RULE OF TIME VALUE OF MONEY 1. CMPD : a. We can set our calculator either begin mode or end mode when we don‘t use pmt. We can say that in case of using n, I, pv, fv, c/y we can set out calculator either begin or end mode. b. N means number of periods in normal case without considering PMT. For ex. Mr. invested Rs.100 for 10 years 6 months, then n would be 10+6/12 c. I means rate of interest. d. Pv means present value. For ex. I invest Rs.20000 for 10 years. Here pv is 20000. Pv means lump sum payment. Present value can be negative or positive as per situation. e. Pmt means regular payment. For ex. Saving Rs.2000 p.a. for 10 years, therefore 2000 is pmt. It can be positive or negative f. Fv means future value. For ex. If I receive Rs. 1 crore after 10 years. Here fv is 1 crore. Fv is always lump sum payment received or paid after some periods. g. P/y means number of payments in a year. For ex. I invest Rs.1000 p.m. for 12 years. Here p/y is 12 h. C/y means how many compounding in a year. For ex. rate of interest 12% p.a. compounding monthly therefore C/Y=12. 2. When money comes in (receiving or cash inflows) consider positive sign, when money goes out (investing or cash outflows) consider negative sign. 3. When there is role of regular payment means PMT in a step, following points should be kept in mind: a. We should always consider set begin or end as per the question. b. If nothing mentioned about regular saving whether in the beginning or end of every period, we always consider BEGIN, reason in all schemes we have to deposit money in advance. c. During post retirement life if nothing mentioned about the withdrawal of money (begin or end). We should consider always BEGIN as we need money immediately after retirement. d. In case of loan if nothing mentioned about repayment whether is made in the beginning or end of every period, we should consider END as logically first we get money then very next period we make repayment.
e. n means total number of payments. Ex1. Mr. Sharma saves or withdraws Rs.2000 p.m. for 10 years. Here n is 10*12 = 120 Ex2. Mr. X saves or withdraws Rs.5000 per quarter for 10 years. Here n is 10*4 = 40 P/y means total number of payments made in a year. Ex1. Mr. X saves or withdraws 2000 pm for 10 years, here p/y=12 but n=10*12=120. (As n means total numbers of payments made) Ex2. Mr. X saves Rs.2000 per quarter for 15 years. Calculate future value if ROI 10% p.a. compounding half yearly. First we should check whether there is role of regular payment in this question. If yes we should consider first of all set begin or end Here we will consider set=begin (as if nothing mentioned saving in the beginning or end we always consider BEGIN) N=15*4=60 (as N is total number of payments are made in that period). I=10 Pv=0 (as there is no lump sum payment) Pmt= -2000 P/y=4 (total number of payment in a year) C/y=2 (total number of compounding in a year) Fv=solve=275680.6996 4. If we need to calculate the present value of regular payment which is increasing by inflation or growth like in salary, we should always use real rate of return, otherwise generally we never use RRR. For Ex. Mr. Sharma saves ( or salary ) Rs 5000 now and increasing by 10% p.a. in a scheme of 30 years. Calculate the present value if rate of interest is 12% p.a. SET=BEGIN N=30 I=(12-10)/1.10
Pmt=5000 PV=solve=116921.050 In case of salary we can calculate the net present value of all future income We can solve it by using growing annuity formula also. First we can calculate the future value using growing annuity formula and then discount it by 12% for 30 years. But better to use RRR. 5. We never use real rate of return in the step of investing money. 6. We never use real rate of return in a step of calculating future value of the regular payment. 7. We use inflation when cost of a goal ( Household Expenses, Car, Education, House, Marriage, World Tour Etc) is given in today‘s term ( present cost ) and we want to find cost of the same in future. Following examples will help you to comprehend this: Current cost of house hold expenses Rs.1 lac p.a., inflation 6% p.a. if you calculate cost of HHE p.a. after 30 years, we have to inflate it for 30 years considering it as PV. As we need to know HHE annually we are not adding all expenses in this question therefore can‘t consider it as pmt. Step to solve: Set = end/begin n=30 I=6 pv = 100000 fv = solve or we can use formulae Fv = Pv(1+r)^n j. Current cost of house hold expenses Rs.50000 p.m. inflation 7% p.a. if you want to know your monthly house hold expenses after 25 years, you simply inflate it by 7% for 25 years. Step to solve :
Set = end/begin n = 25 (don‘t consider 25*12 as you need to know only monthly expenses after 25 years) I=7 pv = 50000 fv=solve or fv = 50000(1.07)25 In CMPD function if n and i in same unit, p/y and c/y must be 1. For ex. Ram saves Rs.2000 per month for 10 years in a scheme that generates 2% p.m. interest, calculate future value? CMPD Set = begin ( as nothing mentioned begin or end, we always consider begin ) N = 10*12 = 120 ( as total number of payments ) I=2 Pmt = -2000 p/y=c/y=1 ( as n and i in same unit, same unit means both are in terms of months ) fv = ? 8. CASH FUNCTION: a. Cash function is always better to use in cases where payments are not constant. b. In cash editor 1 means beginning of first period ( month or year), 2 means beginning of second period or end of 1st year. c. Whenever we calculate future value, we need to take care of last entry. For example Mr. X saves 2000 today and 3000 next year and calculating future value after 2 years. We put 2000 in first entry 3000 in second entry and third entry must be zero as 3rd entry is end of 2 years or beginning of 3rd year.
d. When we calculate future value after 10 years or 15 years , 11th entry or 16th entry must be utilized as 11th entry means end of 10th and 16th entry means end of 15th e. We can use RRR to calculate the net present value of payments which are increasing by some rate. Following examples will help you to comprehend the same: Ex. Current cost of higher education 5lacs p.a. for first 2 years and Rs3 lacs for next 3 years. Inflation 8% p.a. and rate of interest 12% p.a. what is the net present cost of education? i. Case 1 : Higher education starts now. Solution by using cash function: I = (12-8)/1.08 1 = 500000 2 = 500000 3 = 300000 4 = 300000 5 = 300000 NPV = solve ii. Case 2 if higher education starts after 15 years. Solution by using cash function: I = (12-8)/1.08 1 to 15 entries = 0 16 = 500000 17 = 500000 18 = 300000 19 = 300000 20 = 300000 NPV = solve
f. Internal rate of return i.e. IRR is used to calculate the rate of interest of uneven cash inflows and outflows. Following examples will help you to comprehend the same: Ex. 1 If I invest Rs.2000 today and receive Rs.1200 after 1 year, Rs.600 after 2 years, Rs.500 after 4 years. Calculate rate of interest (IRR or CAGR)? Sol. We cannot use CMPD. We have to use CASH FUNCTION 1= -2000 2 = 1200 3 = 600 4=0 5 = 500 (as 5th entry means end of 4th or beginning of 5th) IRR = Solve Ex. 2 There is a scheme in which Rs.100000 p.a. to be invested for first 5 years and inflows 1 lac p.a. will start from the end of 10th year (beginning of 11th year) for 10 years. Now in this case you need to calculate the rate of interest (IRR OR CAGR). Sol. We can solve it by using CASH FUNCTION not CMPD 1 to 5 entries = -100000 6 to 10 entries = 0 11 to 20 = 100000 IRR = Solve
TIME VALUE OF MONEY Calculation of Future Value Future value measures the nominal future of money that a given sum of money is ―worth‖ at a specified time in the future assuming a certain interest rate. Future Value = Present value (1+r)n Q1. Calculate the maturity amount of Rs. 1,18,000 if invested at 8% per annum for 5 years. SOL. Set = Begin N=5 I=8% PV= - 118,000 FV=SOLVE =173380.71 Or Fv= 118000*1.08^5 Q2. You have just inherited Rs.250,000 and plans to deposit it immediately in a bank account that pays 10% interest per year compounded monthly. Calculate the maturity value after 10 years? SOL. Set = Begin N=10 I = 10% PV = - 250,000 P/Y = 1 C/Y = 12(as number of compounding in a year is 12) FV =solve = 676,760.37 Q3. Mr. A aged 35, has Rs.30,000 to be invested today for next 25 years. He plans to retire at the age of 60 years. What would be the retirement corpus he can arrange through his investment if return on investment is 10% p.a. compounded quarterly for first 8 years
and then decreases to 8.75% per annum for 7 years and again increases to 9.25% per annum thereafter. Sol. Step 1:Begin Step 2 Begin Step 3 Begin N = 8, N=7 N = 10 I = 10%, I = 8.75% I = 9.25% PV = - 30,000 PV = -66,112.70 PV = -118,929.55 c/y = 4 c/y = 1, c/y = 1 FV = 66,112.70 FV = 118,929.55 FV = 2,88,074.13 CALCULATION OF PRESENT VALUE Present value is the value on a given date of future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk. PV= Future Amount/(1+interest Rate)^term Q1. How much must be invested today, at 9% p.a., to accumulate Rs.100000 in seven years from today? Sol. Set: End/begin, N = 7, I=9 PV = Solve= -54703.42, FV = 100000 OR PV = 1,00,000/1.09^7 Q2. Geeta has got approximately Rs. 1250000 after 10 years from the redemption of mutual fund on which she has got 9.25% compounded quarterly for first 3 years, 8.25% per annum for the next 4 years and 8%per annum compounded semi-annually for remaining years. Estimate the amount she would have deposited 10 years ago? Step 1 Step 2 Step 3 Set: Begin/End, Set: Begin/End Set: Begin/End N=3 N=4 N = 3,
I = 8% I = 8.25% I = 9.25% C/Y = 2 C/Y = 1 C/Y = 4 FV = 12, 50,000. FV = 98783.15 FV = 719,446.25 PV = solve =-987893.15 PV = solve = -719,446.65 PV = solve = -542,832.42 CALCULATION OF INTEREST & TERM Q1. Mr. Sharma deposits Rs.100 in an investment. Ten years later it is worth Rs.17910.What rate of return did the investor earned on the investment? sol. Set : End/begin, N = 10, I = Solve = 6.0, PV = -10000, FV = 17910 Q2. What annual rate of interest is the bank charging, if you borrow Rs.1 lacs and repay Rs.120000 at the end of 4 years and a quarter? Sol. Set: End/Begin, N = 4+1/4, I = Solve = 4.38, PV = -100000 FV =120000 Annuities Annuity: The term annuity is used in reference to any terminating stream of fixed annuity payments over a specified period of time. Some Qs of annuity are: Rent, Loan EMI‘S, Pension, etc Types of annuities: 1. Ordinary Annuity/Annuity in Arrears An ordinary annuity is essentially a level stream of cash flows made at the end of each period for a fixed period of time.
