RUDIMENTS OF FINANCIAL PLANNING -3

Time Value of Money

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein.

All of us are aware of the proverb “ A bird in hand is worth two in the bush”. The same concept gets extended to the money as well, and we all would prefer to receive RS.100 today, instead of getting Rs.100 next year. This is because the amount of Rs.100 would fetch some interest at least Rs.40 if remains in Savings Account. Thus there is a compensation for waiting. Alternatively, the interest can be called the opportunity cost for the sacrifice of foregoing the use of money today. In short the Time adds value to the money & this is the aspect we will be discussing in this chapter. Time Value of Money ( TVM in short ) is one of the major concepts in the Financial Mathematics and Financial Management which is used to analyse, compare and evaluate different investment or loan or annuity options available. The rate at which the compensation is received in the ‘Rate of Interest’ or ‘ Rate of Return’ in the case of investments.

The following terms are extensively used under TVM concept:
1. Present Value ( PV ) – P – This is the Present Value of the Investment
2. Period ( NPER ) or N – Number of Period for which the Investment is made
3. Rate ( I ) – Rate of Interest at which the investment is made
4. Future Value ( FV ) -A – Resultant amount at the end of the period( PV + Interest)
5. Payment ( PMT ) -Series of equal installments instead of Single payment of PV

The TVM problems can be classified into just 4 categories under two types
a. Lump Sum or Series of Equal installments to
Receive
b. Lump Sum or Series of Equal Repayments ( annuities ) as Future Value

Simple Interest: Simple interest provides just the interest on the amount irrespective of whether the interest is withdrawn or not. For example, if Rs.10000 is invested under Simple Interest of 8%p. a. for 3 years , the total amount would be Rs.12400 as follows
Principal Rs.10000
Interest @8% p. a for 3 years = 10000*8%= 800*3 Rs. 2400
Total amount Rs.12400

Total amount A or FV = P + P * N * I = 10000+10000*3*0.08

Compound Interest: Under the Compound Interest, the interest also earns interest as though the same has been reinvested at the same interest rate. For example, if Rs.10000 is invested for 3 years under compound interest@ 8% p a compounded yearly, then the Total amount would be Rs.12597.12
Principal amount Rs.10000
Value after 1 year with interest @ 8% (RS.800 ) Rs.10800
Value after 2 years with interest @ 8%(Rs.864 ) Rs.11664
Value after 3 Years with interest @ 8%( Rs.933.12) Rs.12597.12
Here Rs.64 in the second year is the result of interest on the interest of Rs.800 and Rs.133.12 in the third year is the interest on 1664 ( 800+800+64) all calculated @ 8% p. a
FV or A = P(1+I)^N = 10000( 1.08)^(3 ) =10000*1.269712 =12597.12

In the above case, the interest is added back to the principal yearly – i.e. the interest is compounded yearly. It is possible the compounding could Half- yearly, quarterly, monthly or even daily. The increase in the frequency of compounding increases the total amount, which can be seen from the following example. Let us calculate the FV of an amount of Rs.10000 invested at 12% p a various compounding options for 1 Year. While PV remains the same at Rs.10000 in all cases, the Rate of Interest ( I ) & the Period ( N ) changes as below:

Annual Compounding: Here I =12, N = 1

FV = 10000*1.12^( 1 ) = 11200

Semi-annual compounding: Here the I = 12/2 = 6, & N= 2 (since there will be 2 such periods)

FV =10000*1.06^(2 ) = 10000*1.1236= 11236.00

Quarterly compounding: Here I = 12/4 = 3(being Qtly), N = 4 (compounding is Qtly)

FV = 10000*1.03^(4 ) = 10000*1.1255 =11255

Monthly Compounding: Here I = 12/12 = 1, N = 12 (as compounding is mthly)

FV = 10000*1.01(12) = 10000*1.126825 =11268.25

Nominal Rate of Return & Effective Rate of Interest: Nominal Rate of Interest is the simplest form of interest where the interest is compounded annually. Effective Rate of Interest takes into account the power and the effect of compounding when the frequency of compounding increases such as Half-yearly, Quarterly, Monthly, etc. For example the Nominal Rate of Interest is 12% p.a in all the above cases, the Effective Rate of Interest is 12.36%,12.55%, & 12.68% when the interest is compounded half-yearly, Quarterly & Monthly as the case may be.

