CFP - Module 1 - IIFP - Students

MODULE POSITIONING
OS ON NG
• Foundation Module for your programme
• Understand the process of financial planning
• Preview into the world of a financial planner
• Sneak
S k view
i of
f the
h other
h specialist
i li subjects
bj iin the
h course
• Obtain the beginner level understanding of specialist

subjects
bj t
DREAMZ INFINITE FINANCIAL PLANNERS

OUR S
OU STRATEGY
EGY
• Understand the subject
• Concentrate on TVM sums
• Understand basics of specialist subjects
• Understand
U d d application
li i of f the
h bbasic
i kknowledge
l d
• Be equipped with Code of Ethics

FINANCIAL
FIN N I L
PLANNING

FINANCIAL
F N N L PLANNING
L NN NG -
DEFINITION
• Systematic, scientific and disciplined process to help people

achieve their financial goals
• Relationship focused process

PROFESSIONAL
WORLD OF A
FINANCIAL PLANNER

Work of Financial Planner
• Financial planner helps people achieve their financial
goals by:
– Making informed decisions about their money and
how it can be used to best advantage
– Develop a sound financial plan covering all aspects
of their financial well being
(from wealth creation to wealth protection)
– Choose products that meet their specific needs;
and
– Review their
h financial
f l situation on regular
l basis
and revise their financial plan as necessary

Work of
W f Financial
F Planner
Financial planner is similar to the medical
general practitioners
Caring for the financial health of the client
Establishing long term, trusting relationship

with the clients,
ANNumber
b of f professional
f i l responsibilities
ibiliti and
d
obligations are conferred

Regulatory Framework
• The financial planning business is regulated by a number of
laws principally
laws,
– the Securities (Contracts) Regulation Act, 1956
– the SEBI Act, 1992 for securities trading,
– the Insurance Act, 1938
– the Insurance Regulatory and Development Authority
Act, 1999 for life and general insurance
– the Consumer Protection Act, 1986 for protecting
consumers against misconduct, misrepresentation, and
unfair trade practices.

Regulatory Framework
– Business will also be regulated by the various codes of
practice
mainly the FPSB’s code of practice and the life and

general insurance codes of practice.
Scope
p of Services
• The comprehensive or holistic approach to financial planning
- initial analysis of the client’s total financial well-being –
b th now and
both d in
i ffuture
t
• In addition to investments, other areas covered are estate

planning, insurance risk management, income and
expenditure, retirement benefits, wealth accumulation and
taxation
• Consumer may request for a limited service

Scope of
f Services
• Th
The planner
l mustt clearly
l l establish
t bli h att the
th commencementt of
f
dealing with the client that a limited service is being
provided
• If the client has requested a limited service,

the financial planner should obtain such a request in
writing from the client.
p
• Independent advisory
y services

Remuneration Models
Service Fees :
Clients pays a fixed fee for the provision of advice and

ongoing reviews as agreed between the two parties.
Commissions :
Commission payments represent a process of ‘selling’

investments; that is, a process designed to convince the
client that he/she should invest in particular investment
products.
d

Categories of Potential Clients
B
Broad
d C
Category
t A
Age G
Group
Young Adult 18-25
g Family
Young y 25-35
Mature Family 35-45
Empty Nesters 45-55
Self
S lf E
Employed
l d /Business
/B i
owner
High- Income earner
Pre-retiree/ retiree 55-65+

Relationship with other
professionals
Chartered Accountants;
Attorneys;
Lawyers;
Insurance Agents;
Investment Agents;
g
Brokers, etc..

Professionalism in Financial Planning
• Features that characterize the membership of a profession:
– A confidential relationship between the professional

advisor and his/her client that is recognized and
protected in law;
– A relationship of special trust between the professional

advisor and his/her client;
– A high level of expertise in the professional advisor

acquired
i d through
h h an involved
i l d process of f education
d i andd
apprenticeship.

– St
Strict
i t standards
t d d and d regulations
l ti f
for admission
d i i tto
practice of the profession;
– Strict standards concerning educational qualifications to

qualify for professional practice; and
– The more recent requirement for continuing professional

education linked to a person’s continuing qualification to
practice

• Professionalism
P f i li iimplies:
li
– Pride in work
– Commitment to quality
– Dedication to the interests of the client, and
– A sincere
i d
desire
i tto h
help
l

Professional
rofess onal language of a
financial plan
• A financial
fi i l plan
l isi the
th blueprint
bl i t for
f ththe client
li t tto
proceed from their current financial position to a
more desirable p position in the future.
• Professionalism in financial planning includes the

style
l andd tone of
f language
l in
i which
hi h the
h plan
l is
i
written.

Successful Financial Planner -
Qualities
• Technical
T h i l skills:
kill
There is an achievement of technical competencies through

a course such as Certified Financial Planner Professional
Education Programme.
In addition, commitment to ongoing education and

professional development as a means of maintaining and
improving technical competencies.

Successful Financial Planner -
Qualities
• People Skills :
Strong interpersonal skills
• ‘P
‘People
l skills’
kill ’ - capacity
i to li
listen iintently
l to the
h information
i f i
which is being conveyed by the client.
• Empathise with clients at certain times as the client

explains difficulties, problems and fears
• High standard of business ethics

SIX STEP PROCESS
• Establishing client planner relationship
• Gathering client data and determining goals and objectives
• Identification of financial problems
• Preparation
p of written alternatives and recommendations
• Implementation of agreed recommendations
• Review and revision of plan

THE SIX STEPS

Establishing
Establ sh ng Client-Planner
l ent lanner
relationship
• Important step in the process
• Developing trust
p g for the meeting

• Preparing g
• Explaining your role in the context of the client

Establishing l ent lanner
relationship (contd..)
• Define the scope of the engagement:
– Identify
Id tif ththe services
i tto b
be provided
id d
– Disclose the compensation arrangements
– Determining the clients and planners responsibilities
– Establish the duration of the engagement

Establishing l ent lanner
relationship (contd..)
– Provide additional information necessary to define or limit the
scope.
– Complaint handling mechanisms – making the client aware of

the same

Gathering
Gather ng cl
client
ent data
• Important to collect all relevant data required for the

process
• Qualitative and Quantitative data collected
• Data collection forms used:

– Personal details
– Income and expenditure details
– Assets
A t andd li
liabilities
biliti d details
t il
– Insurance details

Goal Sett
Setting
ng
• Help the client in setting milestones
• Prioritizing the client’s goals
• Distinguishing between needs and wants of the client

Goal Setting
Sett ng (contd..)
• Important to factor in the following:
– Client’s
Cli t’ attitudes,
ttit d values
l and
d expectations
t ti
– Risk tolerance
– Time horizon
• Collection of supporting documents and records

Analysis
nalys s of Data
• Understand the collected information
• Analyze
A l th
the problems
bl – both
b th express and
d implied
i li d
• Support
S advice,
d i where
h no expertise
i available
il bl
• Contact client, where information collected is not sufficient

Developing
Develop ng Strategies
Strateg es
• Develop alternatives
• Use
U research,
h own or independent,
i d d in
i ddeveloping
l i strategies
i

Presenting
resent ng financial
f nanc al plan
• Discuss the draft plan with the client
• Support the presentation with diagrams and charts,

wherever necessary
y
• Presentation to make the client understand the plan

g the financial
Implementing
p
plan
• Devise an action plan to proceed
• Help the client in selection of the products
• Co-ordinate with other professionals such as accountants,

attorneys, investment advisors, wherever necessary

Monitoring
Mon tor ng the f
financial
nanc al
plan
• A continuous process
• Review
R i th
the progress of
f th
the plan
l
• Any changes in the clients circumstances to be reviewed and

incorporated
• Recommendations to accommodate any changes or new goals

GENERAL PRINCIPLES

REGULATORY REQUIREMENTS
• Public confidence – essential even for trust
• RBI, SEBI & IRDA – three main apex bodies acting as

regulators
• No direct regulation for CFPs
• Governed by the FPSB
• H
Have tto abide
bid bby th
the code
d of
f ethics
thi f for professional
f i l
conduct

CODE OF ETHICS

ETHIC
E H OF INTEGRITY
N EG Y
• Misleading advertising, promotional activities and

representation of authorities
• Responsibilities regarding funds and properties of clients
• No
N statements
t t t to
t b
be made
d misrepresenting
i ti ththe services
i

ETHIC
E H OF OBJECTIVITY
OBJE V Y
• Exercise reasonable and prudent professional judgement
• Adequate disclosures
• Adequate care to be exercised for conflict of interests
• Annual disclosure requirements

ETHIC
E H OF COMPETENCE
OM E EN E
• Be informed of the developments in financial planning
• Offer advice in areas of competence
• Reasonable standards for appointment of representatives

ETHIC
E H OF FAIRNESS
F NESS
• Prospective
P ti clients
li t iinformed
f d about
b t th
the company
• Compensation shall be fair and reasonable
• Rules to be followed by members in industry too
• Disclosure requirements to be maintained with employers

