 2 decimal digits. Apologies for my swagger but thats critical to wake you up.

- Are you improving your return on investment each year (assuming you know the answer to the previous question) ? 

- Do you read enough to make sure that you learn new things and equip yourself to perform better financially every year ?

- Do you have a balanced life chart, which covers social, professional, spiritual and financial goals and targets ? Is your life truly balanced ? (or is this expecting too much from life?)

- Are you in pursuit of any one single BIG dream that is driving you crazy now a days ?

- Do you keep a track of your monthly income and expenses ? and then forecast it to plan your future income and expenses ?

Let me stop here. Don't curse me. The day you would stop ignoring these questions and start answering them, you would realise what was going wrong with your life. 

I know some of the thoughts that may already be percolating in your minds. Well, who has the time to do all this? You are right.  Who has the time to manage his or her own life when we are all so busy ? And that is exactly my point. We are so occupied earning money that we have no clue what do i do with the money that we have earned ? How can i make this money work more efficiently for me ? Forget about efficiencies, there are so many of us who do not even know how much money is locked up in which of our bank accounts, which credit card, and which mutual fund. 

I am not saying that you leave everything else and start talking about money or life, but what our life definitely deserves is to get more organised.

Ite reminds me of a short story of a small boy who goes to a garden to plant 2 trees. He has limited time, so he wants to finish this task quickly, but at the same time he also wants to make sure that he does a quality job. He decides to keep the trees aside and first dig the 2 holes needed to plant the trees. He is full of enthusiasm and energy, as each one of us are at the beginning of our money earning spree. With all the focus, excitement and energy, he digs one perfect hole in a garden. He is so happy to see the result of his hard work and immediately turns around to start and dig the next hole. As he turns around and starts digging the second hole, he does not realize that the mud coming out of the second hole is filling up the first hole itself. Well, he is short of time and can't care about every bout of mud that is getting pulled out from the second hole. There is no shortage of energy or enthusiasm as he continues to dig the second hole. The only unfortunate thing that happens is that by the time he has dug up the second hole, the first one is completely full with the mud that came out of the second hole. He turns around and realizes what mistake he has done.

We are just like that little boy, filled with energy and enthusiasm to earn money without realizing what we are doing with the money that we are digging out each month. Where is it going ? Is it efficiently returning me what it is expected to ? We don't know because we don't have time.Sad but true.

I just hope that we take out enough time in our lives to answer some of the questions above, so that we can get the reward for all the hard work that we have done till now. 

Take out time to organize your life. It will only pay you in the long run.

I want to end up with this famous quote from Tryon Edwards

Organize your life, and you will not only accomplish more, but have far more leisure than those who are always hurrying.

Happy organising

Cheers

Manoj Arora

What are Debentures

 

Those of my investors who are close to the market may have recently heard of lot of noise around Non Convertible Debentures (NCDs) being issued by multiple corporates and open for general public. Before you invest, it is always advisable to get wise about Debentures in general, and Non Convertible Debentures (NCDs). So, i thought of writing this post on this important investment tool in your kitty. Here we go.

What are Debentures?

A debenture is a document that either creates a debt or acknowledges it, and it is a debt without collateral. (For understanding Collateral, refer to the earlier post Understanding Mortgage).

In corporate finance, the term is used for a medium- to long-term debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stock or note, while in some other countries, bonds and debentures are separate instruments. (Refer to the section : "What is the difference between Bonds and Debentures" in the post below)

A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest.

What is the difference between Shares and Debentures?

Although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Debenture holders have no rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company's financial statements.

What are the different types of debentures?

Debentures are divided into different categories on the basis of: 

(1) Convertibility of the instrument 

(2) Security

Debentures can be classified on the basis of convertibility into:

• Non Convertible Debentures (NCD): These instruments retain the debt character and can not be converted in to equity shares

• Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.

• Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company.

• Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.

On the basis of Security, debentures are classified into:
• Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of either the principal or interest amount, his assets can be sold to repay the liability to the investors
• Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company.

Why Convertible or Non Convertible Debentures?
"Convertibility" is a feature that corporations may add to the bonds they issue to make them more attractive to buyers. In other words, it is a special feature that a corporate bond may carry. As a result of the advantage a buyer gets from the ability to convert, convertible bonds or debentures typically have lower interest rates than non-convertible corporate bonds.
Non Convertible Debentures are debentures without the convertibility feature attached to them. As a result, they usually carry higher interest rates than their convertible counterparts.