Holding period return(HPR): Generally, the rate of return is expressed in terms of rate per annum. It is possible that a particular investment is held for certain odd period say 7months 10 days or 1 year 25 days, etc and if the investor wants to know the return he has earned on the investment for the period the investment is held, it is termed as Holding Period Return.

Calculation of holding period return is just academic as this will only indicate the gross earning from the investment and it may not be useful in comparing different products.

Real Rate Of Return ( RRR ): We all know that inflation affects everyone in some form or other. This applies to the Return on the Investment, as well. While the return on investment offers a compensation for parting with the money the inflation reduces the effect of such compensation. Suppose the investment gives a return of 10% and the inflation is 5%, the real return is roughly 5% ( 10-5 ). But the Real Rate of Return after Inflation is given by the formula:

In the case referred above, the RRR is 4.7619% [(1.10/1.05)-1] and not 5% as arrived at in the previous paragraph.

To understand the formula, let us assume that we have Rs.1000 and we are able to get 10 meals @ Rs.100 each today. After one year due to accumulation of Interest Rs.1000 would become Rs1100, taking into account the interest of Rs.100. Due to inflation of 5%, the meal would cost 105 next year. Thus Rs.1100 would be sufficient to provide 10.47619 meals ( 1100/105). Thus the Real Rate of Return comes to 0.47619 for Rs.1000 which works out to 0.047619 per 100 or 4.7619%

Internal Rate of Return( IRR ) & XIRR : In all cases discussed earlier, the return percentage on the investment is constant and the return is uniform. But in can happen that the returns or cash inflows are different during the period under study. Let us assume the case where an investment is made on a Project which obviously cannot give uniform return year after year. If the Investment is taken as ‘Cash outflow’ ( -ve ) and returns are taken as ‘ Cash inflows’ ( +ve ), then, Internal Rate of Return ( IRR ) is that rate of discount, which makes the Present Value of all the return to Zero. We all know that the NPV of an investment is given by the formula:

If NPV is the Net Present Value of all the cash flows connected with the investment starting from year ‘0’ to year ‘n’, then ‘r’ is that rate if interest which makes NPV=0. Alternatively, at the rate of IRR, the Net present Value of all Costs would be equal to the Net Present Value of the Benefits.

Generally, IRR is the best option to evaluate and compare a set of project which have different outflows that give different returns spread over different periods of time. The calculation of IRR through the above formula would be tedious and has to be done on trial & error basis & using the approximation thereafter. Hence the calculations are generally arrived through the Calculators or Worksheet.

While it would be simple to calculate IRR where the Outflows and inflows are on specific dates though out the time period under study, the calculations as above cannot give the right answer where the outflows and inflows occur on various dates during the year. In such cases, we use the ‘XIRR’ formula from the Spreadsheet, by incorporating the dates in one column & the Cash flows in the next column. In short, IRR uses one variable viz. cash flows, the XIRR uses ‘two variables’, viz. dates and cash flows.