E H OF
ETHIC
CONFIDENTIALITY
• Clients details to be kept confidential, some exceptions
provided
• Members doing business owes responsibility to act in good

faith to their employers
• Member liable to hand over to the client,

client documents of the
client, when asked for

E H OF
ETHIC
PROFESSIONALISM
• Respect for other financial planning professionals
• Maintain professional indemnity insurance
• Members should not misstate their authority to represent

the FPSB

ETHIC
E H OF DILIGENCE
D L GEN E
• Services to be provided on a timely basis
• Sufficient information to be collected
• Suitable strategies to be developed
• All significant
g recommendations to be made in writing
g
• Implementation to be ensured on a timely manner
• Establish and maintain written policies and procedures for

effective control and conduct of its business

ETHIC
E H OFF COMPLIANCE
L E
• All services to be performed services in accordance with

applicable laws, rules and regulations
• Co-operate
Co operate with the FPSB in respect of any investigations
• All applicable post certification requirements to be

complied
• Effective system of supervision of all representative

activities performance and training
activities,

LECTURE 2
TIME VALUE OF MONEY

• L
Loss of
f purchasing
h i power of f money: one of
f the
th factors
f t for
f
the interest compensation
• Interest types – Simple and Compound
p Interest – Interest p
• Simple paid as per
p the period
p nominated
for the instrument
• Compounding – takes into account growth on growth – the

multiplier effect

• Simple Interest:
Ram invests Rs. 10,000 in a bank FD which pays him 8%

p interest basis for 3 years.
interest on a simple y
Ram would receive Rs. 800 per year towards interest on the
fixed deposit, even if Ram does not withdraw the interest
on the deposit,
deposit at maturity Ram would receive a total
amount of:
Rs. 12,400
, – Principal:
p Rs. 10,000
,
Interest: Rs. 2,400 (800 * 3 years)

• Compound Interest:
In the above example, if the bank offered 8% p.a. on a

p
compounded basis,, if Ram chooses to receive the total
interest on maturity, then the bank would pay Ram
Rs. 12,597 – Principal: Rs. 10,000
Interest: Rs. 2,597
The additional amount of Rs. 197 (2,597 – 2,400) is on

account of the compounding over the three years.

• Time Value of Money:
– Singular Cash Flows
– Regular Cash Flows

• Singular
Si l C Cash
h Fl
Flows:
– Future Value
– Present Value

• Future Value:
– Calculation of Future Value

• FV = PV *[(1+i)^n]
Where:
FV = Future Value
PV = Present value
I = Interest Rate
N = No. of periods

• E
Example
l 1:
1
Abhay deposits Rs. 5,000 in a bank, which pays 8% interest

compounded annually
annually. How much will the deposit grow after 6
years?
• Solution:
– PV = Rs. 5,000
,
– Interest = 8%
– Period = 6 years
– FV = ?
Calculate using the formula or using the financial calculator
FV = 6,298.56A

• Example 2:
If Ajay borrows Rs. 20,000 @ 10% p.a. compounded half yearly,

how much amount will Ajay have to pay back after 4 years?
Solution:
- PV = Rs. 20,000
- Interest = 10% p.a. or 5% per half year
- Period = 4 years or 8 half years
- FV = ?
FV = 29,549
29 549

• Important
I t t points
i t tto remember:
b
– All the four parameters should be in equal terms
– Convert the period or the rate of interest, wherever

necessary

OTHER PROBLEMS
• R
Rahul
h l iinvested
st d Rs
Rs. 28000/
28000/-in
i ad deposit
sit for
f 5
years. Rate of interest offered to him is 12% per
annum, compounding monthly for 1st 3 years and
compounding
di quarterly
t l f
for nextt 2 years. Wh
Whatt
maturity amount will he get?
• Ans : FV = 50748
50748.73
73

• Mr
Mr. Gupta,
Gupta aged 57 years,
years has recently booked profit by
selling some shares that he purchased long time back and
got Rs. 283000/-. A Financial Planner suggested him to put
the money in a bank FD’s at this age so that the corpus
doesn’tt erode because of stock market volatility
doesn volatility. The
present ROI in bank FD of 3 years 6 months is 9.75%p.a.
compounded quarterly. Please calculate how much he will
get on maturity?
• Ans : FV = Solve=396471.54

• Sanjay has won a lottery of Rs.
Rs 10 lakhs and a Bank
approached him to get this deposit from him in the form of
a Bank FD. The Bank offered him 2 options, i) to deposit the
money for 5 years at 9% p.a. compounded quarterly and ii)
to deposit the money for 5 years at 10%p.a.
10%p a compounded
half yearly. Sanjay could not make out which option is best.
Ans. : FV = 15,60,509.20 @ 9%
FV = 16,28,894,.62 @ 10%

• Ram invests Rs.
Rs 10,000/-for
10 000/ for 3 years in a fixed term deposit
offering interest @ 6% p.a. compounding Half yearly. After
the end of 3 years Ram invests whole maturity amount of
p
this term deposit into another term deposit
p for further 2
years @ 8 % p.a. compounded quarterly. How much will be
the maturity amount Ram will get?
• Ans : FV = solve = 13,990.22

PRESENT VALUE
• Present Value:
– Calculation of Present Value

• PV = FV / [(1+i)
[(1+i)^n]
n]
Where:
FV = Future Value
PV = Present value
I = Interest Rate
N = No. of periods

• Example 1:
Ashok wishes to get Rs. 100,000 after 5 years from now. He

expects to get an annual return of 9% compounding annually, what
amount should he invest today?
Solution:
- FV = Rs. 100,000
- Period = 5 years
- Interest = 9%
- PV = ??
Calculate using the formula or the financial calculator
PV = Rs. 64,993

• Example 2:
Ram has taken a loan from Lakshman. Ram gives Lakshman 2

options of giving back the money. He asks Ram to take Rs. 50,000
today or Rs
Rs. 70
70,000
000 in 6 years time.
time Assuming that Rs.
Rs 50,000
50 000 can
be invested for 6 years @ 6% p.a. compounded annually. Evaluate
which option is better for Ram?
Solution:
There are two ways to solve this problem, either by using a PV

approach or by using FV approach.

• PV approach:
Parameters:
- FV = Rs.
Rs 70,000
70 000
- Interest = 6%
- Period = 6 years
- PV = ??
PV = Rs. 49,347
Compare this PV with Rs. 50,000 – whichever is higher is a

better option for Ram – here, option A

• FV approach:
Parameters:
- PV = Rs. 50,000
- Interest = 6%
- Period = 6 years
- FV = ??
FV = Rs. 70,926
,
Compare this FV with Rs. 70,000 – whichever is higher is a

better option for Ram – here, option A

• Complex Example:
Mr. Shah has booked a new flat in an under construction

project.
p j As per
p the payment
p y schedule,, he has to pay
p y a fee
of Rs. 100,000 today. Then Rs. 1.75 lacs after 1 year, Rs. 2.5
lacs after 2 years and Rs. 3.25 lacs after 3 years. He is
interested in setting the required amount today itself in
q
the form of a bank FD. You are required to advise how much
should he invest if the returns are 8% for 1 year, 8.5% for
2 years and 9% for 3 years, on a quarterly compounding
basis?

• Solution:
Problem to be broken down into 3 parts:
Part 1:
FV = 175,000
Interest = 2% (8% p.a.)
pa)
Period = 4 periods (1 year)
PV = ??
Calculate PV for Part I
PV = 161,673

Part 2:
FV = 250,000
Interest = 2
2.125%
125% (8
(8.5%
5% p
p.a.)
a)
Period = 8 periods (2 years)
PV = ??
Calculate PV for Part II
PV = 2,11,292.19

Part 3:
FV = 325,000
Interest = 2.25% (9% p.a.)
Period = 12 periods (3 years)
PV = ??
Calculate PV for Part III
PV = 248
248,841.92
841 92
Total PV = Part I + Part II + Part III = Rs. 721,807.05
T
Total
l amount to b
be iinvested
d iin Fi
Fixed
dDDeposit
i today
d = Rs.
R 721
721,807.05
807 05

OTHER
O HE PROBLEMS
OBLEMS
• Rahul wants to save for his foreign trip which he plans to

take after 2 years from now. He expects this trip will cost
him Rs.3,50,000/-at that time. How much should he set
p now,, if ROI is 10% p.a.
aside for this trip p compounded
p
yearly?
Ans : PV = 289256.19

• S
Sunil
il is offered
ff d Rs 80000/
80000/- after
ft 7 years.
s Wh
Whatt
amount shall he accept today in “lieu” of this
amount if available ROI is 10% compounded Half
Y
Yearlyl andd iis expected
t d tto remain
i same th
throughout
h t
this period of 7years?
• Ans : PV = 40
40,405.436
405 436

• Mr. Sharma has got his son admitted to a college today
Mr today, where he
has to pay a fee of Rs. 1 lakh today i.e. at the time of admission.
Then Rs 1.75 lakhs after 1 year, Rs. 2.5 lakhs after 2 years and Rs.
3.25 lakhs after 3 years. He wants to set aside the amount
required today itself in the form of Bank FDR
FDR. So how much he
needs to put aside today if ROI is 8% for 1 year, 8.5% for 2 years
and 9% for 3 years, all compounded quarterly?
Ans : PV = 161672.94 @ 8%
PV = 2,11,292.19@ 9 %
PV = 2,48,841.92@ 9%

• The Management of a Company knows that they will have to
pay Gratuity of approx Rs.20 Lakhs 5 years from now, to
their employees retiring at the time and approx. Rs 14
lakhs 7 years from now, for employees retiring in that year.
The company,
company presently having surplus cash flows
flows, wants to
put aside money today for that liability which is sure to
arise. If the rate of interest available in market is 10%
compounded quarterly, how much money should be put aside
today to meet these liabilities?
• Ans : PV = 12
12,20,541.88
20 541 88
PV = 7,01,228.89

