Skip to main content

Stock Markets Fall - Corporate FDs Rise

At a time when stock markets zigzag, what would be the right investment arena? Corporate FDs or equities?

THE sharp fall in the equity markets has changed a lot of things including India Inc’s fund raising plans. This, in turn, has changed investment avenues for retail investors. Till about a year ago, the only way for retail investors to participate in a company’s growth was to buy equities either in the secondary market or invest in primary issues (IPO) or rights issue.

However, the primary market option currently is almost closed with the virtual drying up of the IPO market. Bearish sentiments and lack of investors’ confidence due to wild volatility, on the other hand, has decreased the participation of investors in the secondary market. In such a situation, India Inc is now approaching the potential investors through fixed deposit (FD) schemes.

In fact, FD schemes are not new to India Inc. Earlier, every major company had an FD department and it was considered to be one of the main sources of funding. However, this way of funding decayed slowly as it became easier for companies to raise funds through equity and quasi equity. Besides, equity has no direct servicing cost (except earning and dividends expectations of shareholders), where as interest on FDs is a fixed cost and that has to be paid in all circumstances.

The wheel has now turned a full circle and newspapers are now flooded with advertisements by corporate houses inviting public to entrust their savings with them. To make the deal juicer, most of them are offering interest rates that are significantly higher than bank deposits. But, how attractive are these corporate FD schemes? Do they score over bank deposits or other traditional sources of assured returns only because former offers greater returns? For many investors corporate FDs can be lucrative substitutes for bank deposits. They not only offer higher returns, but many of them also structured similar to a bank FD with facilities, such as premature withdrawal, cumulative accrual of interest, TDS (tax deduction at source) cut up to a certain limit (Rs 5,000) etc.

However, investors should know that bank deposits are insured up to a maximum of Rs 1 lakh per customer and the way banks are regulated in India, it is difficult for retail customers to lose their money.

In contrast, corporate deposits have no such insurance and the investor is solely at the mercy of the company and its financial fate. Given this, it makes sense to invest in corporate FDs that have high credit ratings and are known for their financial soundness and credible past performance. Though corporate FDs look riskier, they carry higher interest rates.

While most corporate FDs are currently offering pre-tax interest ranging from 7–12%, for 1-3 years tenure, interest rate offered by a bank is between 10.25% and 11% for a three-year period. For one year, banks are offering 8.5-9% and there is no TDS up to an interest income of Rs 10,000 a year.

So, is higher interest rate a tempting one to invest his money in corporate deposits? Or is equity investment in these companies still a preferred route? A comparison of the current dividend yields on the company’s stock with post tax return on its FD will give an answer. The sharp fall in stock prices of most companies has led to a spike in the dividend yield, based on the dividend payout last year. Tata Motors, for instance, is available at a dividend yield of over 11% as compared post-tax FD return of 7.6%. Dividends are also tax-free in the hands of the investor. The only catch being that dividends are slave of earnings and they tend to rise and fall in line with profit growth. In the near future, market expects most companies to cut dividend payouts. However, as soon as profit growth resumes, dividends pay out will catch up and the stock prices also will begin to soar. This way, equity investors get the best of both the capital appreciation and cash flows in the form of annual dividends payouts.

But, if equity has its advantages, there are risks, too. The biggest shortcoming here is the market risk associated with equity investments. Equity is a risk capital and returns are a function of external macroeconomic environment.

FDs, on the other hand, are relatively riskfree and, in most cases, post-tax returns from FDs are much higher than the tax-free dividend yields. The risk here, however, is that of creditworthiness of a company. Meanwhile, fear of the company defaulting has become prominent after the Satyam fiasco. But, in such cases, default applies to both debt and equity investment.

Investors are thus advised to go for well known companies that have a strong and credible standing in the market. Unlike a bank FD, where high interest rates usually dominate the investment decision over the choice of bank, the integrity of the company should be given the highest priority in case of corporate FD. A few basis points should not matter, for the assurance that the capital is in safe hands.