2. Annuity Due An annuity due is essentially a level stream of cash flows made in the beginning of each period for a fixed period of time. 3. Deferred Annuity A type of annuity contract that delays payments of income, installments or a lumpsum until the investor elects to receive them. This type of annuity has two main phases, the Savings Phase in which you invest money into the account, and the income phase in which the plan is converted into an annuity and payments are received 4. Growing Annuity A growing annuity is a finite number of cash flows growing at a constant rate. Growing annuity is of two types: a. Growing Annuity by Fixed percentage b. Growing annuity by fixed amount A. Growing Annuity by Fixed percentage: The Formula of calculating future value of a growing annuity when payments are made in the beginning of every period is: FV = PMT [{(1+r)n – (1+g)n}]* (1+r) (1+r) – (1+g) or FV = PMT [{(1+r)n – (1+g)n}]* (1+r) r-g Where, PMT= first payment g = Growth rate r = Interest Rate n = Number of payments The Formula of calculating future value of a growing annuity when payments are made at the end of every period is: FV = Pmt,
*( ) ( ) + ()() or FV = 1stPmt, *( ) ( ) + IMP: Growing annuity with fixed percentage when growth and rate of interest are same. Future Value of growing annuity with fixed percentage when rate of interest and growth rate are same and saving in the beginning of every period = [A*n (1+R)n-1 ] * (1+R) or A * n(1+R)n Future Value of growing annuity with fixed percentage when rate of interest and growth rate are same and saving at the end of every period = [A*n (1+R)n-1 ] A. stands for first payment, R is rate of interest and n is total number of payments B. Growing annuity by Fixed amount The Formula of calculating future value of a growing annuity with fixed amount when payments are made in the beginning of every period is: [{A * Sn + D * (Sn – n)} / r] * (1+r) Where, A = First payments Sn = it is a future value of ordinary annuity (set = End) of Re. -1(pmt = -1) considering number of payments and rate of interest as per the Question N = number of payments R = rate of interest The Formula of calculating future value of a growing annuity with fixed amount when payments are made at the end of every period is: [A * Sn + D * (Sn – n) / r] 5. Annuity in Perpetuity Perpetuity forever is an annuity whose payment continues forever.
Present Value of annuity in perpetuity if received at the end of every period = Annuity required/ rate of interest Ex. If I need Rs.100000 at the end of every year forever how much should be invested today if rate of interest is 10% p.a. Present value = 100000/0.10 = 1000000 Present Value of annuity in perpetuity if received in the beginning of every period = (Annuity required/ rate of interest) * (1 + rate of interest) Or = (Annuity Required/ Rate of Interest) + Annuity Required Questions Based On Ordinary Annuity and Annuity Due 1. Mr. Sharma saves Rs.20000 in the beginning of every year for 20 years, return on investment 12% p.a. how much would be the maturity? Sol. Set: Begin N = 20, I = 12, PMT = - 20000. FV = solve = 16,13,974.71 2. If I need Rs.2 lacs after 10 years, how much I should deposit in the beginning of every year if rate of interest 15% p.a. compounding half yearly? Sol. Set: Begin N = 10 I = 15% FV = 2,00,000 PMT = -8292.70 solve C/Y = 2, P/Y = 1
3. Manav saves Rs. 20,000/- at the end of every year for 5 years and Rs. 30,000/- a year for 10 years thereafter. What will be the total amount in his account after 15 years, if ROI is 10 % per annum? STEP 1 SET: END STEP 2 SET: END N=5 N = 10 I = 10% I = 10% PMT = -20,000 PMT = - 30,000 FV = Solve ( 1,22,102) PV = -122,102 C/Y = 1 FV = Solve (7,94,823.87) P/Y = 1 P/Y = 1 C/Y = 1 4. Rahul decides to deposit Rs. 5,000/- at the end of every month into an account yielding 12% per annum compounded monthly for 20 years. What will be the accumulated value in this account after 20 years? SET: END N = 20*12 I = 12 PMT = -5,000 FV = Solve (49,46,278.82) P/Y = 12 C/Y =12 5.. What amount needs to be invested today at 10 % per annum compounded semi- annually, so that it pays Rs. 1 lac per annum for 5 years, Rs.25000 per half yearly for next 3 years and Rs.20000 per month for next 5 quarters? ( all payments are in the beginning of each period ) Step 1 Step 2 ` Step 3 Set: Begin Set: Begin Set: Begin N = 15 N=6 N=5 I = 10 I = 10 I = 10 PMT = -20,000 PMT =-25000 PMT = 1,00,000
PV = Solve (2,83,575.30) FV = 2,83,575 FV = 3,44,845.17 P/Y = 12 PV = Solve (3,44,845.17) PV = Solve (626983.69) C/Y =12 P/Y = 2 P/Y = 1 C/Y = 2 C/Y = 2 6. Mr. Mohit is 55 years old at present. He has invested some amount in an annuity which will pay him after 5 years Rs. 30,000/- p.m. in the beginning of every month for 10 years. Rate of interest is 7% p.a compounded quarterly Calculate how much amount he has invested now? STEP1. Step 2 Set = Begin set End N = 10*12 N=5 I = 7% I = 7% PMT = 30000 PMT = 0 FV = 0 FV = 2603446.726 P/Y = 12 PV = Solve = 1840180.131 C/Y = 4 P/Y = 1 PV = Solve = -2603446.726 C/Y = 4 7. Mr. Vipin is now 50 years old. He has invested Rs. 1, 50,000/- in an annuity which will pay him after 10 years a certain amount per half year at the beginning for 10 years. Rate of interest is 8% p.a. compounded monthly. Calculate how much he will receive at the beginning of every half year after 10 years? STEP1. STEP 2 Set = End/begin Set = Begin N = 10 N = 10*2 I = 8% I=8 PV = –150000 PV = -332946.035 PMT = 0 PMT solve (23681.6925) P/Y = 1 P/Y = 2 C/Y = 12 C/Y = 12
FV = Solve = 332946.0352 8. Mr. Raju is now 40 years old. He has invested some amount in an annuity which will pay him from the end of 10th year from today, Rs. 30,000/- p.a. for 10 years. Rate of interest is 6%p.a.compounded monthly Calculate how much he has invested today? STEP1. Step 2. Set = End Set = End N = 10 N=9 I = 6% I = 6% PMT = 30,000 PMT = O FV =0 FV = 219057.9982 C/Y= 12 P/Y = 1 PV = Solve = -219057.9982 C/Y = 12 PV = 1,27827.5441 9. Mr. Naman is working in a reputed company and earning Rs. 5,00,000/- p.a. and is now 50 years old. He has invested Rs. 2, 50,000/- in an annuity which will pay him after 5 years a certain amount p.a. at the end of every year for 10 years. Rate of interest is 8% p.a. Calculate how much he will receive at the end of every year after 5 years? STEP1. STEP 2 Set = END / BEGIN Set = END/BEGIN N=5 N = 10 I =8% I = 8% PV= -2,50,000 PV = -3,67,332 PMT=0 FV = 0 FV=0 PMT = 54,743 Solve P/Y= 1 P/Y = 1 C/Y= 1 C/Y = 1 FV=Solve=3,67,332