TIME PERIODS
Example 1:
Sachin has been offered by his friend that Vinod that if he
invests Rs. 150,000 with him, he would provide him with interest @
10% p.a. compounded annually for the time Sachin wants to keep
the funds invested
invested. Sachin is interested in knowing how much time
it will take this amount to grow to Rs. 10 lacs?
Solution:
- FV = Rs 10
Rs. 10,00,000
00 000
- PV = Rs. 150,000
- Interest = 10%
- Period = ??
Solve for n = 20 years

• Example 2:
Sridhar wants to know how fast can he double his money at

a rate of interest of 9% p.a., if he wishes to invest Rs.
150,000 now?
Solution:
PV = 150,000
FV = 300,000 (doubling his money)
I = 9%
n = ??
Solve: n = approx. 8 years

• V
Vyass has
h s given
i a lloan tto Aj
Ajay. Loan
L amountt wass
Rs. 10,000/- and Vyas got back Rs 20,471/- from
Ajay. If rate of interest charged by Vyas was
12% per annum compounded d dM
Monthly,
thl iin h
how many
years has Vyas got back his money from Ajay?
Ans : N = 6 yearss

• Manish got Rs 44
44,423.34
423 34 as maturity amount of
his deposit from ABC Chit Funds Ltd Manish has
given this company a deposit of Rs 27,000/- at an
Annual Nominal Rate of interest of 10%
compounded monthly. How much would have been
the tenure of this deposit in Years, Half years,
Quarters and Months?
• Ans : N = 60 months

RATE
E OF RETURN
E U N
Example 1:
Amar had invested Rs. 12,000, which has grown to Rs. 20,000 in 5
years. At what rate has his investment grown?
S l i
Solution:
PV = 12,000
FV = 20,000
N=5
I=?
S l : I = 11%
Solve:

• Example 2:
XYZ Bank advertises that a deposit of Rs

Rs. 25
25,000
000 with them would
become Rs. 40,000 in four years. What is the interest rate implicit
in the offer?
Solution:
PV = 25,000
FV = 40,000
n = 4 years
I=?
Solve f
for I = 12%

• Deepak deposited Rs 60,000/-
60 000/ in a bank
deposit and got Rs. 98,317/- on maturity
after 5years. If compounding was done
quarterly,
t l whath t was th
the annuall Nominal
N i l
rate of this deposit?
• Ans : I = 2.50%

• Aj
Ajay’s
’ deposit
d i of
f Rs.
R 11,00,000/-
00 000/ earns an
interest of Rs. 32,827/- in 3 years. What
is the Nominal and Effective Rate of
interest if compounding was done Monthly?
• Ans : I = 9.48%
9 48%

• M
Mohit
hit needs
ds Rs 2,00,000/-
2 00 000/ forf afforeign
i ttrip
i one
year from now. His investment advisor tells him
about a scheme in which he can accumulate this
amountt in
i a year, byb making
ki a monthly
thl paymentt of f
Rs. 15360/- only per month for 12 months. Please
calculate for Mohit, much Nominal and effective
rate
t off Interest
I t t iis being
b i offered
ff d iin thi
this scheme?
h ?
• Ans : I = 15%

LECTURE 3
• Regular
R l C Cash
h Flows:
Fl
Annuity
Meaning:
M an ng A series
s r s of paym
payments,
nts, pa
paid at
successive intervals of time over a specified
period of time
Examples: Salary, EMIs, PF contributions

• Types
yp of Annuities:
Ordinary Annuity
Annuity Due
Perpetual Annuity
G
Growing
i Annuity
A it
Immediate Annuity
Deferred Annuity
Ordinary Annuity
– Concept
p
Cash flows occuring at the end of the periods.

F eg: Salary
For S l when
h received
i d att the
th end
d offa
month is referred to as an ordinary annuity
• Example 1:
• A 10 year ordinary annuity has a future value of
Rs 84,000.
Rs. 84 000 If rate of interest is 9%,
9% then what
would be the amount of each annuity payment?
Solution:
n = 10
i= 9%
FVA = 84,000
PMT = ?
Solve for PMT = Rs. 5,528.89
• Example 2:
Ajay wants to purchase a car 5 years from now.

His investments are presently worth Rs. 48,000.
H keeps
He k ps this investment
inv stm nt in a fixed
fix d d
deposit
p sit att a
ROI of 10% p.a. and he is ready to contribute Rs.
5,000 from the end of this month, every month
for 5 years in a RD
RD. What would be his accumulat
accumulat-
ed savings in these accounts at the end of 5 yrs?
Solution: PV = 48000
PMT = 5000
n = 5 * 12 = 60
i= 10/12 = 0.833%
FV = ??
Solve for FV = 466,160.18
• Annuity Due
– Concept
Cash flows occuring at the beginning of the

periods.
For eg: Salary when received at the beginning

of a month is referred to as an ordinary
annuity
• Example 1:
A 10 year annuity due has a future value of Rs.

84,000. If rate of interest is 9%, then what
would
uld b
be th
the amount
m unt off each
ch annuity
nnuit payment?
p m nt?
Solution:
n = 10
i= 9.35%
FVA = 84,000
84 000
PMT = ?
Solve for PMT = Rs

Rs. 5
5,072.37
072 37
• Example 2:
Ramesh wants to start a recurring deposit, by

making equal contributions` at the beginning of
every month for 5 years.
years He wants to accumulate
Rs. 500,000 in this period. How much should be
his monthly contribution if the rate of interest
offered
ff by
y the bank is 9% pp.a.?
Solution:
n=5 5*12
12 = 60
i= 9/12 = 0.75%
FV = 500,000
PMT = ?
Solve PMT = 6,580
• Complex Example:
Amar has deposited Rs. 50,000 in a company FD,

which pays interest at the rate of 10% p.a. How
much amount
m unt c
can
nbbe withdrawn
ithd n att th
the beginning
b innin
of each year for 5 years if first withdrawal is 6
years from now?
Solution:
Problem has to be divided into 2 parts:

• Part 1:
Calculating the FV of the sum deposited now
PV = 50000
n = 6 years
i= 10%
FV = ?
Solve FV = 88,578
• Part 2:
Calculating the amount to be withdrawn at the

beginning of the next 5 years?
PV = 88578
n=5
i= 10%
PMT = ?
Solve in the begin

g mode for PMT = 21,242.42
,
• Ajay has
h to pay Vyas Rs. 2800/-/ at the
h endd of
f
every month for 2 years. If the rate of interest
is 11% p.a., then how much amount can be
accepted by Vyas to settle the loan today?
Ans. PV = 60,075.73
• Ajay is depositing Rs
Rs. 50
50,000/
000/- in an account
today an he plans to contribute Rs. 2,500/- per
month in this account after getting his salary. If
h is getting
he ttin a ROI of f 9% p
p.a., compounded
mp nd d
monthly, then how much will be the accumulated
balance in that account after 4 years?
Ans. FV = 2,15,372.04
• Ajay has deposited Rs. 5,00,000/- in a bank today
@ 9.5% p.a. He wants to know if he withdraws
this money in monthly installments
installments, at the end of
month, for 5 years, then how much will be each
installment?
Ans PMT = 10
Ans. 10,500.93
500 93
• Vyas deposited Rs
Rs. 3
3,00,000/-
00 000/ in a bank and
banker told him that from the end of the month
he could withdraw Rs. 6,374/- every month for 5
years. Vyas wants to know
k how
h much
h ROI he
h is
being offered, please help him?
• Ans. I = 0.833%
• Rohan has won a lottery in which he will get Rs.
3 20 000/ every year for
3,20,000/- f nextt 20 years. Th
The
lottery organizer gave him another offer, the
offered him to take Rs. 30,00,000/- in lieu of
the above mentioned periodic payments.
payments If Rate
of Interest available is 8% p.a. Please advise
Rohan, which offer, is better for him?
• Ans. PV = -31,41,807.17 (reject the offer)

• Vyas wants to retire from work on his 60th
birthday. He wants to put some amount of
funds aside each year, so that he is able to
withdraw Rs.Rs 50,000/
50 000/- per year for 20
years once he retires, with first
withdrawal on his 61st birthday. Vyas is 20
year old
ld att present.
t HHow muchh should
h ld heh
set aside each year for his retirement goal
if he can get ROI of 10%?
• Ans.
n . PV
V = 4,25,678.186
, 5,67 . 6
• Manish is taking a housing loan of Rs. 7,00,000/
7,00,000/-
and is paying a monthly installment of Rs. 8,310/-
on this loan. If bank is charging ROI at 7.5% p.a.
on monthly rests, then in how much time can this
loan be repaid?
• Ans. N = 10 years (120 months)

• What amount needs to be invested today y at
10%p.a., so that it pays Rs. 1 Lakh p.a., for 5 years
from the 6th to 10th year? First payment starts
at the beginning of 6th year.
year
• Ans. PV = 3,79,078.68
Deepak is 35 years of age today and wants to
know that if he needs to earn an annual income of
Rs. 1,00,000/- from the age of 60 to 75 years, in
the
h beginning of f each
h year, then
h how
h muchh
amount he needs to invest today? The rate of
interest is 10%..
Ans. PV = Rs. 8,36,668.74

• Manish joins BIFM Ltd. with a salary package
• of Rs. 5,00,000/- p.a. His present age is 33
years. He wants to start accumulating funds for
buying a flat in Delhi 5 years from now. He feels
h needs
he n ds tot have
h a corpus
p s of
f Rs.
Rs 25,00,000/-
25 00 000/ forf
this dream. He wants to contribute 50% of this
target from his own savings. His financial planner
advised him to save Rs 1212,800/
800/- p.m.,
p m starting
from today, for 5 years in a scheme to reach is
goal . Please calculate what is the rate of return
being
g projected
p j by
y his Financial Planner in the
offered scheme.
• Ans. I = 1.50%
• Vyas has got Rs
Rs. 5
5,93,170.54
93 170 54 as maturity proceeds
of his Life Insurance Policy. His annual premium
was Rs.15000/- p.a. and he paid his premium for
16 years.
s Pl
Please
s calculate
l l t th
the rate
t off return
t n that
th t
he got on this policy?
• Ans. I = 10%
LECTURE 4
TEST QUESTIONS

• At the time of retirement,, Mrs. Shyamala
y is given
g
a choice between two alternatives:
– an annuall pension of
f Rs. 10
10,000
000 as llong as she
h
lives; and
– a lump sum amount of Rs. 50,000 .
If Mrs. Shyamala expects to live for 15 years and

the interest rate is 15%, which option appears
more attractive?