Compound Annual Growth Rate (GAGR): Compound Annual Growth Rate ( GAGR ) is the rate at which the investment has grown over the period had all the intermediate cash flows were reinvested at this rate. It is the nth root of the gross percentage of return over n years as shown below

The concept can be understood with an example. Suppose you had invested a sum of Rs.10000 in a Fund on 1st April 2010 and it has become 13500 on 1st April 2011 , 15000 on 1st April 2012 & finally to Rs. 18000 on 1st April 2013. The CAGR in this case would be
-1 = 1.8 ^(1/3 )-1 =1.21644 – 1 = 0.21644 = 21.644%
This means that the investment of Rs.10000 has grown at the Compounded Annual Growth rate of 21.644% during 3 years under study, which can be re-checked with the following
FV = 10000*1.21644^(3) =10000*1.7999999 = 18000 ( which is the value realized )

Rudiments of Financial Planning – 2

RUDIMENTS OF FINANCIAL PLANNING -2

“When I was young I thought that money was the most important thing in life; now that I am old I know that it is” ~Oscar Wilde

From the previous session it could be realized that objective of “Financial Planning” is to provide a comprehensive Financial advice to the individual to achieve his Financial goals/dreams. Under the current scenario everyone knows that he should adopt a sound financial planning to meet various requirements of life, like providing a comfortable lifestyle for self & family, providing top class education to your children, providing funds for their overseas education or wedding or business venture. This is apart from providing inheritance to the loved ones. But one should be clearly understood that Financial Planning is not just investment strategy, although investment planning is part of Financial Planning. Effectively, the Financial Planning is the comprehensive strategy to reach financial goals. The entire financial planning process could be classified into:

1. Emergency Planning: To meet any emergencies that the individual may encounter like sudden loss of monthly income or delay in receipt of monthly income.
2. Risk Planning: To look after the welfare of the loved ones in the unfortunate and untoward happenings, to meet medical emergencies, accidents that may envisage treatment of self or repairs and maintenance of building and vehicles.
3. Goal Planning: This refers to the funds requirement for the specific goals like Education/Higher education of children, Wedding Expenses of Children, Seed capital for business ventures of self or children etc.
4. Retirement Planning: This is one of the major issues one should plan well ahead especially with the risk of living long looming large with high inflationary trend.
5. Succession Planning: This aspect covers the planning for the inheritance to be left behind for the loved ones and to save them from the unhappy legal issues. Perhaps this point has not received the importance it should have got which is one of the main reason for a number of legal issues pending in the courts.

The study of Financial Planning could be simplified into two main objectives (1) guarding against risks & (2) growing your investments. But, before commenting the process of Financial Planning, one should realize the following important aspects which would be vital to prepare a realistic Financial Plan.

1. Time Value of Money: It is said that Albert Einstein called the idea of compounding as the eighth wonder of the world, obviously because the system of compounding assures growth of money which contradicts the very statement ‘money doesn’t grow on trees’. An investment of Rs.100000 for 10 years at 8% interest would be just Rs 180000 if there is no compounding, but would become Rs.215892, if compounded annually, while it would be Rs.220803 if compounded quarterly. Thus compounding enhances the value of money which plays a vital role in financial planning.

2. Inflation: Inflation affects everyone uniformly which in turn could significantly alter the real value of the anticipated future incomes throwing the plans out of gear. Hence it is imperative to incorporate the impact of inflation in the future value calculations.

3. Taxation: While one is happy to see that his money earns some interest as return, such return also comes with a catch – “Tax”. Applicability of Tax determines many rather most of the investment decisions.

4. Difference between wants and needs: Every person has his individual needs and wants and what is applicable to A as need may be want for B. For example the need of a two-wheeler is a need for small businessman offering door-delivery while it could be want (rather less essential) for a professional working from home. In the same context, the same small businessman looking for a car instead of a two- wheeler, at the start of his business becomes a want.

5. National & International Economic Scenario: While no one predict and plan or anticipate a sudden economic upturn or down-turn, these changes could cause concern about the future plans.

A New Tool in the hands of Insurance companies

If there is a test that could predict how far a person is susceptible to disease and how fast is he aging, everyone would like to take up such test because this issue has remained suspense for the mankind.  Several companies like Spectracell, Telo Me, Life Length etc have already been offering Telomere Test costing anywhere between $100 -$500.

What are Telomeres?