10. Mr. X is 30 years of age and decides to save Rs.1,50,000 at year end and increases his saving 10 % every year. If ROI is 18 % p.a. What will be his accumulated corpus at the age of 50? Sol. It is a case of growing annuity with fixed percentage saving at the end of every period. The Formula of calculating future value of a growing annuity when payments are made at the end of every period is: FV = PMT [{(1+r)n – (1+g)n}] r – g FV=1,50,000 * ((1.18) ^20 – (1.10)^20) /(0.18 – 0.10) FV = 3,87,47,877.48 11. Mrs. Sharma decides to save Rs.100000 today and thereafter he increases his saving 10% every year. Calculate the accumulated amount after 40 years if rate of interest is 14% p.a. compounded monthly? Sol. The Formula of calculating future value of a growing annuity when payments are made in the beginning of every period is: FV = PMT [{(1+r)n – (1+g)n}]* ( 1 + r) r – g FV = 100000[ (1.1493)^40 – (1.10)^40] (1.1493) 0.1493 – 0.10 FV = 503918428 (We need to convert 14% p.a. compounding monthly into annual effective as saving annually) (CNVR n = 12, I = 14, EFF = solve = 14.93) 12. Mrs. Y saves Rs.80000 now and wants to increases her saving 2000 every year. Calculate the accumulated corpus she will be having after 26 years if roi is 12% p.a.? Sol. It is a case Growing Annuity with Fixed Amount The Formula of calculating future value of a growing annuity with fixed amount when payments are made in the beginning of every period is: FV = [A * Sn + D * (Sn – n) / r] * (1+r) = [80,000*150.33… + 2000* ( 150.33…-26)/0.12] * (1.12) (Calculation of Sn: set = end, N=26, i=12, pmt = -1, Fv = solve = 150.3339345) FV= 1,57,90,820.64 13. Mrs. Sharma decides to save Rs.100000 today and thereafter he increases his saving Rs.5000 every year. Calculate the accumulated amount after 40 years if Roi is 14% p.a. compounded monthly? Sol. The Formula of calculating future value of a growing annuity with fixed amount when payments are made in the beginning of every period is: FV = [A * Sn + D * (Sn – n) / r] * (1+r) First we need to convert 14% p.a compounding monthly into annual effective 43
CNVR n =12, I = 14, EFf = solve = 14.93420292 = [100000 * 1746.33….+5000 * ( 1746.33…-40)/ 1.1493…] * (1.1493…) (Calculation of Sn: set = end, N=40, i=14, pmt = -1, c/y = 14, Fv = solve = 1746.334509) = 266373647 AMORTIZATION Amortization: Amortization is the distribution of a single lump-sum cash flow into many smaller cash flow installments, which can be determined by the amortization schedule. Under amortization every installment consists of both principal and interest. Greater amount of the payment is applied to interest at the beginning of the amortization schedule, while more money is applied to principal at the end. Flat Interest Rate Flat interest rate, as the term implies, means an interest rate that is calculated on the full amount of the loan throughout its tenure without considering that monthly repayments (EMIs) gradually reduce the principal amount. As a result, the Effective Interest Rate is noticeably higher than the nominal Flat Rate quoted in the beginning. The formula of calculating fixed rate of interest is – Interest Payable per Installment = (Original Loan Amount * No. of Years * Interest Rate p.a.) / Number of Installments For Q, if you take a loan of Rs 1, 00,000 with a flat rate of interest of 10% p.a. for 5 years, then you would pay: = (100000 + 10% of 100000*5)/5 =Rs30000 per year. This method is particularly used to calculate the interest payable for personal loans and vehicle loans. In this method, you have to pay interest on the entire loan amount throughout the loan tenure. It is actually less popular among the borrowers because even if you gradually pay down the loan, the interest does not decrease. Reducing / Diminishing Interest Rate Reducing/ Diminishing balance rate, as the term suggests, means an interest rate that is calculated every month on the outstanding loan amount. In this method, the EMI includes interest payable for the outstanding loan amount for the month in addition to the principal repayment. After every EMI payment, the outstanding loan amount gets reduced. Therefore, the interest for the next month is calculated only on the outstanding loan amount. The formula for calculating reducing balance interest is – Interest Payable per Installment = Interest Rate per Installment * Remaining Loan Amount For Q, if you take a loan of Rs 1, 00,000 with a reducing rate of interest of 10% p.a. for 5 years. Your annual repayment would be Rs.26380 instead of Rs.30000 which is paid as per flat rate of interest. In the first year interest would be charged on 100000 and 2nd year interest would be charged on Rs.90000; in the second year interest would be charged on Rs.83620 (100000-16380) and so on.
Unlike the flat rate method, you would end up paying Rs.131900 instead of Rs. 1.5 lakh. 49 This method is particularly used to calculate the interest payable for housing, mortgage, property loans, overdraft facilities, and credit cards. Difference between Flat Interest Rate and Reducing Balance Rate In flat rate method, the interest rate is calculated on the principal amount of the loan. On the other hand, the interest rate is calculated only on the outstanding loan amount on monthly basis in the reducing balance rate method. Flat interest rates are generally lower than the reducing balance rate. Calculating flat interest rate is easier as compared to reducing balance rate in which the calculations are quite tricky. In practical terms, the reducing rate method is better than the flat rate method. Q1. Mr. Sharma has taken a housing loan of Rs 20 lacs for 25 years @ 8% p.a. reducing monthly, calculate the following: a. EMI (equated monthly installment ) Sol. Go to CMPD Set = End, n=300, i=8%, pv=20,00,000, p/y=c/y=12, pmt = solve = -15,436.32 Total interest paid in first 5 years Sol. Go to AMRT Pm1 =1 Pm2=60, SINT=-7,71,656.29 Here PM1 means payment number starts with. And PM2 means payment number ends with. b. Principal paid in last year Sol. Go to AMRT Pm1=24*12+1=289 Pm2=300 SPRN=1,77,452.61 c. Interest paid in 14th installment Sol. Go to AMRT Pm1=14 Pm2=14 INT=13,143.60 d. Total principal paid in first 12 years Sol. Go to AMRT Pm1=1 Pm2=144 SPRN=5,05,786.98 50
e. Total interest paid in last 12 years Sol. Go to AMRT Pm1=13*12+1 Pm2=300 SINT=7,96,779.85 f. Outstanding loan after 12.5 years Sol. Go to AMRT Pm1=1 Pm2=12.5*12 BAL=14,60,811.20 g. Total principal paid from 12th year till 20th year Sol. Go to AMRT Pm1=11*12+1 Pm2=240 SPRN=7,95,855.98 Q2. Mr. X has taken a housing loan of Rs.5000000 of 20 years @ 11% p.a. reducing monthly on floating bases. The bank would increases rate of interest to 12% p.a. reducing monthly after 3 years, what would be the new EMI? Sol. Set=End N = 240 PV = 50,00,000 I=11 FV=0 P/Y=12 C/Y=12 PMT=solve = -51,609.42 Now we need to calculate the outstanding loan after 3 years Go to AMRT: PM1=1, PM2=36, BAL=47,54,960.38 Now we need to calculate the new EMI SET=END N=240-36 PV=ANS execute I=12% P/Y=C/Y=12 PMT= solve = -54,739.84
3. Given a 9% p.a. interest rate, an asset that generates cash flows of Rs.10000 in year1, Rs. 20000 in year 2, and Rs. 10000 in year 3, and then sold for Rs. 150000 at the end of year 4 has a present value of______ Sol. Go to Cash I=9 Cash = Exe 1=0 2 = 10000 3 = 20000 4 = 10000 5 = 150000 NPV = Solve= 139993.52 4. Vinay is evaluating an investment that will provide the following returns at the end of each of the following years: year 1, Rs. 12,500; year 2, Rs. 10,000; year 3, Rs. 7,500; year 4, Rs. 5,000; year 5, Rs. 2,500; year 6, Rs. 0; and year 7, Rs. 12,500. Vikas believes that he should earn an annual rate of 9 percent on this investment. How much should he pay for this investment? Sol. Set I = 9 CF1 = 0 CF2 = 12,500 CF3 = 10,000 CF4 = 7,500 CF5 = 5,000 CF6 = 2,500 CF7 = 0 CF8 = 12,500 Set I = 9 and Solve for NPV = Rs. 37,681.