• A 12-payment annuity of Rs. 10,000 will begin 8
years hence (the first payment occurs at the end
of
f 8 years).
) Wh
What iis the
h present value
l off this
hi
annuity if the discount rate is 14%?

• Fifteen annual p
payments
y of Rs. 5,000/-
, are made
into a deposit account that pays 14% interest per
year. What is the future value of this annuity at
the end of 15
5 years?

• As p
per the latest advertisement,, IDBI Bank
states that it will pay a lumpsum of Rs. 44,650/-
at the end of 5 years to the investors who deposit
annually Rs. 6,000/- per year. What is the
interest rate implicit in the offer?

• Shahrukh Khan wants to g
go on a world tour which
will cost him Rs. 1 million. He is able to save Rs.
80,000/- annually to fulfill his desire. How long
will he have to wait if his saving are able to fetch
him a return of 14%p.a.

• Michael Schumacher received an amount of Rs.
20,00,000/- on retirement from the Ferrari’s. He
deposit it in his bank account which pays him 12%
interest. If he withdraws annually Rs. 2,00,000/-
how long he can continue to do so.

GROWING
ANNUITIES

• Type 1: The formula for calculating FV of a
growing annuity where contribution increases by a
Fixed Percent age every year is:
F of
FV f Growing
G Annuity =
PMT x [{(1+R)N – (1+G)N}/{(1+R)-(1+G)}]
Here
Here, PMT = First installment
N = No. of Periods
R = Rate of Interest
G = Growth Rate of Periodic

• Type 2: The formula for calculating FV of a growing annuity
where contribution increases by a every year is:
FV of Growing Annuity =
A x SN + [[D x ((SN –N)/I]

) ]
Here, A = First installment

SN = Future Value of Ordinary Annuity of Re.1
f “N” period
for i d att “I” Interest
I t st
N = Period of Deposit
I = Rate of Interest
D = Amount Growing per periodic installment

• Rahul is 30 years of age and is currently earning a
annuall salary
l of
f Rs
R 33,00,000/-p.a.
00 000/ He
H has
h started
t t d
saving 10% of his salary at the end of each year.
What accumulated amount he would be having g in
this scheme at his retirement age of 60?
• Ans. FV = 1,63,29,000/-
• Deepak is 40 years of age and he is getting a
salary
l of
f Rs.
R 3838,000/-
000/ per month.
th HeH wishes
i h to
t
save 20% of his every Quarterly Salary every
year at the end of the year.
y y If his salary
y
increases by 10% every year and ROI is 11% p.a.
then what will be his accumulated saving at the
age of 58?
• Ans. FV = 89,70,432

• Debashish opened
p a monthsly
y recurringg deposit
p
account with an initial deposit of Rs. 5,000/-. If
he increases his investment by a fixed amount of
Rs 100/- every month,
Rs. month then what would be the
amount in his account after 3 years, assuming that
rate of interest remains constant at 9% p.a.
• Ans. NFV = 2,74,416.42

• Perpetual
P l Annuity
– Concept:
• Fixed amount being received till perpetuity,
where n (no. of periods) is unknown
• Formula:
– PV of perpetual annuity
= Annuity required/ Rate of interest

• Example 1:
Amar wants to initiate an endowment prize in his school in

memory of his son.
son He wants an amount of Rs.
Rs 1,500
1 500 being
passed on to the student who scores the first rank every
year in Standard 8. How much amount should the school
take from Amar, if it expects an interest rate of 6%?
Solution:
PV of perpetuity = Annuity/ Expected rate of interest
= 1500/0.06
= 25,000

• Rahul wants to invest some amount of money
today so that, if rate of interest remains
constant, he gets a month interest of Rs. 7500/-
every month.
m nth If th the R
Rate
t of f Int
Interess is 9%
9%, th
then
n
how much amount Rahul should invest today?
• Ans. PV of Annuity in Perpetuity = Rs.10,00,000.

• Vyas opened a SIP in a Mutual Fund scheme. He
contributed Rs. 2,500/- per month in that scheme
and his total unit holding after 4 years was worth
Rs. 1,76,522/
1,76,522/- after 4 years. He encashed it and
got the units redeemed. He wants to know how
much was his realized return on this investment.
Please tell him both Nominal Yield on the
investment.
• Ans.
A I = 11.5%
5%

EFFECTIVE RATE OF
INTEREST
NTERE T
• Effective Rate of Interest:
– Concept
– Calculation:
EROI = (1+i)^m-1
where, i= rate of interest for the period of

compounding
m= periods of compounding
m

• Example 1:
If rate of interest is 11% p.a. compounded quarterly, what is

the effective rate?
Solution:
i= 11/4 = 2.75
m= 4
S l f
Solve for EROI = 11
11.46%
46%

• Example 2:
Calculate the effective rate of interest offered by NSC,

which p
pays
y interest @ 8% p.a.
p compounded
p semi-annually?
y
Solution:
i= 4
m= 2
S l f
Solve for EROI = 8
8.16%
16%

REAL RATE OF RETURN
• Real
R lR Rate
t of
f return
t
– Concept
– Also called as the inflation adjusted rate of return
– Calculation:
RROI = [(1+r)/(1+i)]-1
[(1 )/(1 i)] 1

• Example 1:
Amrish is getting a return of 11% on his

investments. If the current inflation is at 7%,
calculate the real rate of returns?
Solution:
n= 11%
i= 7%
Solve for RROI = 3.7%

3 7%

• Net Present Value
– Concept
• A discounted cash flow method used to
evaluate the projects or investments
• Useful for decision making
• Two ways to solve:
– Present Value for each cash flow
– Using the Cash function in the financial
calculator

• Mr. Ashar invested Rs. 200,000 in an investment
th t gives
that i Rs.
R 4040,000
000 f
for th
the fi
firstt 4 years and
dRRs.
60,000 for the next 3 years. If the discount rate
is 12%, you are requested to calculate the NPV of
the cash flows?
Solution:
Method 1 – Financial calculator

Use the Cash function – input
p i=12%
Next, input the cash flow per year in the
order they occur
Solve for NPV

• Method 2:
Can be solved using

g the concept
p of PVA also
Part I:
P
Presentt Cash
C h outflow
tfl = -200,000
200 000 ((att year 0)

Part II:
PMT = 40000
n = 4 years
i= 12%
PVA = ?
Solve for PVA = 121

121,494
494 (at year 0)

Part III - a:
PMT = 60000
n = 3 years
i= 12%
PVA = ?
Solve for PVA = 144,110

144 110
Th s PVA would be at the end of the 4th year,

This
which has to converted to year 0.

Part III - b:
FV = 60000
n = 4 years
i= 12%
PV = ?
Solve for PV = 91,584
NPV = (Part II + Part IIIb) – Part I

= 13,078.40

• V
Vyass is projecting
j ti an iincome st
stream providing
idi RsRs.
2,000/- for first 3 months, Rs.3,200/- for the
next 2 months, Rs. 3,700/- for next 6 months and
R 800 for
Rs. f 2 monthsth th
thereafter.
ft Pl
Please calculate
l l t
the Present Value of this cash stream if rate of
interest is 9%?
• Ans.
Ans NPV = 24
24,513.72
513 72

• Aj
Ajay is being
b in offered
ff d 2 in
investments,
stm nts which
hich h
have
periodic cash flows. Please advise him which one
is better if rate of interest is 12% p.a.?
• Scheme 1:
– Initial Outflow = 11,00,000
00 000
– Cash Inflows = 20,000
30,000
15,000
35,000
1 15 000
1,15,000

• Scheme 2:
– Initial
I iti l O
Outflow
tfl = 11,00,000
00 000
– Cash Inflows: NIL
60,000
18,000
36,000
1 20 000
1,20,000
A
Ans. NPV = 39,946.88
39 946 88
NPV = 51,613.55
Recommend Scheme 2

• Internal Rate of Return:
Concept:
Rate at which the present value of outflows

equals the present value of inflows
Can be used to compare

p the returns of 2
investments for their evaluation

• Calculation:
– Trial and Error method
– Using financial calculator

(Sums solved herein are based on the use of
financial calculator)

• Example 1:
In the previous sum, find the IRR?
Solution:
Steps to solve the problem using the calculator is
th same
the s m ass for
f NPV.
NPV
ff
Difference – the rate ((i)) will not be input,
p , the
cash flows will be entered in the same order and
then solve for IRR
Answer = 14%