 

We all know that Chromosomes are the genetic blue print of life. DNA instructs the cells when to multiply and when to die. Telomeres are special DNA sequence located at the end of a chromosome to ensure their stability during the division of cells. They can be compared to the plastic caps at the end of the shoe laces which protect them from unraveling, thereby ensuring that the genes are not eroded.  They serve as protective buffers that prevent chromosomes from becoming attached to each other or rearranging.  When a cell divides it uses a protein sequence of the chromosome as a map and template of what is to be duplicated. During such division the telomere also shorten progressively depending upon the enzyme Telomerase, due to normal wear & tear, besides lifestyle habits like diet, smoking, lack of sleep, exercise etc. This process continues until the telomere becomes very short to be divided. This limit is known as Hayflick Limit which is estimated between 30-80 divisions, in the case of normal humans. Elizabeth Blackburn received the 2009 Nobel Prize in Physiology or Medicine jointly with Carol Greider and Jack W Szostak, for for the discovery of “how chromosomes are protected by telomeres and the enzyme telomerase”. She observed that Telomere shortness is associated with everything associated with age related diseases like cardiovascular disease, diabetes, dementia, osteoarthritis. Studies have shown that deficiencies in nutrients such as Folate and Vitamin C & D can shorten telomeres and that the process of telomere shortening can be slowed or even reversed by boosting the natural enzyme telomerase.

After nearly 30 years of research, the analysis of telomere length is emerging as commercial generic marker that is linked to ageing and disease, as well as a tool in the search for new medications. A Telomere Test is a blood test that measures the lengths of telomeres for the purpose of determining the person’s biological age which measures the changes in the body of the person which in turn would gain insight into their health, lifespan and susceptibility to diseases like Cancer, Alzheimer’s etc. Scientific evidences suggest that shorter telomeres may be associated with higher risk of developing cardiovascular, central nervous system and other age related diseases.

With continued research scientific advancement in the study, Telomere could play a vital role in many aspects of human life

1. Insurance companies may insist upon Telomere test before providing Life or Medical Cover and may seek higher premium for risk covers wherever required.
2. Risk of disease such as Cancer, diabetes would be diagnosed earlier so that treatment could start sooner.
3. Employers may insist upon Telomere test for before hiring new employees.

Sooner or later Telomere tests could be insisted upon by the Insurance companies at least in the case of large insurance policies so as to protect themselves. With the scientific evidence that vegetarian diet can help prevention of disease like diabetes, high cholesterol, hypertension, etc, some insurance companies in the US/UK have started offering lower insurance premium for Vegetarians. Perhaps the Telomere Test could become trump card in the hands of Insurance companies for deciding the premiums in future.

Rudiments of Financial Planning – 1

 RUDIMENTS OF FINANCIAL PLANNING -1

The undisputed fact is that Financial Planning is a vast subject that requires extensive learning through regular class room lectures with realistic problems and case studies. Never the less an effort is being made to provide a small window to the subject through these pages.

The Financial Planning is nothing but the development of a Strategy to meet the various needs of the individuals over his lifetime. It must be understood that the needs of each person differs from the other depending upon several factors exclusive to each of them. Again, the needs are not exactly the same as wants although they may have some common factors.

The link between Health and Wealth has been well doumented and hence they are always used in together in all our greetings. Naturally, the same principles for better health management become the basic requisites for better wealth management as well. Although Financial Planning doesn’t necessarily mean ‘Wealth building’, we are using it here for simplicity. The basic requisites for a  successful health management and the wealth planning are -Determination, Diagnosis, Direction, and Discipline – FOUR D’s in short.

Determination: While everyone has an ambition to build wealth, to meet his various needs, there is always a doubt as to the timing, quantum and the procedure for the growth. In the past, one thought of starting a financial planning through investment strategies around 25. But today, the young people start getting income through their Hobbies converted to profession from their teens. All that he requires is a determination to start a concrete financial planning to meet his future goals.

Diagnosis: Diagnosis here refers to the analysis to assess where the Individual stands with reference to his future goals. We all know that the Individual’s Income, Expenditure, Assets and Liabilities specify his financial standing based on which the future plans or goals are built.