Questions Based on Inflation The following information given below to solve first 9 questions Current age of a person = 30 Retirement age = 60 Life expectancy = 85 Rate of Interest = 12% p.a. Inflation = 7% p.a. Current house hold expenses = 4 lacs p.a. Current cost of marriage = 25 lacs Current cost of education = 10 lacs Current cost of house= 50 lacs Current cost of world tour =10 lacs Q1. How much should be saved monthly for 10 years for higher education if required after 10 years? Cost of education today=10L, Cost after 10 years @7% inflation=10L*(1.07)^10=19.67L Set: Begin N = 120 I = 12 FV= 19.67 P/Y = 12 C/Y = 1 PMT = Solve (-8780.51) Q2. How much should be saved monthly for 15 years for house if required after 15 years Cost of house today=50L, cost after 15 years @7% inflation=1,37,95,157 Begin N = 180 I = 12% PV = 0 FV = 1,37,95,175 PMT = Solve (-28,985) P/Y = 12 C/Y = 1 Q3. How much should be saved quarterly for 20 years for marriage if required after 20 years? Cost of marriage after 20 years = 25L*1.07^20 = 96,74,211 Sol Set Begin, N = 80 I = 12 PV = 0 FV = 9674211 PMT = Solve (-31255) P/Y = 4 C/Y = 1
Q4. How much should be saved half yearly for 30 years for marriage if required after 30 years Cost of marriage after 30Y = 25L*1.07^30 = 19030637.61 58 SOL: Set Begin N = 30*2 I = 12% FV = 19030637.61 PMT = Solve(-36,200) P/Y = 2 C/Y = 1 Q5. What would be annual house hold expenses at age 60 a, Household expense at 60 = 4L*1.07^30 = 30,44,902 How much corpus will be required at age 60 if require Rs.10 lacs per annum fixed during post retirement life. Sol :Set Begin N = 25 I = 12% PMT = 10,00,000 FV= 0 PV = Solve 87,84,315 P/Y = 1/ C/Y=1 Q6. How much corpus will be required at age 60 if require Rs.10 lacs per annum inflation adjusted during post retirement life. RRR= (12 – 7)/( 1+ .07) = 5/1.07 = 4.6728% Begin, N=25, I = 4.6728....%, Pmt=10,00,000, fv=0, PV= Solve-1,52,48,586.44 Q7. If Rs.100 lacs required at age 60 , how much should be saved monthly during pre- retirement life Set Begin, N=30*12, i=12%, PV=0, Fv=100,00,000, PMT = SOLVE 3,245.72 P/Y = 12 C/Y = 1 Q8. If saving Rs.5000 pm during pre-retirement life, how much corpus would be at age 60? How much can be withdrawn monthly fixed amount during post retirement life? And how much can be withdrawn annually inflation adjusted during post retirement life? 59
Step 1 step 2 Step 3 Set Begin, set begin set begin N=360, N=300 i=(12-7)/1.07 i=12, I= 12 PV =-15404866 PV=0, PV=-1,54,04,866 PMT = SOLVE=10,10,248.79 Pmt=-5000, p/y=12 P/Y = 1 P/y=12, c/y=1 C/Y = 1 C/y=1, Pmt=Solve 1,53,849 N = 25 Fv=Solve1,54,04,866 Q9. If saving Rs.50000 half yearly during Pre- retirement life, how much corpus would be at age 60? How much can be withdrawn quarterly fixed amount during post retirement life? And how much can be withdrawn monthly inflation adjusted during post retirement life? Begin, Begin Begin n=60, n=100 n=300 i=12, i=12 i=(12-7)/1.07 pv=0, pv=ans pv=2,62,84,755 pmt=-50,000, p/y=4 p/y=12 p/y=2, c/y=1 c/y=1 c/y=1, pmt=7,80,144 pmt=1,46,671.69 fv=2,62,84,755 Q10. Your Uncle expects to live another 10 years. (Should he live longer, he feels you would be pleased to provide for him.) He currently has Rs.50000 in savings which he wishes to spread evenly in terms of purchasing power over the remainder of his life. Since he feels inflation will average 6 percent annually, his annual beginning-of-year withdrawals should increase at a 6% growth rate. If he earns 8 percent on his savings not withdrawn, how much should his first withdrawal be to be made in the beginning of each year? Sol Set: Begin n = 10 I = RRR = 1.8867 PV = - 50000 PMT = Solve = 5430 P/Y = 1 C/Y = 1 Q11. Mr. Aman aged 25 has invested Rs. 1,00,000 for a world tour with his family after12 years .The current cost for the tour is Rs.5lacs and the inflation rate is expected to be 5.5% per annum for first 5 years and 6.5% per annum thereafter. He is also planning to invest around Rs 60,000 in the gold ETF after 5 years so that he is able to enjoy the trip probably without any deficit. Rate of interest for the entire period on investments is 11% per annum. Calculate the surplus or deficit amount for him to achieve this target? Sol. STEP 2 STEP 1 SET : END/BEGIN 60 SET : END/BEGIN N=7 N=5 I = 6.5 I = 5.5
PV = -500000 PV = -653480 FV = 653480 Solve FV = 1015499.12 Solve Total cost of world tour after 12 years = Rs.1015499.12 STEP 3 STEP 4 SET: END SET : END N = 12 N=7 I = 11 I = 11 PV = -100000 PV = -60000 FV = 349845.05 Solve FV = 124569.60 Solve Total maturity value after 12 years of both investments = 349845.05+124569.60= Rs.474414.65 Thus Aman would be facing a deficit = 1015499.12 - 474414.65= Rs.541084.47 Q12. Mr. Dinesh has invested in a fund Rs.75,000/- for his daughter‘s marriage which is expected 18 years down the line. The cost of marriage in today‘s monetary term costs Rs.90000/- and inflation is expected to be at 6% for the first ten years and 5% for the next eight years. Mr. Dinesh will also be contributing Rs.25000/- at the end of 9 years from now to the above said fund. Interest Rate for the entire period is assumed to remain fixed at 12%p.a. Calculate surplus or deficit amount for Mr. Dinesh to achieve his target? Sol To solve this problem, we need to know actual marriage expenses after 18 years. STEP 1 STEP 2 SET: END SET: END N = 10 N=8 I= 6 I = 5 PV = -90000 PV = -161176.29 FV = S= 161176.29 Solve FV = 238130.79 Solve So, marriage expenses after 18 yrs. will be Rs.238130/- Now, we have to calculate future value of Rs.75000/- for a period of 18 years and Future Value of Rs.25000/- for a period of 9 years STEP 3 STEP 4 SET: END SET: END N = 18 N=9 I = 12 I = 12 PV = -75000 PV = -25000 FV = 576747.43 Solve FV = 69326.96 Solve So, the amount he will have at the end of 18 years will be 576747+69327 = Rs.646074/- Marriage Expenses after 18 years are Rs.238130/- He will have a surplus of Rs. (646074-238130) = Rs.407944/-
Different types of Returns 1 Holding Period Return “It is the total returns inclusive of capital appreciation and regular income in the form of rent, dividends etc. right from the point when investor buys the assets till the point of sale or calculating return.‖ HPR =(Ending Price - Beginning Price + Cash Dividend)/ Beginning Price Where, Ending Price = E1 Beginning Price = B0 Cash Dividend / Interest = D Ex1. Swami Krishnamurthy bought a house five years ago for Rs.1500000. Today thehouse is worth Rs.2250,000. What is the Holding Period Return? Sol. We have, E = Rs.2250000 B = Rs.1500000 D=0 By applying the formula we get, (2250000-1500000)/1500000 = 0.50 or 50% Ex. 2 Suppose by selling an investment for Rs.1500 a person yield 60% returns during ―n‖ years. During the period he also earns Rs.100 as the interest. What amount has the person invested? Sol. We have, E= Rs.1500 B=? D= Rs.100 HPR = 60% by applying the formula we get, (1500- B0) +100 = 0.6 B= Rs.1000 Ex.3 A building that is held for 8 months, during which time it generates Rs.24000 in rental income (in excess of costs), and then sold for an Rs.30000 profit. Its original purchase price was Rs.250000. Calculate the holding period return? Sol. We have, E= 250000+30000= Rs.280000 B= Rs.250000 D= 24000 HPR =? By applying the formula we get, [(280000- 250000) + 24000]/250000 = 21.6% 69
Ex 4. What will be the holding period return of a 30 years bond paying an annual coupon of Rs. 80 and selling at face value (Rs. 1000)? Assuming the bond holder sells the bond after a period of one year at par value. Sol. We have, End Value = Rs.1000 Begin Value = Rs.1000 Interest = Rs.80 HPR =? By applying the formula we get, [(1000 + 80) – 1000]/1000 = 0.08 or 8% 2. Compounded annual growth rate (CAGR) Compounded Annual Growth Rate is the year - over - year growth rate of an investment over a specified period of time. The compound annual growth rate is calculated by taking the Nth root of the total percentage growth rate, where n is the number of years in the period being considered. Ex.1 If the annual growth rates of a factory in 5 years are 3.5%, 5.4%, 6.8%, 7.3% and 6.5% respectively, then the compounded growth of output per annum for the given period is Sol. We know that, CAGR = [(1+R1)(1+R2)(1+R3)…………..(1+RN)]1/5-1 = [(1.035)(1.054)(1.068)(1.073)(1.065)]1/5 – 1 = 5.89% Ex.2 Sharma made an investment of Rs.100000/- in a listed company 4 years ago. Calculate the compounded annual rate of return if Sharma sells his investment for Rs. 560000/- Sol. We know that, CAGR = (ending value /starting value)1/n – 1 = (560000/100000)1/4– 1 = 53.83% Ex.3 Rs.1,00,000 invested 5 years ago is now Rs.6 lakh, what is the compounded annual growth rate? Sol. We know that, CAGR = (ending value /starting value) 1/n – 1 = (600000/100000)1/5 – 1 = 43% 70 EX.4 As a college student thirty years ago, Amit purchased Rs.5000 shares of Wall Chand agar Industries. He recently sold the stock for Rs.105000. During his holding period, he received a total of Rs.12000 as cash dividends. Both his original and selling commissions were Rs.50 each. Calculate the CAGR.