• Manish invested in a Limited Payment
y
Endownment Policy of sum assure of Rs.
3,00,000/- in which policy term was of 15
years b
butt premium
i was payable
bl only
l for
f 5
years. He paid an annual premium of Rs.
24 863/ and got Rs.
24,863/- Rs 5,30,000/-
5 30 000/ on
maturity after 15 years. Please calculate
the Rate off Return
u he g got?
• Ans.
Ans IRR = 11
11.69%
69%

LECTURE 5
Payback period :
- Traditional method of evaluation of projects

- does not use the discounted cash flow methods
- takes into account the speed at which the cost
of the project is recovered
• Calculation:
– PBP is that
h period in which
h h the
h originall
investment is recovered in periodic cash flows:

• Example 1:
Dinesh invested Rs. 100,000 in a scheme that pays

back Rs. 28,000 per year for 5 years. Calculate
the Payback period?
Solution:
Initial outflow = Rs. 100,000

Yearlyy inflows = Rs. 28,000
,
PBP will be [28000 + 28000 + 28000 +

( 6000/ 8000)]
(16000/28000)]
= 3.57 years

• Example 2:
Consider the problem used for the NPV method
the PBP would be worked out as:
=[40000+40000+40000+40000+(40000/60000)]
= 4.67
4 67 years

• Ram made some investment in which initial cash
outflow was Rs. 40,000/- and its yield cash
inflows for next 5 years. Please calculate the Pay
Backk period.
d The
h cash h inflows
fl of
f 5 years were as
follows:
• Year 1: Rs
Rs. 12
12,000/
000/-
• Year 2: Rs. 10,000/-
• Year 3: Rs. 14,000/-
,
• Year 4: Rs. 8,000/-
• Year 1: Rs. 10,000/-
• Ans. PBP = 3.5 years

INVESTMENT
INVES MEN
CONCEPTS
• Holding Period Return
– Concept
– Calculation of HPR
HPR = (Current Yield + Price Change)/ Initial

Investment
Current Yield = Dividends, Interest income

earnedd
Price change
g = Capital
p Appreciation
pp

• Example
E l 1:
Ajay bought some shares for Rs. 75,000. After 1 year

he gott a dividend of
f Rs.
Rs 1500.
1500 One year after receiving
receivin
the dividends, he sold these shares for Rs. 90,000.
You are requested to calculate the HPR for Ajay.
Solution:
Dividends = 1,500
1 500
Price Change = (90,000 – 75,000) = 15,000
HPR = (1
(1,500
500 + 15
15,000)/75,000
000)/75 000 = 22%

• Example
p 2:
Mahesh invested Rs. 20,000 in shares of Infosys Ltd.

He got a dividend of Rs. 1,200 after one year. In 2nd
year, h
he gott a dividend
di id d of
fRRs. 11,400
400 and
d th
then sold
ld
these shares for Rs. 25,000 after receiving the
dividends. Calculate the HPR.
Solution:
Dividends = 1,200
1 200 + 11,400
400 = 2
2,600
600
Price Change = (25000 – 20000) = 5,000
HPR = (2600 + 5000)/ 20000 = 38%

• C.A.G.R
– Concept
– Calculation of CAGR
CAGR = [{(1 + HPR)^1/n} – 1] * 100

• Example 1:
Ajay bought some shares for Rs. 75,000. After 1 year he

got a dividend of Rs. 1500. One year after receiving the
dividends,, he sold these shares for Rs. 90,000.
, You are
requested to calculate the HPR for Ajay.
Solution:
HPR = (1,500 + 15,000)/75,000 = 22%

(as worked out in the previous slides)
CAGR = [{(1+0.22)^1/2}-1]*100
= 10.45%
10 45%

• Example
p 2:
Mahesh invested Rs. 20,000 in shares of Infosys

Ltd. He got a dividend of Rs. 1,200 after one year.
In 2nd year, he got a dividend of Rs. 1,400 and
then sold these shares for Rs. 25,000 after
receiving the dividends. Calculate the HPR.
Solution:
HPR = (2600 + 5000)/ 20000 = 38% or 0.38
CAGR = [{(1+0
[{(1+0.38)
38)^1/2}
1/2}-1]*100
1]*100
= 17.47%
CALCULATING
REQUIRED RATE OF
INTEREST
• What rate of interest is required to maintain an
investment if the inflation is 6% and tax rate is
10%?
Ans.
n . ROI = 6.67
6.67%

• What rate of interest is required to maintain an
i
investment
t t if th
the inflation
i fl ti iis 4.90%
4 90% and
d ttax rate
t
is 10%?
• Ans. ROI = 5.44%

• Risk and return concepts:
– Standard
St d d D Deviation
i ti
• Deviation from the expected returns
– Variance
q
• Derived as the square of
f standard deviation
of a security

• Example:
Following are the returns of a stock during the last five
years:
Year Return
1 6%
2 4%
3 5%
%
4 -7%
5 8%
Compute the following:
a. Standard Deviation of the stock

a
b. Variance of the stock

Period Returns R - E (R) [R - E (R )2]
1 6 2.8 7.84
2 4 08
0.8 0 64
0.64
3 5 1.8 3.24
4 -7 -10.2 104.04
5 8 4.8 23.04
E(R ) = 3.2
sum of [R - E (R )2] = 138.8
Variance = 27.76
S.D. = 5.27

– Beta
• Measure of volatility of a security or a
portfolio in comparison to the market as a
whole – sensitivity of a stock with respect
to the market

• Performance Measures for Portfolio returns:
– Treynor Measure:
= (Rp – Rf)/b
Where, Rp
p = return on portfolio
p
Rf = risk free return
b = beta of portfolio

• Example:
Fund Alpha’s expected return = 12%

Beta of the fund = 0.4
Ri k f
Risk free rate
t = 8%
Solve for Treynor’s Index?
T. Index = (12-8)/0.4 = 10

– Sharpe Measure:
= (Rp – Rf)/S.D.
Rf)/S D
Where, Rp = return on portfolio

Rf = risk free return
S.D. = Standard Deviation of portfolio

• Example:
Pioneer Mutual Fund has delivered an average
return of 10% over the last yyear and has a
standard deviation of 0.15. Calculate the sharpe
measure for Pioneer, if the risk free return is 5%.
Solution:
Rp = 10%
Rf = 5%
S.D.= 0.15
Sharpe measure = (10-5)/0.15 = 33.33

• Jensen’s Measure:
= Rp – [Rf + b(Rm-Rf)]
Where, Rp = return on portfolio

Rf = risk
i k free
f return
t
b = Beta of the portfolio
Rm = return on market portfolio

• Example:
Pioneer Mutual Fund has delivered an average return of 10%

over the last year and has a beta of 0.95. During the same
time, the market index delivered returns of 12%. Calculate
the Jensen
Jensen’ss measure for Pioneer
Pioneer, if the risk free return is
5%.
Solution:
Rp = 10%
Rf = 5%
Rm = 12%
b = 0.95
0 95
Jensen’s Measure = 10 – [5 + 0.95(12-5)] = 4.335

BOND PROBLEMS
• Bond
B dP Problems:
bl
2 types of problems:
On Finding
One: F n ng out th
the curr
current
nt pr
price/
c / value
a u of th
the
bond
Two: Finding out the YTM

• Current Price of the Bond:
- Concept:
p used to find out the right
g price
p of the
bond, where the expected rate is different than
the coupon rate.

• Example:
What will be the value of the bond with a par
value of Rs. 1,000 that yields 8% return and will
mature after 5 years? The market rate in the
bonds market is 6%
Solution: FV = 1,000
PMT = 80
n=5
i= 6%
PV = ?
PV = 1,084.24

• Example:
A bond (face value of 1,000) with a yield of 12%, pays

interest semi-annually. The bond has a term to maturity of
4 years.
rs Th
The expected
xp ct d yield
i ld is 14%
14%, find its current
curr nt pric
price?
?
Solution:
FV = 1,000
PMT = 60 (semiannually)
n = 8 (semiannually)
i= 7%
Solve for PV = ?
Ans = 940.28

• Yield to Maturity of the Bond:
– Concept:
• It is the internal rate of return of the bond
that equates the present value of the bond’s
outflows
fl to the
h present value
l off its inflows
fl
• In case the market rate of interest is
different than the coupon rate
rate, YTM of the
bond will be different than the coupon rate

• Example:
Ramesh
R h purchased
h d a Rs.
R 1,000
1 000 f
face value
l b bond
dffor R
Rs.
1032.40. The bond has a 10% coupon rate and four
years to maturity, it makes annual payments.
Solution:
Using the calculator
FV = 1,000
PV = 1032.40
PMT = 100
n=4
i=?
S l f
Solve for ii, which
hi h is
i the
th YTM = 9%

AMORTISATION
MOR IS ION
SCHEDULES
• Amortization Schedule:
– Concept
• Schedule depicting the payment of the loan
instalments
• Also depicts the break-up
break up of the loan
instalment into the principal and interest
repayment
• Most commonly used method is the EMI
schedule

• Example:
Amrish has taken a loan amounting to Rs. 500,000.

XYZ Bank has offered him an interest rate of 9%
p.a. for a tenure of 20 years. Amrish is interested
to know how much of EMI will he have to pay for
the same and also the repayment schedule for the
first 2 years.