Directions: Directions are in fact the goals of the individuals both in terms of time frame and quantum of funds for each goal – something like sending the daughter to college for graduation and post graduation for 3 + 2 = 5 years, from her 18^th year with average expenditure of Rs.300000 p a at current prices, buying a house for Rs.50.00 Lakhs after 3 years with a Loan of 40 Lakhs to be repaid in 20 years, etc.

Discipline: Like regular exercise is essential to maintain and improve his health, one has to start his planning right earnest and continue the plan of investment regularly in disciplined manner to achieve the planned goals

 

These will be explained in detail in the future  posts…….

 

Walletview for the Month April 2013

Market Trend during the Month

	This week	Last Week	Change
	30th Ap 13	30th Mar13
Sensex	19504	18836	3.55%
Nifty	5930	5683	4.35%
Rs./ USD	53.80	54.30	-0.92%
Rs./Euro	70.28	69.51	1.11%
Gold /Gram       Rs.	2715.00	2960.50	-8.29%
Silver /Gram     Rs.	46.60	54.57	-14.6%
Crude US$ / Barrel	102.24	109.36	-6.51%

Direct Cash Transfer could save up to 0.5% of the GDP: According to the International Monetary Fund, Indian Govt could save about 0.5% of the GDP, with the integration of Aadhar Card with the Direct Cash Transfer which is substantial apart from the advantages of better utilisation of the funds. The Unique Identification Authority of India (UIDAI) has so far issued 350 million cards and plans to issue 600 million cards by 2014, indicating that the issue of cards to the entire population of 1.2 billion could spill over beyond 2014. The Direct Cash Transfer through Aadhar is expected to bring down the costs and diversion by eliminating the middlemen and procedural delays.

12 million multiple LPG Connections weeded out. With the strict implementation of the Know Your Customer( KYC) norms, the Oil marketing companies have successfully weeded out app 1.20 Crores duplicate/multiple connections out 14 crores connections, by April 2013. This is yet another step towards the ambitious Direct Cash Transfer Programme and the saving on account of such multiple ineligible connections alone works out to app Rs.600 Crores.

Railways join one billion plus club in Freight Loading Indian Railways have transported 1010 M.T freight and have joined the select group of Billion Plus club in freight movement, with China( 1100 MT) , Russia(1200 MT) and USA(  1380 MT). The major chunk of the loadings came from Coal,  Iron Ore, Steel, & Cement.

Divestment bailouts cost a loss of Rs.215 Crores to LIC While the LIC bailed out the Govt in the divestment programme of 2012/13 and turned out to be the largest acquirer of the Public Sector Gems, it also ended up with a likely loss of Rs.215 Crores during the year. All the seven companies Hindustan Copper Ltd ( HCL), NMDC, OIL India, NTPC, Rashtriya Chemicals& Fertilisers( RCF),NALCO & SAIL are all selling below the floor price and the Investment Value of 4820 Crores has fallen by 215 Crores.

Yamaha plans to make the world’s cheapest motorcycle in India Japanese two-wheeler giant is setting up its fifth global research centre in Surajpur in UP, and  plans to roll out the world’s cheapest Motorcycle priced at around USD 500 from India. The proposed bikes with 100 CC engines to be produced in India could become global hubs for development of low-cost bikes which could be exported to Africa and Latin America, where demand for such products exists.

KSIDC plans joint venture with Korean firm for solar equipment.  Kerala State Industrial Development Corporation (KSIDC) has signed MOU with the Korean company.Jusung engineering to set up a solar cell and module manufacturing plant at Kollam. The project expected to cost Rs.500 Cr. would manufacture solar cells and modules of 6” dimension with an annual capacity of 100 MW.