Sol. CAGR = [(105000 + 12000 - 50) / 5000 + 50]1/30- 1 x 100 = (23.158)1/30 - 1 x 100 = 11.04% EX.5 Calculate CAGR from the data given below On 1st Jan 2015, I started my investment portfolio with Rs.10000 On 1st Jan 2016, I made a loss, so my portfolio drops to Rs.8000 On 1st Jan 2017, I recouped my loss somewhat and my portfolio stands at Rs.9500 On 1st Jan 2018, my portfolio ends at Rs.12000 Sol We know that, CAGR = (ending value /starting value) 1/n – 1 = (12000/10000)1/3– 1 = 6.26% 3. Nominal and Effective rate of return Nominal Interest Rate: The nominal interest rate is the periodic interest rate times the number of periods per year; for Question, a nominal annual interest rate of 12% based on monthly compounding means a 1% interest rate per month. For example: 12% p.a. compounding monthly 16% p.a. compounding half yearly For easy to understand we can say that nominal rate of interest is difficult to understand for a layman. Effective Interest Rate: The actual interest rate that accrues, after taking into consideration the effects of compounding (when compounding occurs more than once per year). The effective interest rate is always calculated as if compounded annually. People can understand effective rate of interest easily. Ex. 12% p.a., 15% p.a. The effective rate is calculated in the following way, where r is the effective rate, i is the nominal rate and n is the number of compounding periods per year r = (1 + i / n)n– 1 Use of Financial Calculator: CNVR, ie conversion mode is used for calculating EFF (Effective rate) When we press CNVR in our calculators we get 4 options: 1. N = 0, 2. I% = 0, 3. EFF : 4. APR: where N is the number of times compounding is done 71 I is the interest rate EFF is the effective rate of interest APR is the nominal rate of interest
Questions: Ex1. What is the effective rate of interest for 12%p.acompounded monthly, quarterly, semiannually? Sol. Press = CNVR Press = CNVR Press = CNVR N = 12 N=4 N=2 I = 12 I = 12 I = 12 EFF = Solve = 12.68 EFF = Solve = 12.55 EFF = Solve = 12.36 Ex2. What is the effective annual yield of an investment paying at a 10% annual rate, compounded quarterly? Sol. Press = CNVR N=4 I = 10 EFF = Solve = 10.38 Ex.3 15% p.a. return is equal to ………p.a. compounded monthly Sol. Press = CNVR N = 12 I = 15 APR = Solve = 14.057% EX.4 If the continuous time return is 10%, find the annual return. Sol. Effective rate of return = e 0,10-1 = 10.52% 1. If the continuous time return is 11.8% find the monthly return Sol. Effective rate of return = e0,118-1 = 12.51% Monthly return = (1.1251)1/12-1 = 0.99% 2. If the continuous time return is 10.5% find the quarterly return Effective rate of return = e 0,105-1 = 11.07% Quarterly return = (1.1107)1/4-1 = 2.66% 3. If the nominal rate of interest is 8.5% and compounding is done half yearly, the effective rate of interest will be: Sol. Press: CNVR N = 2 I = 8.5 EFF: Solve = 8.68 4. The difference between the effective rate of return of a bond with a coupon rate of10.75% when compounded weekly and semiannually is
Sol. Press: CNVR Press: CNVR N = 52 N=2 I = 10.75 I = 10.75 EFF : Solve = 11.34 EFF : Solve = 11.04 Difference = 11.34 - 11.04 = 0.30% 4. Tax adjusted rate of return & Inflation adjusted rate of return Inflation Adjusted Rate of Return: Inflation adjusted rate of return is a measure that accounts for the return period‘s inflation rate. Inflation adjusted returns reveals the return on an investment after removing the effects of inflation. It is calculated as follows: Inflation Adjusted Return = {(1 + Return) / (1 + Inflation Rate) – 1} * 100 Or We can use this formula: RRR = (return – inflation) / (1+ return ) Tax adjusted rate of return: Tax adjusted rate of return is more appropriate return as it takes in to consideration both tax and inflation. Purpose: one can know the required rate that is required to be maintained for the same level of investments given both the inflation and tax rate. 1. Formula used to calculate the required rate for maintaining same level of investment taking the effect of tax and inflation: = {(Inflation)/(100 - tax rate)} x 100 73
Questions Q1. Calculate the real rate of return if the rate of inflation to be 4.5% and rate of interest is 16%? Sol. RRR = (16-4.5)/1.045 = 11% p.a. Q2. A bond that pays interest annually yields a 7.25 percent rate of return. The inflation rate for the same period is 3.5 percent. What is the real rate of return on this bond? Sol. RRR = (7.25-3.5)/1.035 = 3.62% Q3. If you are promised a nominal return of 12% on a one year investment, and you expect the rate of inflation to be 3%, what real rate do you expect to earn? Sol. RRR = (12-3)/1.03 = 8.74% Q4. If the real interest rate is 5.3% p.a. and inflation is 4%, find the nominal rate of interest. Sol. RRR = (ROI – INF)/1+INF 5.3 = (ROI – 4)/1.04 5.3*1.04 + 4 = ROI ROI = 9.51% Q5. If the real interest rate is 5.3% and inflation is 7.5%, find the nominal rate of interest. SOL. 13.2% Q6. If the nominal interest rate is 12.3% and inflation is 7.6%, find the real rate of interest SOL. 4.37% Q7. If the nominal interest rate is 12.4% and inflation is 7.8%, find the real rate of interest? Sol3.99% Q8. If the interest rate is 12% and the real interest rate is 2%, find the inflation rate. Sol. RRR = [(1 +ROI)/(1+INF) – 1] * 100 2 = [(1.12)/(1+INF) – 1] * 100 2/100 = [(1.12)/(1+INF) – 1] .02+1 = (1.12)/(1+INF) (1+INF) = 1.12/1.02 (1+INF) = 1.098 INF = 1.098 – 1 = .098 = 9.8% p.a. Q9. If the interest rate is 15% and the real interest rate is 4%, find the inflation rate? Sol. 10.577% 74 Q10. If the interest rate is 8% and the real interest rate is 2%, find the inflation rate? Sol. 5.8823% Q11. What rate of return is required to maintain the same level of investment if the inflation rate is 7.14% and the tax rate is 30%. Sol Required rate to maintaining the same level of investment =( Inflation/1-tax rate) *100
= 0.0714/(1-0.30) x 100 = 0.1020 x 100 = 10.20% Or We can solve in the following way 7.14/(1-0.30) = 7.14/.7 = 10.2% Q12. What rate of return is required to maintain the same level of investment if the inflation rate is 6% and the tax rate is 20%. Sol. Required rate to maintaining the same level of investment = 6 / (1-0.20) = 7.5%
FINANCIAL PLANNING Financial planning is a process of taking holistic view of financial needs of individuals Identifying the various needs of investors. Converting these needs into specifics in terms of amount of money and the time when it would be required. Planning saving and investment in a manner that enables one to achieve the pre specified goal. Financial Planning is defined as a process of determining an individual's financial goals, and after considering his resources, risk profile and current lifestyle, to detail a balanced and realistic plan to meet those goals. Who is a financial planner? He understands the universe of investment options. He is well informed on the risk and return attributes of these options. He is well versed in taxation. He uses this knowledge to advise investors in financial planning. He builds in the client’s ability to save, appetite for risk, requirements for cash flows, and tax status. He reviews the plan on a regular basis and revise their financial plan as necessary. Remuneration of FP Fee Commission Fee and Commission Both Financial Planners to work without any conflict of interest. Financial Planning Process SIX STEP PROCESS Six Steps Of Financial Planning
Monitoring the Establishing and Gathering Client Data & recommendations Goals PDleafninnienrgrethlaeticolniesnh-tip recommendations Implementing the Analysing and Financial plan Evaluating Financial recommendations Status Developing and Presenting Financial Planning Recommendations/ Alternatives Establishing the Relationship The first meeting of a financial planner with his client is very important as this is an opportunity to know your client, build the relationship and inspire confidence Clients who have confidence in their Financial Planner are able to be open, honest and frank To be able to get the maximum relevant information from the client a Planner must know sound interviewing skills Establishing the Relationship Preparing for the meeting Confirm details of the meeting What to bring How long the meeting may take Projecting a professional image Meeting in office Dress Getting the client to talk Explain your role Comprehensive financial planning Defining the scope of the engagement Identify the services to be provided Disclosing compensation arrangement Determining the client’s and the financial planner’s responsibilities Duration of the engagement Disclosing information Qualification, references of existing clients