• Solution:
First step: To find out the EMI or the monthly repayment

figure using the PVA/ FVA formula:
PV = 500,000
n = 240 months
i 9/12 = 0
i= 0.75%
75%
PMT = ?
Solve for PMT = 4

4,499
499 or approx 4
4,500
500
Next Step would be to draw the amortization schedule for

2 years!
y

Months EMI Interest Principal O/s Principal
1 4,500 3,750 750 499,250

2 4,500 3,744 756 498,494
3 4,500 3,739 761 497,733
4 4,500 3,733 767 496,966
5 4,500 3,727 773 496,193
6 4,500 3,721 779 495,415
7 4,500 3,716 784 494,630
8 4,500 3,710 790 493,840
9 4,500 3,704 796 493,044
10 4,500 3,698 802 492,242
11 4,500 3,692 808 491,434
12 4,500 3,686 814 490,619
13 4,500 3,680 820 489,799
14 4 500
4,500 3 673
3,673 827 488 972
488,972
15 4,500 3,667 DREAMZ833
INFINITE FINANCIAL PLANNERS
488,140
16 4,500 3,661 839 487,301
17 4 500 3 655 845 486 456
MEAN
ME N – ARTHEMATIC
R HEM I
MEAN

GEOMETRIC MEAN

• Compute Geometric Mean return for an
investment with the following per period return
8.9% , 10%, 7.7%, 13%?
Ans. GM = 9.88%

• Four Portfolios have an annual return of 5%, 8%,
12% and 19%
19%. Assuming Rs 50,000/
50 000/- is invested in
each portfolio. Calculate the average rate of
return on the portfolio?
• Ans. ROR = 11%

• Sathi owns the following portfolio.
Shar Weigh Beta Exp.

e t R t
Return
1. 0.30 1.20 20
2
2. 0 25
0.25 0 75 15
0.75
3. 0.45 1.0 22
• What is the expected rate of return on the

portfolio?
• Ans. Expected rate = 19.65

• Sathi owns the following portfolio
Share Weight Beta Exp. Return
1
1. 0 30
0.30 1 20
1.20 20
2. 0.25 0.75 15
3
3. 0 45
0.45 10
1.0 22
• What is the Portfolio Beta?
• Ans. Portfolio Beta = 0.9975

• Following are the information of three mutual funds,
funds
Reliance, TATA, SBI and the market.
Mean Standard Beta

Return % Deviation%
Reliance 14 17 1.2
TATA 10 15 0.95
SBI 13 19 1.35
Market
M k t 12 18 1
1.
Index
The risk free return rate is 5%. Calculate the Treynor

Measure of Reliance Fund.
Soln = 7.5

• The market price of a bond is Rs 1600/- and the
face value of Rs
Rs. 2000/-
2000/ . The bond will pay
interest @ 5%p.a. for 3 years and redeemed at
par. Compute YTM?
• Ans.
Ans YTM = 13
13.54
54

• A Rs.10,000/- face value zero coupon bond with a
10 y
years term to maturity.
y Currently y sells as to
produce on 8% YTM. What is the bond’s price?
Calculate the bond’s price if its yield rises to
10% its yield falls to 5%?
10%.,
• Soln. = 4632,3855,6139
, ,

• Rajiv recently purchased bond with a Rs. 1,000/-
face value, a 10% coupon rate, and four years to
maturity The bond makes annual interest
maturity.
payments the first to be received in one year
from today. Rajiv paid Rs. 1032.40 for the bond.
I What is the bond’s
I. bond s yield to maturity?
II. If the bond can be called two years from now
at a price Rs. 1100, what is its yield to call?
• Soln. 9%,12.76%

LECTURE 6
EMPLOYEE BENEFITS
• Defined
D fi d BBenefit
fit plans
l
• Defined Contribution plans
• Hybrid plans

DEFINED BENEFI
BENEFIT
PLANS
• sspecifies
ifi s th
the b
benefits
fits each
h employee
l receives
i s att
the time of retirement
• employee may or may not contribute for the same
• benefit payable is not dependent on the

contributions made by the employee

DEFINED
CONTRIBUTION PLANS
• benefit payable herein is based upon the
contributions made by the employee and/ or by
the employer during the work life of the employee
• growth rate of the funds – important factor

HYBRID PLANS
• Combination of both plans
• Rate of contribution is fixed and the benefits

payable is also fixed

EM LOYEE S PERSPECTIVE
EMPLOYEE’S E S E VE –
DEFINED BENEFIT PLANS
• Advantages:
– Assured of getting a retirement benefit, which

can be ascertained even during work life
-Interest
Int st rate
t risk
isk transferred
t nsf d tto employer
mpl

• Disadvantages:
– vesting
sti period
i dbbefore
f th
the employee
l becomes
b s
eligible for the benefits
– Benefits to employees may not be given

immediately before retirement

EMPLOYEE’S
PERSPECTIVE –
DEFINED
CONTRIBUTION PLANS
• Advantages:
– No vesting period for the benefits
– No fear of employer tactics to affect the
benefit available at the time of retirement

• Disadvantages:
Di d t
– Benefit dependent on the employee’s

employee s
contributions during work-life
– Interest rate risk is borne by the employee

EMPLOYER’S
PERSPECTIVE –
DEFINED BENEFIT
PLANS
• Advantages:
– benefit payable to the employee is fixed

• Disadvantages:
– Difficult to ascertain the exact cost of the

retirement benefits for the employer
– Employer has to bear the brunt of the interest

rate
t mmovements
m nts
– Need f
for regulatory
g y approvals
pp
– Individual employee’s share difficult to be

demarcated

EMPLOYER’S PERSPECTIVE –
DEFINED CONTRIBUTION
PLANS
• Advantages:
– Employer’s liability towards the employee’s retirement
benefits is well defined
– Changes or movements in interest rates do not affect
the employer’s liability
– No need for actuarial valuations and certifications from
regulatory author
authorities
t es
– Share of each employee can be easily ascertained
– Informed decisions in relation to the promotion and pay
revisions for the employees
p y can be undertaken.

GRATUITY
• St
Started
t d of
f as a gratuitous
t it paymentt tto employees
l
in the past
• lesser benefits paid or denial of benefits to some

employees
• Governed by Payment of Gratuity Act, 1972

• Applicability:
– to every factory, mine, oilfield, plantation, port

and railwayy company;
p y
– every shop or establishment within the meaning
of any law for the time being in force in
relation to the shop & establishment Act in a
St t in
State i which
hi h 10 or more persons are
employed, or were employed, on any day of the
preceeding twelve months
– such
h other
th establishments
t bli h t or class
l of
f
establishments, in which ten or more employees
are employed, or were employed, on any day of
the preceeding 12 months,
months as the CG my by
notification specify in this behalf.

• Liability to pay gratuity under the Act:
– Mandatory to pay gratuity in case of
superannuation retirement
superannuation, retirement, resignation
resignation, death
or disablement.
– In case of superannuation
p and retirement,
employee should have put in a minimum of 5
years of continuous service for the liability
– But in case of employee leaving due to death or
disablement, minimum service period criteria
does not exist.

• Taxability under I.T.
I T Act:
Employees divided into three categories:

` a.
a Government employees
b. Employees covered under P.O.G.A
c. E l
Employees other
th than
th a. & b.
b

LEAVE ENCASHMENT
• Encashment can be done at retirement or
during
g period
p of
f service
• Employees divided into 2 categories –

Government & Non-government
• Encashment during
g service,, taxable in both
cases

• At retirement, whether on superannuation or
otherwise:
– Govt. employees – amount recd is exempt
– Other employees (whichever is less):
• Amount actually received
• Notified amount – Rs.
Rs 300
300,000
000
• 10 months average salary (10 months
immediately preceeding the date of
retirement)
• Cash equivalent of earned leave (Leave on
the basis of 30 days leave for every
completed year of service.)

RETRENCHMENT
COMPENSATION
• Compensation received by a workman under the
Industrial Disputes Act
• Amount exempt under this clause shall not
exceed-
– an amountt calculated
l l t d in
i accordance
d with
ith the
th
provisions of clause (b) of section 25F of the
Industrial Disputes Act, 1947; or
– such amount, not being less than five lakh
rupees, as the Central Government may,
p y in this behalf,,
specify
• whichever is less:

VOLUNTARY
RETIREMENT
COMPENSATION
• The employer has to have a separate scheme
known as the Voluntary Retirement Scheme

• Exemption under I.T:
– a public sector company; or
– (ii) any other company; or
– (iii) an authority established under a Central,
State or Provincial Act; or
– (iv) a local authority; or
– (v) a co-operative society; or
– (vi) a University established or incorporated by
or under
d a Central,
C t l State
St t or Provincial
P i i l Act
A t and d
an institution declared to be a University under
section 3 of the University Grants Commission
Act 1956 (3 of 1956); or
Act,

– ((vii)
ii) an Indian
I di I Institute
tit t of fTTechnology
h l within
ithi
the meaning of clause (g) of section 3 of the
Institutes of Technology gy Act, 1961 (59
( of
1961); or
– (viia) any State Goverment; or
– (viii)
( iii) such
h iinstitute
i of
f management as theh
Central Government may, by notification in the
Official Gazette,, specify
p y in this behalf
Upto an amount of Rs. 500,000

PROVIDENT
DE FUNDS
F D
• Statutory Provident Fund
– maintained by Government and semisemi-govt
govt
organizations, local authorities, railways,
universities and recognized educational
institutions
– Eligibility:
• Temporary govt servants after continous
service of one year, re-employed pensioners
and permanent govt servants

• Contribution
Sum to be fixed by the employees, subject to a

min of 6% of emoluments and not more than the
employee’s total emoluments.
Emoluments include pay, leave salary and any

remuneration of the nature of pay recd on foreign
service. DA excluded.