Typical Features of Debentures

• Debentures are listed on Stock Exchanges.
• Issuance and Trading will be in De mat form only.
• Interest will be paid through Direct Credit / ECS / RTGS / NEFT mode.
• A good credit rating is required for the company to issue a Debenture.

Who Should Invest in Debentures?

• Investors who expect a stable consistent return with least risk.
• Investors who want to have consistent monthly returns. 
• Fixed Deposit Investors can look at debentures to improvise their returns.
• Investors looking at portfolio diversification with the Fixed Income security.

What is a difference between a bond and a debenture?
In many countries, Bonds and Debentures are separate instruments. Long‐term debt securities issued by the Government or any of the State Government’s or undertakings owned by them or by development financial institutions are called as Bonds
Instruments issued by other entities are called Debentures.

What is a Coupon rate?
The Coupon rate is simply the interest rate that every debenture/Bond carries on its face value and is fixed at the time of issuance.
For example, a 9% p.a coupon rate on a bond/debenture of  $ 100 implies that the investor will receive $ 9 p.a. as the interest. The coupon can be payable monthly, quarterly, half‐yearly, or annually or cumulative on redemption

What is Put and Call Options in Debentures?

Debentures can have put and / or call options.

• A “put” option means that you have an option to surrender the debenture if you want to, and get back your principal. A put option gives a lot of flexibility to you – if interest rates go up, and you can get better rates from the market, you can exercise the put option and get back your money. You can invest it elsewhere, and get better interest.

• A “call” option means that the company has an option to ask you to surrender the debenture, and pay back the principal to you. A call option gives flexibility to the company – if interest rates go down, and the company can get funds at lower rates from the market, it can exercise the call option and give your money back to you. It can then raise money from the market at lower rates.

Income Tax on Debentures / Bonds

For income tax purpose, the debentures are treated like debt instruments. Since debenture is a capital asset, no Income Tax is deductible at source.

If you sell the debenture on the stock exchange before holding it for a year, it would be a Short Term Capital Gain – it would be included in your income and would be tax as per prevailing IT slabs.

• If you sell it on an exchange after holding it for a year or more, the gain would be long term capital gain. This long term capital gain should be calculated without indexation, and would be taxed at 10% of the gain.

Benefits of investing in Debentures 

1) Better Returns: Debentures like NCD’s (Non Convertible Debentures) provide a higher rate of interest for their investors.

2) Good Liquidity: To sell NCDs, investor has two options.

• Sell on the Stock Exchanges to anyone willing to buy
• Exercise the Put /Call option and trade it back with the issuing corporate.

Related Links :
Understanding Mortgage

Identify your Dream Momento

 

It was exactly 1 year back on the same day when our family was visiting Disney World at Orlando, Florida, USA. That visit continues to stay as one of the most amazing, memorable and also one of the most inspiring trips i every had in my life till date (i am sure there are many more to come with we being financially free soon !!)

Well, it is so easy to get lost in the adventure, excitement, fun and frolic that these Disney parks have to offer you, that you could hardly think anything else happening in the outside world . We used to start right in the morning and go past mid night, and there was never a single moment where one can feel bored or short of adrenalin rush. The whole environment that gets created in the park with dance, music, fun and adventure all around, is overwhelming for anyone. This was our first trip to a Disney park and the excitement was overflowing.

Among all this fun and frolic that the park has to offer you, there is a subtle message that is delivered in the Magic Kingdom park of Disney World. This message is about the story of Mickey Mouse and how this entire kingdom of entertainment was created because of a dream of a single man, by the name of Walt Disney. While on the Magic Kingdom park, we saw a few movies that depicted the history of the origin of mickey mouse and realization of a dream. 

To me, these entire set of parks are the result of a dream of this one man, whose dream started with a mouse. He used his hand made drawings to sketch various moods of Mickey Mouse. While the world laughed at him for imagining a park just for entertainment at that time when making two ends met was the daily struggle of everyone's life. Over and above this, consider the fact that the foundation of this dream was a character none other than a mouse. Who would have imagined that dream would get converted into such sprawling park complexes across so many countries across the globe. There are so many such parks today around the world. The man, Walt Disney, was very sure of his dream and he had a particularly strong belief in the fact that "Dreams Do Come True".