Data Gathering and Goal setting Identify goals Short term goals Medium term goals Long term goals Data Gathering & Goal setting Quantitative Information List of Assets and Liabilities Existing insurances if any Current Income Current Expenditure Time frame for major events/goals Specific income requirements after retirement Present liabilities Qualitative Information Risk tolerance Attitude towards inflation protection Attitude towards accumulation of wealth Concern for leaving the estate for next generation volatility Attitude towards various sectors / investment types Risk profile CONSERVTIVE (90% Debt, 10% Cash) Do not want to take any risk with money, just want guarantee of capital with secure income, if possible. MODERATELY CONSERVATIVE (80% Debt, 10% Equity, 10% Cash)
Want security of capital with stable income stream, satisfied with modest growth on the capital. BALANCED (50% Debt, 40% Equity, 10% Cash) Reasonable growth on the capital invested, moderate income stream with moderate level of risk. MOEDRATELY AGGRESSIVE (40% Debt, 50% Equity, 10% Cash) High level of growth on the capital invested, modest level income steam with high level of risk. AGGRESSIVE (20% Debt, 70% Equity, 10% Cash) High level of growth on the capital invested, high Income potential with higher level of risk. DATA COLLECTION FORM Personal Details Child/dependent details Health Details Estate planning details Employment Details Current Income Professional Details Current Expenses Housing Transport Food Health Education Life insurance Personal Other Assets Investment Liability Insurance policies Annuity plan Investment Risk Profile Objectivity Analysis of client data /information: Personal information Age Number of dependents Insurance coverage Health details Habits Occupational information Nature of work done Period of current employment Employee benefits etc..
Financial information Asset – Liabilities Sources of income Expenses Risk profile identification Identification of Financial problems Adequate insurances Retirement planning Child education Child marriage Proper Asset allocation Liquidity provisions Wills and powers of attorneys Study the time horizon of investment matching with time horizon of goals Assets are sufficient to cover liabilities Step Three Analyze and assess the client’s financial status. The financial planning professional analyzes the client’s information, subject to the scope of the engagement, to gain an understanding of the client’s financial situation. The financial planning professional assesses the strengths and weaknesses of the client’s current financial situation and compares them to the client’s objectives, needs and priorities. Developing and Presenting Financial Planning Recommendations/ Alternatives Step Four Develop the financial planning recommendations and present them to the client. The financial planning professional considers one or more strategies relevant to the client’s current situation that could reasonably meet the client’s objectives, needs and priorities; develops the financial planning recommendations based on the selected strategies to reasonably meet the client’s confirmed objectives, needs and priorities; and presents the financial planning recommendations and the supporting rationale in a way that allows the client to make an informed decision. Step Five Implementation of agreed recommendations The financial planning practitioner and the client shall mutually agree on the implementation responsibilities consistent with the scope of the engagement.
The client is responsible for accepting or rejecting recommendations and for retaining or delegating implementation responsibilities. The financial planning practitioner and the client shall mutually agree on the services, if any, to be provided by the practitioner. The scope of the engagement, as originally defined, may need to be modified. The practitioner’s responsibilities may include, but are not limited to the following: Identifying activities necessary for implementation; Determining division of activities between the practitioner and the client; Referring to other professionals; Coordinating with other professionals; Sharing of information as authorized; and Selecting and securing products and/or services. Step Six Review & Revision of plan. The financial planning professional and client mutually define and agree on terms for reviewing and reevaluating the client’s situation, including goals, risk profile, lifestyle and other relevant changes. If conducting a review, the financial planning professional and the client review the client’s situation to assess progress toward achievement of the objectives of the financial planning recommendations, determine if the recommendations are still appropriate, and confirm any revisions mutually considered necessary. Code of Ethics Regulatory Issues All Financial Planners certified by FPSB India are required to adhere to certain Code of Ethics and Rules of Professional Conduct Code of Ethics are general standards and apply to all members Code of Ethics & Rules of Professional Conduct CFP Certificants are required to sign Code of Ethics and Professional Conduct Rules with FPSB India Non compliance with any of the rules can result in loss of the CFP mark All CFP certificants are required to strictly abide by these rules Integrity Objectivity Competence Fairness Confidentiality Professionalism
Diligence Compliance 1. Integrity Members shall observe high standards of honesty in conducting their financial planning business and shall offer and provide financial planning services with integrity. This code essentially expects the CFP to act out of utter honesty in all that they say and do; hence nothing should be done to mislead the clients whether advertising your services or delivering the service or in maintaining the accounts of their clients with them. A CFP’s relationship with his client in respect of any client’s assets with him is that of a fiduciary (a person who holds assets in trust for a beneficiary). 2. Objectivity Members shall disclose to the Client any limitation on their ability to provide financial planning services This code of Ethic imposes on the CFP the duty to be objective in his plan, that is not be influenced or biased on account of any compensation/remuneration to be received out of making any recommendations in the plan. In case there is some extraneous compensation being received, the CFP ought to share that information with the client. Similarly, it is enjoined upon the CFP to share with the client if there is any limitation on the services that the CFP can provide. 3. Competence Member shall provide competent financial planning services and maintain the necessary knowledge and skill to continue to do so in those areas in which the Member is engaged. A CFP is expected to be competent in providing the services offered to the client. It is also expected that the CFP will continually be updating the knowledge set by participating in the CE programme on an ongoing basis. The member shall also have a set of competency standards for his representatives as well. 4. Fairness Members shall provide financial planning services in a manner that is fair and reasonable If a member enters into a business transaction with a client, the transaction shall be on terms that are fair and reasonable to the client. The client must be kept informed of the members details required for professional relationship (address, contact, designation etc); the client should have access to complaint redressal mechanism. 5. Confidentiality Members shall not disclose any confidential client information without the specific consent of the provider of that information unless compelled to by law or as required to fulfill their legal obligations. A member must , … give to the client… any original document (not photocopies) related to the provision of financial planning advice for which the client has paid or will pay for…. … any member … has access to information and knowledge concerning FPSB India … must keep confidential…
