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Bonds

Bond is an instrument of indebtedness of the bond issuer to the holders. These are a kind of fixed income securities. Depending on the terms and conditions of the bond, interest is paid to the holder. The principal is repaid on a date that’s called the maturity date. The ownership can be transferred in the secondary market. These are more secure because here we have guaranty of repayment of principal.

Types of bonds              

Fixed income securities are generally classified on the basis of the time frame/ maturity period.

Bills: fixed income securities that have a maturity period of one year.

Notes: fixed income securities that have a maturity period between one to ten years.

Bonds: fixed income securities that have a maturity period of more than ten years.

Government bonds: These are issued by the government authorities and are as safe as the debt of a stable country. They are free from state and local taxes on the interest payments.

Municipal bonds: these are the next in matters of risk after government bonds. They are also called as “munis”. The main advantage of such bonds Is that the returns are free from federal taxes. These are very good tax saving instruments. Local governments may sometimes make their debts tax free for the residents leading to tax free municipal bonds.

Corporate bonds: these are bonds that are issued by the company to raise capital. There is no limit as such. These give higher yields than a government bond because they have a higher risk of defaulting than a government. The driving factor in case of these bonds is the credit quality. The higher the credit quality the lower is the interest rate. Corporate bonds can also be convertible is nature. The holder can get them converted into stocks or callable bonds.

Zero Coupon Bonds: This is bond that does not have coupon payment but I issued at a discount to par value.

Trading

Retail Debt Market: NSE has introduced a new and simpler way of investing in bonds and fixed income securities. The retail investors can buy and sell government securities from different locations through NSE brokers and sub brokers in the same manner as trading of equities is done. This market is known as “Retail Debt Market”.

Wholesale Debt Market:  It provides a trading platform for a wide range of debt products.

It is a market where corporate bonds, government bonds, municipal bonds, negotiable certificates of deposit, and various money market investments are traded.

Bond duration

A bond’s duration represents the weighted average time to full recovery of Interest and principal payments.

There are four main types of bond duration calculations which are as follows:

1)Macaulay duration: Macaulay duration is calculated by adding the results of multiplying the present value of each cash flow by the time it is received and dividing by the total price of the security. The formula for Macaulay duration is as follows: 

n = number of cash flows t = time to maturity C = cash flow i = required yield M = maturity (par) value P = bond price

2)modified duration: Modified duration is a modified version of the Macaulay model that accounts for changing interest rates. Because they affect yield, fluctuating interest rates will affect duration, so this modified formula shows how much the duration changes for each percentage change in yield.

3) Effective duration: The modified duration formula discussed above assumes that the expected cash flows will remain constant, even if prevailing interest rates change; this is also the case for option-free fixed-income securities. On the other hand, cash flows from securities with embedded options or redemption features will change when interest rates change. For calculating the duration of these types of bonds, effective duration is the most appropriate. 

Mutual Funds

We all know how a mutual fund works, what are its advantages and disadvantages, all spoken and heard about a lot. From an investor point of view, when it comes to investing and choosing the right type of mutual fund it gets worse than a maze. The main aim here is to explain what the different types of mutual funds are, how are they sub-divided and what are the characteristic of each.

                       

Based on Structure

Open ended Mutual Funds are not listed on the stock exchanges. They are open for subscription throughout the year. The investor can purchase funds directly from the fund and not the existing unit holders. The unit holders can buy and sell their units at the prevailing NAV.

Close ended Mutual Funds are funds that raise capital trough initial public offering (IPO). It is listed and traded on the stock exchange. They have a lock in period. Once invested, amount can be withdrawn or switched only after the completion of the lock in period. The stock prices of such funds fluctuate according to the changing market forces of demand and supply.

Based on Objective

Equity Funds: These funds typically invest into stocks. They need to be aggressively managed due to the quick changes in the markets. They are also known as Stock Funds. Depending upon the objectives of the fund they may be further categorized as abroad market, regional and single country funds (region of investment being the main criteria). They can also be categorized depending upon the sectors concentrated in the fund.

Equity funds can be further classified as follows:

                    Classification on the basis of Capitalization

                   

Ø  Large Cap Funds: It includes companies whose market capitalization is more the $10 billion.

Ø  Mid Cap Funds: It includes companies whose market capitalization ranging between $2 billion and $10 billion.

Ø  Small Cap Funds: It includes companies whose market capitalization is more the $10 billion.

NOTE: Market capitalization is calculated by multiplying the outstanding shares and the stock price per share.

                            Classification on the basis of Sector

                       

Ø  Depending on Sector: Such funds concentrate on investing in a particular sector. For example infra, pharmaceutical, banking etc.  The risk in case of these funds would be high because these funds are less diversified.

Ø  Thematic: Thematic fund is the opposite of a sectoral fund. As the name suggest, the investing of the fund follows a particular theme, for example multi sector, international exposure, commodity exposure etc.

             Classification on the basis of Index funds

                           

Ø  NIFTY Index: As the name suggests the fund invests in NIFTY. For this purpose we need to understand what we mean by NIFTY. NIFTY consists of top 50 stocks belonging to 21 different sectors of the economy. It is used for benchmarking fund portfolios, index based derivatives and index funds.

Ø  Junior Index: It represents 100 most liquid stocks traded on the NSE. A company cannot be listed on both NIFTY and NIFTY junior at the same time.

Balanced Funds:In this fund, the returns is generally a combination of  capital appreciation and current income. This is possible when the fund invests in Bonds, preferred stocks and common stocks. Depending upon the ration of debt and equity in the portfolio, the fund may be further classified as debt oriented balanced fund or equity oriented balanced fund. This is mainly preferable for investors who are looking for a mixture of safety, income and modest capital appreciation.

Debt Funds: As the name suggest the Fund mainly invests in debentures, bonds, treasury bills, Etc. Suitable for investors who are risk adverse. The incomes of these funds may not be high enough as that of a Equity oriented mutual fund. The returns are regular.

                  

Ø  Liquid Funds: Liquid funds are those funds that invest in “liquid assets”. Liquid assets are those assets that are easily convertible into cash or cash equivalents, the reason being that they have a market where people are ready to by the asset. The price fluctuations in this case is also relatively stable. These are mainly short term in nature ranging from 3 months to 1 year maturity period.

Ø   Gilt Funds: This fund mainly invests in medium and long term government securities and top corporate debt instruments. Since it invests mainly in government securities they are said to be low risk.

Ø  Income Funds: The main aim of such funds is to have regular income. It may be on monthly, quarterly or yearly basis. They invests in a variety of government bonds, municipal bonds, corporate debt instruments, preferred stocks, money market instruments and regular dividend paying instruments.

Ø  FMP: FMP stands for fixed maturity plan.  This has been introduced in the market in the recent years. These are basically debt funds with fixed duration.  Typical debt funds are open-ended. Since the duration is fixed in advance the investors cannot enter and exit as their wish.

Ø  Floating Rate Funds: In such funds the rate of interest is not fixed and changes  with change in market conditions.

Ø Arbitrage Funds: these are funds that try to take advantage of the price discrepancies of same commodities in different markets.

9 questions you must ask your financial planner. By P.V.Subramanyam. A must read

http://in.finance.yahoo.com/news/9-questions-you-must-ask-your-financial-planner-063533327.html