While in the park, we also saw an amazing show in the evening lawns of the Cinderella Castle which reiterated this message that "Dreams Do Come True" if we follow them, chase them and go after it in spite of all obstacles.

I was overwhelmed and inspired, and kept thinking about the whole experience we had with our dreams. I did not ever wanted to forget this experience. While we were leaving the last park on the 3rd day after seeing Magic Kingdom, Animal Kingdom and Hollywood Studios, we were shopping for our own gifts and i wanted to buy a memento that can keep this overwhelming experience alive in my heart for ever. I got a hand sized Mickey Mouse memento which has his hands up in the air. I always keep this memento on my table at home. It gives me the required push whenever i am down and out. It reminds me of my dreams that i want to achieve once i am financially free. It tells me that nothing is impossible. I look at me the first thing in the morning to solidify my dream, and to keep moving ahead.

Here is a snap of the momento that serves as my "Dream Momento".

This memento always refreshes the memories of  Disney World and also reminds me that "Dreams Do Come True". I would urge you all to define a momento for your dreams, something which can remind you of your dreams every day. Seeing such a momento every morning will not only make you feel excited about your goals and dreams but also push you forward in the right direction

Happy Dreaming !!

Cheers

Manoj Arora

Related Links :

Never Never Never Give Up

Go, Chase Your Dream !!

One person can make ALL the difference

Your Dream is your First Step

Have Hope.. and Dare to Dream !!

 

 

 

 

Understanding Mortgage

 

^{Understanding mortgage and few other key terms and concepts around it will help us understand more on this critical aspect of money management in our lives. So, lets go..}

In layman's definition, a mortgage is a loan to finance the purchase of one's home. This is clearly the biggest debt that you would ever get into in your life.

Literally, The word mortgage is a French Law term meaning "death contract", meaning that the pledge ends (dies) when either the obligation is fulfilled or the property is taken through foreclosure.

Your home is a collateral for such a loan. Collateral means anything that you pledge as security for re-payment of your home loan. For mortgage, your home is the collateral. Remember that the collateral is subject to seizure on default. It is logical and very obvious that the bank would not give you a loan which is more than the value of the collateral.

To repay the debt (loan), you make monthly installments or payments that typically include the following:

(1) Principle: The principal is simply the sum of money you borrowed from the bank or financial institution to buy your home. Before the principal is financed you can give the lender a sum of cash called a down payment to reduce the amount of money that will be financed by the bank.

(2) Interest: Usually expressed as a percentage called the interest rate, interest is what the lender charges you to use the money you borrowed.

Principle and interest comprise the bulk of your monthly payments in a process called as amortization. Amortization is a process which reduces your debt (principle) over a fixed period of time. Over this period, which can be generally anywhere between 10 to 30 years, the principle component of the loan (the original loan) would be slowly paid through Equated Monthly Installments (EMIs). With amortization, your monthly payments are largely interest during the early years and principal later.

(3) Taxes: The taxes are the property taxes your community levies based on a percentage of the value of your home. The tax is generally used to help finance the cost of running your community, say to build schools, roads, infrastructure and other needs. You must pay property taxes even after your mortgage is paid off.

(4) Insurance : Though this is optional in some regions of the world, you might definitely want to consider one or both of the following insurances to safeguard your home:

a) Home insurance This covers your home and your personal property against losses from fire, theft, bad weather, natural calamities and other causes. Even if you pay cash for your home, you should buy home insurance unless you can afford to repair or rebuild your home if it's damaged or destroyed. 

b) Life Insurance - You should consider buying life insurance if you think that it would be financially challenging for someone in your family to continue to pay the EMIs for your home in case of your death. Typically, you should go for a term plan which gives you maximum returns with minimum investments.  

Foreclosure or Repossession 

The possibility that the lender has to foreclose, repossess or seize the property under certain circumstances is essential to a mortgage loan. Without this aspect, the loan is arguably no different from any other type of loan.

Types of Amortized loans 

Across the globe, there are two types of mortgage loans available:

1. Fixed rate mortgage (FRM)

The interest rate charged by the lender is fixed at the time of signing the mortgage contract and does not vary irrespective of prevailing market and economic conditions

2. Adjustable-rate mortgage (ARM) 

This is also known as a floating rate or variable rate mortgage. In some countries, such as the United States, fixed rate mortgages are the norm, but floating rate mortgages are relatively common in other countries like India.