Ex1. Rakesh informed you that prior to consultations with you, he had contacted another CFPCM practitioner who demanded a flat remuneration of 35% of the “Assets under Management” from Rakesh for providing his services. Is there any violation of “Code of Ethics” as stipulated by FPSB India by the earlier Practitioner? (A) This is a matter of mutual consent between the practitioner and the client only. (B) This is a violation of Code of Ethics of Professionalism. (C )This is a violation of Code of Ethics of Fairness. (D) This is a violation of Code of Ethics of Compliance. Ans. C Ex 2. While entering into a relationship with you, Prasoon assumed that you being a practicing Certified Financial Planner, you are fully able to take care of the execution of all aspects of his Financial Plan, i.e. Taxation, Insurance, Investments, etc. As per FPSB India Code of Ethics, what is the best proposition in this context? (A) This is the right assumption which can be made about all Certified Financial Planners. (B) The scope and limitations of the services of the Certified Financial Planner needs to be disclosed in the beginning, specifically in writing, by the Certified Financial Planner to the client. (C) A Financial Planner can never take care of all aspects of a Financial Plan. (D) A Financial Planner is concerned with only making a Financial Plan and not its execution. Ans. B
Ex. 3. In your initial meeting, to make an impression on your client, you discuss the Financial Plan made by you for a famous doctor and also his spending habits with Arvind. Which Code of Ethics prohibits you to have such a discussion with Arvind? (A) Code of Ethics of Professionalism (B) Code of Ethics of Confidentiality (C) Code of Ethics of Fairness (D) Code of Ethics of Integrity Ans. B Ex. 4. Some time back Umang’s investment advisor, also a CFP, recommended him a savings product stating that it offered an assured annual return of 12%. Umang was skeptic about the returns and did not invest. You realize that the product has been misrepresented. In reality it is the simple rate of interest with a lock in period of 10 years. According to you ________. the advisor has violated Code of Ethics of Fairness the advisor has violated Code of Ethics of Integrity the advisor has violated Code of Ethics of Professionalism the advisor has violated Code of Ethics of Diligence Ans. B Ex.5. In the initial stage of Financial Plan preparation, you told Ravinder and also mentioned in the Engagement Letter that you would charge fixed fee for the Financial Plan construction and you would also earn commission on sale of recommended financial products, if the same is accepted. Which code of ethics binds the CFPCM Practitioner to disclose conflict of interests? Objectivity Fairness Integrity Professionalism Ans. A. Ex.6 . You have disclosed in writing to Mr. X on your ability to advise and sell on a restricted range of products, and some other limitation of their capacity to serve him. You have complied with the Code of Ethics of _____________. Integrity Objectivity Fairness Diligence Ans. B. Ex. 7. Suneel has asked you a practicing CERTIFIED FINANCIAL PLANNER CM about the ownership of CFPCM mark in the world. You have explained to him that _________________.
CFPCM mark is owned by FPSB India CFPCM mark is owned by FPSB across the worldC) CFPCM mark is owned by CFP Board across the world D) CFPCM mark is owned by FPSB, Denver (US) outside the United States Ans. D. 8. Mr. X has come to know about this CFPCM practitioner through a newspaper advertisement. The theme and wording of advertisement says that along with preparation of Financial Plan, they also help to generate assured return of 12% p.a. According to FPSB India’s code of ethics, the practitioner has violated _________. Code of Ethic of Objectivity Code of Ethic of Professionalism Code of Ethic of Fairness Code of Ethic of Integrity Ans. D 6. Professionalism Members shall ensure their conduct does not bring disgrace to the financial planning profession. a member shall not engage in any conduct that reflects adversely on his or her integrity …or upon the profession. A member shall not misrepresent the status of their membership of the FPSB India A Member shall not misstate their authority to represent the FPSB India 7. Diligence Members shall act with due skill, care and diligence in providing financial planning services A member shall provide services diligently and on a timely basis, and after securing sufficient information …….. recommendations must be implemented in an accurate, efficient and timely manner. a member shall establish … policies and procedures for effective control and conduct of business 8. Compliance Members must maintain knowledge of and comply with the Constitution of FPSB India, the FPSB India’s Code of Ethics and Rules of Professional Conduct and all applicable laws, rules and regulations of any government, government agency, regulatory organization, licensing agency or professional association governing the members’ professional activities. A member shall ensure that information and relevant documents … be retained for seven years … Ex.9. As a CFP Certificant, which of the following will not be a correct interpretation of the Rules of Conduct pertaining to the Code of Ethics of Diligence for you while dealing with the client? (A) A significant recommendation may be given orally, however confirmation must be given in writing as soon as possible.
(B) As a CFP Certificant, you are considered to be more knowledgeable than Vijay and hence may not need to explain the recommendation and basis in a manner that Vijay may comprehend. (C) As a CFP Certificant, you shall enter into an engagement with Vijay only after securing sufficient information to be satisfied that Vijay's needs and objectives warrant the relationship. (D) As a CFP Certificant, you shall confirm in writing to Vijay where a subsequent instruction given by him alters the financial strategy of his portfolio under your supervision. Ans. B. Ex.10. You have mentioned to your client that you shall ensure all information and relevant documents given to or gathered by you are securely stored to establish at any time that it has complied with the FPSB India’s Professional Standards and be available for inspection by the FPSB India when required. Such records shall be retained for seven years from the date the document was last acted upon. This is according to the Code of Ethics of __________. (A) Compliance (B) Professionalism (C) Diligence (D) Objectivity Ans. A. Ex.11. At the earliest point in the relationship, you have disclosed in writing to your client that you are authorized to sell or advise on a restricted range of products, and any other limitation of their capacity to serve him. You have complied with the Code of Ethics of _________. (A) Compliance (B) Objectivity (C) Diligence (D) Competence Ans. B. Ex. 12. Anoop before approaching you has also contacted another CFPCM Practitioner for the preparation of his Financial Plan. In his first meeting with the practitioner, Anoop asked him the sources of compensation available to the practitioner by making a Financial Plan for him other than fee. But the practitioner refused to answer this question by saying that this is out of the scope of engagement. According to FPSB India’s code of ethics, the practitioner has violated Code of Ethic of _________. (A) Objectivity (B) Professionalism (C) Fairness (D) Integrity Ans. A.
13. Which of the following shall you avoid while providing Financial Planning services to your client in line with the Ethical and Professional Conduct of CFPCM Certificant entailed by FPSB India? (A) Keep the client informed of developments in the field of Financial Planning. (B) Advice the client in those areas in which you have competence. (C) Seek council of qualified individuals for areas in which you lack adequate competence. (D) Alter existing financial strategy promptly, even without confirming to client, if the change in circumstances materially impacts the client’s financial goals. Ans. D.
LIFE INSURANCE PRODUCTS 1: TERM ASSURANCE PLAN • Term Assurance Plan: • (i) It is given for a ‘specified period’. • (ii) A non participating plan. • (iii) Sum Assured is payable only on the death of the insured during the ‘specified period’. • No survival or maturity benefit. • (iv) As it covers only death risk, mortality based ‘risk’ premium is charged. • Hence, it is a very low cost plan at young ages. TYPES OF TERM INSURANCE PLANS Pure Term Insurance Plan Term Insurance with return of premium PURE TERM INSURANCE • (i) It is given for a ‘specified period’. • (ii) A non participating plan. • (iii) Sum Assured is payable only on the death of the insured during the ‘specified period’. • No survival or maturity benefit. TERM INSURANCE WITH RETURN OF PREMIUM • In this plan at the end of the term all premium will be returned. Ex1. Which option is better Option 1 > pure term insurance of S.A. 50 lacs, term 30 years, premium 7000 p.a. Option 2 > term insurance with return of purchase price, S.A. 50 lacs, term 30 years premium 12000 p.a. RISK FREE ROI = 6% p.a. SOL. Option 2 > 12000*30 = 360000 Option 1 > begin, n = 30, I = 6, pmt = -(12000-7000) FV = Solve = 419008 Whole Life Plan: • The Sum Assured is payable only on death, yet some insurers pay the Sum Assured when the life assured completes some higher age along with bonus.