Popular posts from this blog

All about "Derivatives"

What are derivatives? Derivatives are financial instruments, which as the name suggests, derive their value from another asset — called the underlying. What are the typical underlying assets? Any asset, whose price is dynamic, probably has a derivative contract today. The most popular ones being stocks, indices, precious metals, commodities, agro products, currencies, etc. Why were they invented? In an increasingly dynamic world, prices of virtually all assets keep changing, thereby exposing participants to price risks. Hence, derivatives were invented to negate these price fluctuations. For example, a wheat farmer expects to sell his crop at the current price of Rs 10/kg and make profits of Rs 2/kg. But, by the time his crop is ready, the price of wheat may have gone down to Rs 5/kg, making him sell his crop at a loss of Rs 3/kg. In order to avoid this, he may enter into a forward contract, agreeing to sell wheat at Rs 10/ kg, right at the outset. So, even if the price of wheat falls ...

Zero Coupon Bonds or discount bond or deep discount bond

A ZERO-COUPON bond (also called a discount bond or deep discount bond ) is a bond bought at a price lower than its face value with the face value repaid at the time of maturity.   There is no coupon or interim payments, hence the term zero-coupon bond. Investors earn return from the compounded interest all paid at maturity plus the difference between the discounted price of the bond and its par (or redemption) value. In contrast, an investor who has a regular bond receives income from coupon payments, which are usually made semi-annually. The investor also receives the principal or face value of the investment when the bond matures. Zero-coupon bonds may be long or short-term investments.   Long term zero coupon maturity dates typically start at 10 years. The bonds can be held until maturity or sold on secondary bond markets.

Mutual Fund Review: SBI Bluechip Fund

Given SBI Bluechip Fund's past performance and shrinking asset base, the fund has neither been able to hold back its investors nor enthuse new ones   LAUNCHED at the peak of the bull-run in January 2006, SBI Bluechip was able to attract many investors given the fact that it hails from the well-known fund house. However, the fund so far has not been able to live up to the expectation of investors. This was quite evident by its shrinking asset under management. The scheme is today left with only a third of its original asset size of Rs 3,000 crore. PERFORMANCE: The fund has plunged in ET Quarterly MF rating as well. From its earlier spot in the silver category in June 2009 quarter, the fund now stands in the last cadre, Lead.    Benchmarked to the BSE 100, the fund has outperformed neither the benchmark nor the major market indices including the Sensex and the Nifty. In its first year, the fund posted 17% return, which appears meager when compared with the 40% gain in the BSE 1...

Principal Emerging Bluechip

In its near ten year history, this fund has managed to consistently beat its benchmark by huge margins The primary aim of Principal Emerging Bluechip fund is to achieve long term capital appreciation by investing in equity and related instruments of mid and small-cap companies. In its near ten year history, this fund has managed to consistently beat its benchmark by huge margins. This fund defined the mid-cap universe as stocks with the market capitalisation that falls within the range of the Nifty Midcap Index. But, it can pick stocks from outside this index and also into IPOs where the market capitalisation falls into this range. Principal Emerging Bluechip fund's portfolio is well diversified in up to 70 stocks, which has aided in its performance over different market cycles. On analysing its portfolio, the investments are in quality companies that meet its investment criteria with a growth-style approach. Not a very big-sized fund, it has all the necessary traits to invest with...

Mutual Fund MIPs can give better returns than Post Office MIS

Post Office MIS vs  Mutual Fund MIPs   Post office Monthly Income Scheme has for long been a favourite with investors who want regular monthly income from their investments. They offer risk free 8.5% returns and are especially preferred by conservative investors, like retirees who need regular monthly income from their investments. However, top performing mutual fund monthly income plans (MIPs) have beaten Post Office Monthly Income Scheme (MIS), in terms of annualized returns over the last 5 years, by investing a small part of the corpus in equities which can give higher returns than fixed income investments. The value proposition of the mutual fund aggressive MIPs is that, the interest from debt investment is supplemented by an additional boost to equity returns. Please see the chart below for five year annualized returns from Post office MIS and top performing mutual fund MIPs, monthly d...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now