Adjustable rates / Floating Rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Since the risk is transferred to the borrower, the initial interest rate may be, for example, 0.5% to 2% lower than the average fixed rate.

Mortgage underwriting 

It is the process a lender uses to determine if the risk (especially the risk that the borrower will default) of offering a mortgage loan to a particular borrower is acceptable. Most of the risks and terms that underwriters consider fall under the three C’s of underwriting: credit, capacity and collateral (In the UK they are known as the three canons of credit - capacity, collateral and character).

To help the underwriter assess the quality of the loan, banks and lenders create guidelines and even computer models that analyze the various aspects of the mortgage and provide recommendations regarding the risks involved. However, it is always up to the underwriter to make the final decision on whether to approve or decline a loan.

Getting involved with real estate, and hence with mortgage loans, is a critical aspect of financial freedom, even after you are financially free.  In fact, my book "From Rat Race to Financial Freedom" will explain you how you can leverage the mortgage loans to maximize your annual returns.

Happy mortgaging till then !!

Cheers

Manoj Arora

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Push through your Self Doubt

 

For time immemorial, whenever i start working on anything new, the first thought that comes to my mind is that whether i can do it or not. Even if i know that i will be able to do it, i am not sure if i can do justice to the task at hand by giving it the best possible result in the end. am i the best available person to perform the job?

I am sure many of you, for innumerable times, must have got involved in a debate with our inner voice which makes you believe that you may not be the most capable person around to handle the goal at hand. So many times, you would have done a mental scan of a list of people who are more qualified, better skilled and appropriately positioned to handle the goal in your hand that it creates self doubt within you whether you can achieve a target successfully or not.

Welcome to the club of self doubters. First thing i must tell you is that "Don't worry !! You are not alone, and this is perfectly normal". There is a battery of success stories which have originated from a self doubting mind. Goldie Hawn pushed through his doubts to become an academy award winner. He says "I always had self doubt. I wasn't good enough. I wasn't smart enough"

One of the strategies to overcome self doubt is called as the "Done It Before Strategy". Imagine the accomplishment or a series of accomplishments that you have achieved in the past. Remember your state of mind when you started those tasks. Did you have self doubt? May be yes. But you got involved in the task, learned new things, did whatever was needed to come out triumphant in the end.

Tiger Woods uses this strategy and has to say this to himself when he goes for a high pressure putt - "I have done this a thousand times earlier. Relax, i can do it one more time"

Self Doubt, to an extent, is a very positive sign. It can also be termed as "healthy insecurity" Frank Gehry, a famous architect says "I approach each project with a new insecurity, as if i am doing this for the first time".

This healthy insecurity causes us to focus on ourselves and our work and pushes us to perform the best every moment and every day of our life. Many successful people have used this self doubt as a tool to learn and perform every time without letting the past laurels to make them complacent about the project in hand. 

One of the leaders whom i personally appreciate in my last organization, used to say "You may have excelled over last 10 projects, but you are as good as the performance in your last project." To continue to perform, you need to get past your previous accomplishments and start afresh. I remember switching different roles in my organization every 1-2 years. Each time, i take up a new role, i start with a self doubt. My train of thoughts typically start with a self doubt, but then turns into a thinking process and then documenting process. I start writing on a blank sheet of paper, whatever i need to do to be successful in this new task. Every day morning starts afresh, with a defined set of tasks and a renewed enthusiasm to become successful in the latest challenge that has been thrown at me. The day goes with its own ups and downs and the next day morning is a fresh start with a fresh set of ideas that keep me going.

Financial Freedom is no different or difficult a challenge. It is definitely achievable but at the same time, the fact remains that only 1% population of the people who make an attempt towards it, ultimately succeed. If you are having self doubt, welecome to the club. But now, you got to think that you have achieved many great things in life and this is also achievable. Rather than relying on your past accomplishments, you have to take this as a fresh challenge and make it happen. This strategy will enable you to learn new things, overcome mistakes, come up with new ideas and strive you towards your goal of financial freedom. 

You can definitely push yourself out of self doubt and achieve the greatest things in life.

Cheers

Manoj Arora

Know more about Company Fixed Deposits

What are company fixed deposits?

Fixed Deposits in companies that earn a fixed rate of return over a period of time are called Company Fixed Deposits. Financial institutions and Non-Banking Finance Companies (NBFCs) also accept such deposits. Deposits thus mobilized are governed by the Companies Act under Section 58A.