Jet Airways announces Rs.2058 Cr. Alliance with Etihad Airways Jet Airways announced the sale of 24% stake to the Abu Dhabi based carrier, Etihad Airways for about Rs.2058 Cr making it the first investment by a foreign airlines in a domestic airline company after the change in the FDI policy. Jet would allot 27.26 million shares in a preferential offer to Etihad at a price of Rs.754.74 each after which Etihad would be holding 24% of the enlarged share capital of Jet. The deal is expected benefit both the airlines by way of immediate revenue growth and cost synergy opportunities and both the companies.

Australian food chains Country Chicken plans Indian hub Australian Food Chain, Country Chicken, is planning to set up a unit in Chennai to ensure standardisation of food taste and quality. Initially, the unit will meet the requirements of Indian and Sri Lankan requirement restaurants, which in turn could become the global food processing hub. Their first restaurant was opened in Chennai recently and the Sri Lankan restaurants could be operational within a couple of weeks and the chain plans to open as many as 300 outlets in 4 years. Country Chicken, established in 1994, has currently more than 450 outlets across the world in New Zealand, Saudi Arabia, UAE, Russia and Fiji.

Scientists Create World’s lightest Material Scientists at Zhejiang University, China have produced world’s lightest solid material – carbon aerogel which weighs just 0.16 mg/ Cubic cm which overshadowed the earlier record of the German developed graphite aerogel weighing 0.18 mg/Cubic cm. Carbon aerogel has excellent elasticity and can bounce back quickly when compress. It has the highest absorption capacity of 900 times its weight and can play an important role in pollution control like oil spill control, Water purification and Air purification.

Worldkit technology turns  your desk into touchscreen  The technological  advancement has resulted in a variety of gadgets like smart phones, Tablets  and the latest wearable computers like Sony smart-watch and Google Glass. Each of these inventions came due to the different processing capabilities and processing display systems to meet the diversified needs, although they have similar functionality. Imagine a situation of carrying a single gadget which can create a multiple display sizes depending upon the need, instead of a laptop, Tablet and a smart phone, which would eliminate the carrying of several gadgets. Researchers at  Carnegie Mellon University have just demonstrated that with their revolutionary technology ‘Worldkit’ , which would enable you to run any surface like your desk, door or wall and convert them into touch screen. Unlike the earlier technology “Kinect” which required larger projectors for such projections, the new technology uses much smaller projectors and bulbs which can be fixed to any portable gadgets like smart phones and watches. With the size of the processors and memory shrinking, the future gadgets with the new Worldkit technology could make the current gadgets obsolete very soon.

100 billion Earth-like planets in our Galaxy With Microlensing Observation in Astrophysics or gravitational microlensing strategy devised by the Japan – New Zealand collaboration, the scientists at Auckland University expect to identify as many as 100 billion Earth-like planets combining the data from the Kepler space telescope. The team plans to look at planets orbiting stars at distance typically twice the Sun-Earth distance so that these planets are cooler than earth. While Kepler measures the loss of light from a star when a planet orbits between earth and the star, microlensing measures the deflection of light from a distant star that passes through a planetary system en route to Earth – an effect predicted by Einstein in 1936.

 Indian-made ‘Pink diamond’ fetches $39 million. A rare 34 Carat ‘Princie’ diamond, which once belonged to the Nizam of Hyderabad, was sold for a record price of $39 million at Christie’s sale in New York which translates to $1135000 per carat. The 34.65 carat Fancy Intense Pink cushion cut diamond was from the Golconda mines in South India, was acquired by an anonymous collector through bidding over phone.

First Step

While started my blog experience with blogger with my odd writings, I was contemplating to create a blog for the my professional postings, whatever they are worth. But writing has not been my favorite subject from school days. Thankfully, the subjects I had chosen were never demanding such writings either.I am reminded of the famous observation that writing is lonely endeavor, which served as a convenient excuse to delay the inevitable. But there has to be a beginning for everything and here I am, thanks to WordPress.
Though I am still not conversant with WordPress Blog, the post has commenced perhaps as a half-baked product.