• R
Recognised
i dP Provident
id t F
Funds:
d
– Applicability:
• (a) to every establishment which is a factory
engaged in any industry specified in
Schedule I and in which twenty or more
persons are employed
l d and
d
( ) to any
(b) y other establishment employing
p y g
twenty or more persons or class of such
establishments which the Central
Government may by notification in the
Official Gazette specify in this behalf

• Contributions:
– 12 per cent of the basic wages dearness
allowances and retainingg allowance (if
( any)y)
– Reduced contribution (10%) in case of:
• In case of sick companies or
• where the accumulated losses of the
company exceeds its entire net worth at the
end of any financial year
• any establishment engaged in manufacturing
of jute, bread, coir or gum industries

• Employees
p y Pension Fund
– Carved out of the PF scheme – an eg. Of the

h b d scheme
hybrid h – employee
l does
d not contribute,
b
but employer does.
– Contribution:
• 8.33% of employer
p y contribution to PF +
1.16% by Central Government

• Employees
p y Deposit
p Linked Insurance:
– to provide life insurance benefit to employees

covered under PF
– all employees who are members of EPF scheme

get auto membership of EDLI
E
– Contribution @ 0.50%
0 50% of employees salary is
paid (max limit of Rs. 6500) and @ 0.01% as
admin charges

• No maturity benefit. Life ins cover available only
as long as member of EPF.
• In the
th event
nt of
fddeath
th off an
n employee
mpl d
during
in
employment, nominee is paid an amount equal to
the average balance in the PF account during the
past
st 12 months
ths or during
d i the th period
i d of
f
membership, whichever is less.
• If average balance exceeds Rs. 35,000 then

amount will be 35000 plus 25% in excess, subject
to max of 60,000

PUBLIC PROVIDENT FUND
• Governed under the PPF Act, 1968
• Saving avenue for self employed professionals &

employed people too
• Account can be opened:

– SBI branches and its subsidiaries
– Head Post Office
– Sub-post offices
– Any of the nationalised banks

TAX TREATMENT
• Statutory Provident Fund:
– Employer’s contribution – exempt from tax
– Employee’s contribution – deduction u/s 80-C
– Interest on PF balance – exempt from tax
– Lumpsum payment at the time of retirement –

exempt from tax

• Recognised Provident Fund:
– Employer’s
p y contribution – exempt
p upto
p limits
– Employee’s contribution – deduction available
– Interest on contribution – exempt upto limits

exempt in case of certain conditions

• Unrecognised
g Provident Fund:
– Employer’s contribution – taxability deferred
– Employee’s contribution – no deduction

available
– Interest on contribution – exemption based on

limits

taxability as laid down

SUPER ANNUATION
• Ch
Characteristic
t i ti – DB or DC – to
t bbe d
determined
t i db by
the employers and employees
• No statutory superannuation benefit available for

employees
• Benefit provided by employer through approved

life insurance companies

• Funding
F di arrangements:
– Payment by employer
– Payment through Trust

PAYMENT
YMEN BY EM
EMPLOYER
LOYE
• One case: No scheme, payment for annuity

restricted to only few employees at retirement –
out of current revenue
• Second case: Scheme framed, benefits paid by

the employer without any fund.
fund

• Disadvantages:
– In absence of scheme,, not everyone

y covered
– Else, payment of pension dependent on the financial

situation of the employer → No profits, no pension
– AS 15 by ICAI lays down that the retirement benefits

has to be provided on an accrual basis.
basis
– Can also arrange with Life Insurance Companies

PAYMENT BY TRUSTS
• Second method to administer super-annuation

benefits
• Separate Trust to be created, which is

irrevocable and distinct from the employer
p y
• Employer has to transfer the contributions to the

superannuation
ti benefit
b fit

APPROVED
SUPERANNUATION FUND
• H
Helps
l s an employer
l enjoy
j tax
t benefits
b fits in
i relation
l ti
to the payments made for the fund
• Defined in I.T. Act: “Approved Superannuation

Fund means a superannuation fund or any part of a
superannuation fund which has been and continues
to be approved by the Chief Commissioner or
Commissioner in accordance with the rules
contained in Part B of the Fourth Schedule.
Schedule.”

PENSION
ENS ON PLANS
L NS –
INSURANCE COMPANIES
• LIFE INSURANCE CORPORATION OF INDIA
– Both Immediate
Immed ate & Deferred Pension
ens on Plans
lans
– Jeevan Akshay V:
• Immediate
di Annuity
i PlPlan
• Purchased through single payment or regular
payment
p y too

JEEVAN AKSHAY –
TYPES OF ANNUITIES
Regular annuity for life .
• Annuity payable for 5 , 10 , 15 or 20 years certain
and thereafter as long as the annuitant is alive
Annuity for life with return of purchase price on
death of the annuitant .
Annuity increasing at simple rate of 3% p.a.
Annuity for life with a provision of 50% of the
annuity to spouse for life on death of the
annuitant
Annuity for life with a provision of 100% of the
annuity
it to
t spouse for
f life
lif on death
d th of f the
th
annuitant

• Jeevan Suraksha
• Jeevan Dhara
These are Deferred
f Annuityy plans
p that
allow the policyholder to make provision
for regular income after the selected
term
Tax relief under Section 80 CCC is
available on premiums paid under New
Jeevan Suraksha 1.

ICICI PRUDENTIAL
• Life Time Super Pension

– 5 Annuity options
– 4 Investment funds – flexibility of ULIP plans
– Tax benefits
– Life cover - optional

• Life
Lif Link
Li k S
Super P
Pension
i
– Single premium payment
– Opt
Option
on to pr
pre determine
t rm n your rretirement
t r m nt ag
age
– Also offers tax benefits

• Forever
F Life
f
– Regular premium payment terms
– Riders available with policy
– 5 options of annuity payouts
– Guaranteed additions
– Life cover available

OTHER COMPANIES
• HDFC STANDARD Life Lif
Provide both unit linked as well as traditional
p
policies
• Kotak Mahindra Life Insurance Company

– Unit linked retirement plan

PENSION PRODUCTS –
MUTUAL FUNDS
• UTI Mutual
M t l Fund
F d → UTI Retirement
R ti tBBenefit
fit
Plan
• Templeton Mutual Fund → Templeton India

Pension Plan

UTI Retirement
U et rement Benefit
Benef t
Plan
• Obj
Objective:
ti
– To provide pension to investors at the age of
58 years
y
• Functioning:
– Similar to mutual funds
– Any resident/non-resident
resident/non resident individual in the age
group of 18 to 52 years can join the plan, which
matures at age 58.
– Investments could
ld bbe lump
l sum or systematic

• The minimum investment - Rs. 10,000 (in a lump
sum or in instalments of a minimum of Rs 500 (a
maximum of four instalments a year) up to the age
of
f 52.
52
• There is no limit on the maximum amount y

you can
i
invest.
• A minimum of Rs 10,000 can be invested in a

lumpsum or periodically up to the age of 52 years
to set up
p a retirement kitty.
y

• After the age of 58, investments can be encashed
at the NAV-based repurchase price.
• If staying invested
invested, a monthly pension from the
age of 58 for the rest of your life.
• Premature repurchase before the age of 58 is
allowed at a discount of 10 per cent to the NAV.
NAV
• After the age of 52, pension begins five years

from the date of investment.
investment
• Repurchase allowed at the NAV-related
repurchase price five years from the date of
investment.
investment

PROBLEMS
• C
Concepts:
t
– Present Value of payments
– Future Value of payments
– Present value of annuities
• PMT * [(1+i)^n-1]/i
[(1 i) n 1]/i
– Future value of annuities
• PMT * [1-{1/(1+i)^n}]/i

• Problem1:
Calculate the present value of an immediate

annual annuity payable for 10 years certain at the
rate of Rs. 10,000 pp.a., the first instalment being
due at the end of one year. Assume rate of
interest as 7% p.a.