How are they different from Company Equity?

when you purchase a Company Equity (shares), you become a part of the company and share the profit and loss of a company depending on the company performance. Unlike being a shareholder of a company, here you are loaning a fixed amount to a company for a fixed tenure so that they can go ahead with their business . investments. You expect a fixed return irrespective of the company performance.

How are they different from Bank Fixed Deposits?

Company Fixed Deposits are done directly with companies and not with intermediate banking institutions. Since you are directly depositing your money with the company, you have more risk and also you get more returns.

Why to invest in Company Fixed Deposits?

a) Company fixed deposits will give you a higher return than comparative bank fixed deposits. This is because of the additional risk. e.g. Shriram Transport Finance FD was offering 12% CAGR during August 2012 when the maximum FD return available from a Bank FD was 9.5%.

b) You can invest for a shorter lock in period like 6 months.

c) Company Fixed Deposits are non transferable that means there is no fear of FD receipt being stolen. In case it falls into wrong hands ,it cannot be misused. The FD holder in such a case should write to the company which shall issue duplicate deposit receipt upon execution of an indemnity and cancel the previous one. 

d) No Income Tax is deducted at source if the interest income is up to Rs 5,000 in one financial year. Investment can be spread in more than one company, so that interest from one company does not exceed Rs. 5,000

 

What are the risks associated with Company Fixed Deposits?

a) These deposits are unsecured, i.e., if the company defaults, the investor cannot sell the documents to recover his capital, thus making them a risky investment option.

b) It is difficult to choose the right Fixed Deposit in the absence of a 'rating'. This is because apart from NBFCs and housing finance companies, other companies need not go for a rating for their fixed deposits.

c) Company fixed deposits have higher risk than bank fixed deposits because these type of deposits are unsecured, if the company goes bust you will lose your money, and unlike banks, they don’t have any backing of the RBI. RBI does not rate company fixed deposits, and in case of default by the company – RBI is not going to back them in any way.

d) Company fixed deposits may be unsecured debt, which means there is no underlying collateral, and in case of default, you won’t get the funds back by selling off your documents.

How to chose a Company for a Fixed Deposit?

a) Do look at the financials of the companies. The company must be making profits and paying dividends year after year.

b) If the company is posting sustained fall in revenues and profits, it is a cause for concern. Simply avoid companies that are making losses

c) You will be better off looking at taxes and dividends paid by the company. Since these two are cash expenditures, paid to outsiders such as government and non-promoter shareholders, there is little accounting jugglery possible here. A sustained increase in taxes paid and dividends indicates that company's business is doing well. If you can do some number crunching, do look at the interest coverage ratio - just divide 'earnings before interest and tax' by the interest paid by the company. Higher the number, the better it is. You can also look at the debt-equity ratio - total debt divided by shareholder funds. Lower the number, the better it is.

d) Look for a good rating on the deposit scheme wherever available.

Other important notes on Company Fixed Deposits

a) Company fixed deposits are rated by Rating Agencies. The rating agencies hand out ratings to the particular offering, and that can help you make a decision. For example, The Shriram Transport Finance FD scheme was rated tAA (investment grade) by Fitch. These ratings can help raise flags if any offering is rated low, and you can possibly avoid such fixed deposits.

b) Today, investors have many such options like Ansal Housing, Apollo Hospitals, Unitech, Bilcare, Godrej Properties and Unitech. Typically, one can earn around 9-12% from these company fixed deposits.

c) In case of companies listed on stock exchanges, you can get yearly and quarterly numbers of these companies on websites of the exchanges.You can get most of the information about a company when you go to your securities account or visit other common websites like http://www.nseindia.com/ or http://www.moneycontrol.com

d) Company fixed deposits are not always unsecured debt. In some cases, they issue secure debt as well.

Like most investing decisions, whether you invest in these things or not, and how much money you do will depend on your particular circumstances. If you prefer safety over everything else, then it is best to leave these things alone. If you have a moderate risk appetite then you might as well try investing money with some of the better known companies.

A beginner in this field may be lost in the numbers game. Hence it is better to stick with companies that are accepting fixed deposits for a long period of time. A long track record surely offers some comfort.

An extra 1 to 2 % of interest earned through thoughtful investment in a consistent manner in company fixed deposits can go a long way in fast pacing your financial freedom. The reason for that is simple. There is an amazing power in compounding.

Cheers

Manoj Arora

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