• Solution:
– Variables:
• Annuity - 10,000
• No. of years (n) - 10
• Rate of interest (i) - 7%
• Present Value - Find (?)
• Use present value of an annuity formula to

find out the present value of the income
stream
• Answer – Rs. 70,236

• Problem
P bl m 2:
What would be the p present value at a rate off

interest of 6% p.a. of a deferred annuity payable
for ten years certain, the first payment falling
due at the end of 6 years from now.
now The annuity
is payable at the rate of Rs. 100,000 p.a. for the
first 5 years and Rs. 200,000 p.a. for the next 5
years.
years

• Solution outline
outline:
– Annuity starts from year 6 (end) to year 15
(end) for a total period of 10 years
– To
T find outt th
the p
present
s nt value
l n now, ii.e. att year 0
– payment to begin at the end of 6 years from
now
– Two stage model:
• First – find out the present value of the
annuity
annu ty for 10 years
» This can be broken down into 2 parts
as the annuity payments differ over
the period of 10 years.
years
• Second – find out the present value as on
today of the amount as arrived above
• Part I:
– S
Segmentt A ((yearss 6 to
t 10)
• Annuity (A) – 100,000
• No.
No of years (n) – 5
• Interest rate (i) - 5%
• Present value at yyear 5 – Find ((?))
– PV of annuity formula – Rs. 432,947.67

– Segment B (years 11 to 15)
• Annuity (A) – 200,000
• No. of years (n) – 5
• Interest rate (i) - 5%
• Present value at year 10 – Find (?)
– PV of annuity formula – Rs. 865,895.33
– Convert this PV of annuity to present
value as on year 5
– Future value (FV) - Rs. 865,895.33
– No.
N of f periods
i d ((n)) -5
– Interest rate (i) - 5%
– Present Value (PV) - Find (?)
» Answer – Rs. 678, 451.65

• Total present value at year 5 – Rs.11,11,399.32
• Convert this amount to present value at year 0
– FV – 11,11,399.32
– n - 5
– i - 5%
– PV - ?
• Answer – 870,810.45
870 810 45

• Problem 3:
– Varun, aged 45 years saves at 8% p.a. Rs.
200 000 in the beginning of a year for the
200,000
first 8 years and then stops saving. On
retirement at the age of 65 years, he intends
to keep
k aside
id a sum of
f Rs.
R 10
10,00,000
00 000 out off the
h
accumulated amount of the above savings as
liquid
q moneyy for emergencies
g and to invest the
balance amount at 6 % p.a. providing withdrawal
of a fixed amount at the end of every year for
15 years.
years Find the amount of annual withdrawal.
withdrawal

• Solution outline:
– Retirement after 20 years
– Contribution p
period – first 8 y
years (in
( the
beginning)
– Amount to be set aside for contingencies
– To find out the amount of annual withdrawal

from the balance accumulated funds.

• Find future value at the end of 8 years for the
contribution made during this period
– A - Rs. 200,000
– n- 8
– i - 9%
– FV - 24,04,207.29

• F
Find
d future
f value
l of f the
h accumulated
l d amount at
the end of the balance 12 years
– PV - 24,04,207.29
– n- 12
– i - 9%
– FV - ? (Find)
• Answer – Rs. 67,62,229.17

• Derive amount available for withdrawals and find
out the annual withdrawal amount:
– Amount
A t as reserve – Rs.
R 500
500,000
000
– Balance amount available – 67,62,229.17 –
500,000 = 6 62,62,229.17
,6 , 9. 7
– PV - 62,62,229.17
– n - 20
– i - 6%
– A - ?
• Answer: Rs. 545,970

• Solution
S l ti outline:
tli
To arrive at the amount required to maintain her

standard of living at her retirement age by
Inflating
nf at ng h
herr per
p r annum expenditure
p n tur at th
the
inflation rate.
90% of the same would be the required

expenditure during retirement

• PV - 250,000
• n - 25 (55
(55-30)
30)
• i - 5% p.a.
• FV - ?
– Use simple PV and FV formula to solve
– Answer – Rs. 846,589

• Problem
P bl 5:
5
Sharib, aged 25 plans to retire at age 55

Sharib 55. His life
expectancy is 75. His current annual expenditure
is Rs. 250,000. He estimates no reduction in his
expenses post-retirement.
i If iinterest rate iis
expected to be 8.5% and inflation is 5% p.a., how
much will he save to p
per annum in order to achieve
his targeted income, if he does not want to leave
an estate.

– Problem to be divided into 3 parts:
• First, find the value of the annual
expenditure
d at age 55
• Second, find out the present value of the
amount needed to fund the retirement
standard of living (retirement corpus)
• Third, find out the amount to be saved per
annum during working life for the
retirement corpus.

• First step: Value of annual expenditure at age 55
PV - 250,000
n - 30
i - 5%
FV - ?
– Use the FV formula
• Answer: Rs. 10,80,486

• Second
S c nd st
step:
p: P
Present
s nt value
lu of
f retirement
ti m nt corpus
c pus
– A - 10,80,486
, ,
– n- 20 (75-55)
– i - 3.33% (real return, adjusted for

inflation) [(1+r)/(1+i)]
[(1+r)/(1+i)]-11
– PV - ? (find)
• Answer – Rs. 1,55,90,483

• Third step: Amount to be saved per annum
– FV - Rs 11,55,90,483
Rs. 55 90 483
– N - 30
– I - 8.5%
– A - ? (find)
Answer – Rs. 125,512

• Problem 6
6:
Rahul, aged 42 years has got a contractual

assignment
ssi nm nt in D Dubai
b i for
f a period
p i d off 15 years.
s HHe
has been on this assignment for the past 6 years
and has already saved Rs. 5 lakh every year. He
now plans
l s tto save
s Rs.
Rs 15 lakh
l kh for
f his b balance
l
period, then come back to India for a retired life.
If his savings earn an interest @ 7% p.a. during
th accumulation
the l ti stage,
t how
h much h money will
ill he
h
accumulate when he returns to India?

Step 1: Find the accumulated balance of the
annual savings done over the last 6 years.
years
Step 2: Find
F nd out the future value of the
accumulated value as arrived in Step 1.
Step 3: Find out the accumulated value of the

annual savings over the next 9 years
Step 4: Add step 2 + step 3

• Step 1:
– PMT - 500,000
– N - 6
– I - 7%
– FV - ? (find)
• Answer - Rs. 35,76,645.37

• Step 2:
PV - 35,76,645.37
35 76 645 37
n - 9
I - 7%
FV - ? (find)
Answer: 65,75,516.63

• Step 3:
PMT - 15,00,000
N - 9
I - 7%
FV - ? (find)
Answer: 1,79,66,983.12

• Step 4:
St 2 + St
Step Step 3
65,75,516.63
65 75 516 63 + 11,79,66,983.12
79 66 983 12 =
2,45,42,499.75

• Problem 7:
I th
In the above
b problem,
bl if his lif
life expectancy
t is 85
years and the accumulated savings earn a return

years,
of 8% p
p.a.,, how much money
y can he spend
p p.a.
p
during his retired life?

We have derived the accumulated value as at the
time
i of
f retirement,
i using
i the
h same, we can derive
d i
the spending per annum that can be made.

made

• PV - 2,45,42,499.75
• N - 8%
• I - 34
• PMT - ? (find)
(fi d)
• Answer: Rs. 21,18,118.60

• Problem 8:
Mehul,
M h l agedd 33,
33 plans
l to save 12% off hi
his salary
l at
the end of every year until his retirement at the
g of 58 years.
age y He is currently
y getting
g g an annual
salary of Rs. 360,000 which is expected to
increase 8% every year. If his savings earn 7.5%
interest p
p.a.,, how much accumulated money y will he
have on his retirement?

Problem based on increasing annuity
• Formula to be used:
A*[{(1+r)^n-(1+g)^n}/(r-g)]

A - 43,200 (12% of 360,000)
n - 25 (58 years – 33 years)
I - 7.5%
g - 8% (growth rate of annuity)
FV - ? (find)
( )
Answer: Rs. 64,81,171.44

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MODULE POSITIONING

• Foundation Module for your programme

• Understand the process of financial planning

• Preview into the world of a financial planner

• Obtain the beginner level understanding of specialist

DREAMZ INFINITE FINANCIAL PLANNERS

• Understand the subject

• Concentrate on TVM sums

• Understand basics of specialist subjects

• Be equipped with Code of Ethics

DREAMZ INFINITE FINANCIAL PLANNERS

DREAMZ INFINITE FINANCIAL PLANNERS

• Systematic, scientific and disciplined process to help people

• Relationship focused process

DREAMZ INFINITE FINANCIAL PLANNERS

DREAMZ INFINITE FINANCIAL PLANNERS

DREAMZ INFINITE FINANCIAL PLANNERS

Caring for the financial health of the client

Establishing long term, trusting relationship

DREAMZ INFINITE FINANCIAL PLANNERS

DREAMZ INFINITE FINANCIAL PLANNERS

mainly the FPSB’s code of practice and the life and

• In addition to investments, other areas covered are estate

• Consumer may request for a limited service

DREAMZ INFINITE FINANCIAL PLANNERS

• If the client has requested a limited service,

DREAMZ INFINITE FINANCIAL PLANNERS

Clients pays a fixed fee for the provision of advice and

Commission payments represent a process of ‘selling’

DREAMZ INFINITE FINANCIAL PLANNERS

DREAMZ INFINITE FINANCIAL PLANNERS

DREAMZ INFINITE FINANCIAL PLANNERS

– A confidential relationship between the professional

– A relationship of special trust between the professional

– A high level of expertise in the professional advisor

DREAMZ INFINITE FINANCIAL PLANNERS

– Strict standards concerning educational qualifications to

– The more recent requirement for continuing professional

DREAMZ INFINITE FINANCIAL PLANNERS

– Dedication to the interests of the client, and

DREAMZ INFINITE FINANCIAL PLANNERS

• Professionalism in financial planning includes the

DREAMZ INFINITE FINANCIAL PLANNERS

There is an achievement of technical competencies through

In addition, commitment to ongoing education and

DREAMZ INFINITE FINANCIAL PLANNERS

Strong interpersonal skills

• Empathise with clients at certain times as the client

• High standard of business ethics

DREAMZ INFINITE FINANCIAL PLANNERS

• Establishing client planner relationship

• Gathering client data and determining goals and objectives

• Identification of financial problems

• Implementation of agreed recommendations

• Review and revision of plan

DREAMZ INFINITE FINANCIAL PLANNERS

DREAMZ INFINITE FINANCIAL PLANNERS

p g for the meeting

• Explaining your role in the context of the client

DREAMZ INFINITE FINANCIAL PLANNERS

– Disclose the compensation arrangements

– Determining the clients and planners responsibilities