Endowment Plan: • Hence, the Sum Assured is payable: on survival to the end of the term or on earlier death. • The plan is generally a participating one. • The accrued bonus is paid along with the Sum Assured at the time of claim. MATURITY • Maturity = Basic Sum Assured + Bonus1 + Bonus2 BONUS • Simple reversionary bonus • Guaranteed simple reversionary bonus • Final additional bonus or terminal bonus or loyalty bonus Calculate maturity amount & Return • Ex 1. • S.A. = 100000 • Term = 20 years • Premium = 5000 p.a. • Simple reversionary bonus = Rs.50 per thousand sum assured • Final Additional Bonus = Rs.100 per 1000 S.A. • Sol. Maturity = S.A. + Bonus1 + Bonus2 = 100000 + 50/1000 * 100000*20 + 100/1000*100000 maturity = 210000 • Yield> begin, n=20, pmt=-5000, fv = 210000, I = sol =6.63% • Ex 2. • S.A. = 100000 • Term = 20 years • Premium = 5000 p.a. but risk prem is Rs.200 • Simple reversionary bonus = Rs.50 per thousand sum assured • Final Additional Bonus = Rs.100 per 1000 S.A. • Sol. Maturity = S.A. + Bonus1 + Bonus2 •= 100000 + 50/1000 * 100000*20 + 100/1000*100000 maturity = 210000 • Yield> begin, n=20, pmt=-(5000-200), fv = 210000, I = sol =6.978% Anticipated Endowment Plan ( Money Back Plan ) • In this plan some % of S.A. is payable regular interval of tenure and end of the tenure balance S.A. along with bonus is paid.
Money Back Plan • Ex 1. • S.A. = 200000, Term = 20 years, Prem=12000 p.a. • SRB = Rs.44 per thousand sum assured • Final Additional Bonus = Rs.80 per 1000 S.A. • Survival Benefits are paid 20% of S.A. after 5,10,15 years and 40% at maturity. • Calculate maturity and yield? • Maturity = 40% of S.A. + Bonus1 + Bonus2 • = 80000 + 44/1000 * 200000*20 + 80/1000 *200000 • = 272000 • YIELD> • 1to5> -12000 • 6> 40000-12000 =28000 • 7 to 10 > -12000 • 11 > 28000 • 12 to 15 > -12000 • 16 > 28000 • 17 to 20 > -12000 • 21 > 272000 • IRR = SOLVE = 6.745% RIDERS • Life insurance riders are additional benefits over a primary policy, which come into play in case of a specific eventuality. The insurance company usually charges an additional premium for each supplementary benefit The additional premium ceases when such benefit expires or is cancelled Some of the riders are: • (i) Premium Waiver Rider • (ii) Term Rider • (iii) Double Accident Benefit • (iv) Permanent and Total Disablement (v) Critical illness Premium Waiver Rider If the proposer/insured dies, the future premium will be waived off. TERM RIDER • An additional sum assured (Term Rider sum assured) equivalent to the Basic sum assured under the main policy is payable on the death of the life assured during the term of the policy.
Accident Benefits Riders It includes accident death. It is also called double indemnity benefit or double accident benefit Generally one additional sum assured is paid • Total & Permanent Disability (TPD): • This benefit is available along with the Total & Permanent Disability (TPD) Benefit. • Where a TPD is granted, all the future premiums falling due (from the following policy anniversary) under the policy are waived by insurer. 10% of s.a. is paid till normal maturity. The Critical illness benefit rider • The Critical illness benefit rider will take care of your medical expenses in event of a critical disease. • Cancer Kidney Failure • COMA Major Burns • Brain surgery Blindness • Open heart replacement ULIP • ULIPs are structured in such that the protection element and the savings element are distinguishable, and hence managed according to your specific needs. In this way, the ULIP plan offers unprecedented (never before seen or done) flexibility and transparency. Variable Insurance Plans: • As per the option given by the insured, a small or major part of the insurance money is invested in equity market. • The insured is offered a choice of three funds generally called - (i) Safe Fund, (ii) Balanced Fund and (iii) Growth Fund. ULIP • Policy administration charges • These charges are deducted on a monthly basis to recover the expenses incurred by the insurer on servicing and maintaining the life insurance policy like paperwork , work force etc.
Premium allocation charges: • These charges are deducted upfront from the premium paid by the client. These charges account for the initial expenses incurred by the company in issuing the policy. • Ex. Cost of underwriting, medicals & expenses related to distributor fees. After these charges are deducted the money gets invested in the chosen fund. Mortality charges: • Mortality expenses are charged by life insurance companies for providing a life cover to the individual. • The expenses vary with the age and either the sum assured or the sum-at-risk which is the difference between sums assured and fund value of the insurance policy of an individual. Mortality charges are deducted on a monthly basis. Fund management charges: • A portion of the ULIP premium, depending on the fund chosen, is invested either in equities, bonds, G- Securities or money market instruments. • Sometimes it is a combination of these. Managing these investments incurs a fund management charge (FMC). ULIP Age : 30 Sum assured = 100000, Term 20 years, premium 10000 p.a. Mortality charges Rs.1.5 per thousand s.a. (begin ) Policy admin charges : 250 per annum (begin) Premium allocation charge: 1st year 10% of prem And thereafter 4% of premium p.a. Fund management charges 1.35% p.a. ( end ) Gross return of fund 10% p.a. At death fund value and sum assured both payable.
EXCEL SHEET SUM 100000 GROSS 10% P.A. ASSURED YIELD 150 YEAR PREM 10000 250 BALANCE AFTER 1.35% FINAL BAL 10%, 4% MORTALITY POLICY INVESTM-ENT 1 PREM CHARGE ADMIN 8600 FMC 9332.290 2 ALLOCATION CHARGE 9200 9460.000 20110.314 3 10000 CHARGE 150 9200 20385.519 127.710 31806.088 4 10000 150 250 9200 32241.346 275.205 44497.756 5 10000 1000 150 250 9200 45106.697 435.258 58270.120 6 10000 400 150 250 9200 59067.532 608.940 73215.201 7 10000 400 150 250 9200 74217.132 797.412 89432.855 8 10000 400 150 250 9200 90656.721 1001.931 107031.443 9 10000 400 150 250 9200 108496.141 1223.866 126128.550 10 10000 400 150 250 9200 127854.587 1464.698 146851.776 11 10000 400 150 250 9200 148861.405 1726.037 169339.585 12 10000 400 150 250 9200 171656.954 2009.629 193742.231 13 10000 400 150 250 9200 196393.543 2317.369 220222.761 14 10000 400 150 250 9200 223236.454 2651.313 248958.110 15 10000 400 150 250 9200 252365.038 3013.692 280140.273 16 10000 400 150 250 9200 283973.921 3406.928 313977.597 17 10000 400 150 250 9200 318274.300 3833.648 350696.169 18 10000 400 150 250 9200 355495.357 4296.703 390541.328 19 10000 400 150 250 9200 395885.786 4799.187 433779.302 20 10000 400 150 250 9200 439715.461 5344.458 480698.990 10000 400 150 250 487277.232 5936.159 10000 400 150 250 6578.243 400 250 400 7.768415% Annuity Plans • An annuity plan – commonly called a pension plan -provides regular income to the annuitant as per the plan provisions. Life Insurance vs. Annuity: • Annuity is called the ‘reverse’ of life insurance because • (i) ‘life insurance’ cover the risk of dying early whereas ‘Annuity’ covers the risk of living too long.
Types of Annuity Plans • There are two types of annuity plans depending upon as to when will the payments commence: • (i) Immediate Annuity • (ii) Deferred Annuity Immediate Annuity • 1. Immediate Annuity: • The client pays lump sum premium i.e. single premium. (also called purchase price) • Annuity payments are made by the insurer with immediate effect as per the client’s option for the frequency. Deferred Annuity • 2. Deferred Annuity: • A client may desire annuity payments from a future date – called deferred date. • Such an annuity is named as ‘Deferred Annuity’. • The purchase price can be paid by the client in lump sum in the beginning; or in installments during the deferment period. LIC JEEVAN AKSHAY -VI • Type of Annuity: • Annuity payable for life at a uniform rate. • 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 payable for life increasing at a simple rate of 3% p.a. • Annuity for life with a provision of 50% of the annuity payable to spouse during his/her lifetime on death of the annuitant. • Annuity for life with a provision of 100% of the annuity payable to spouse during his/her lifetime on death of the annuitant. • Annuity for life with a provision of 100% of the annuity payable to spouse during his/ her life time on death of annuitant. The purchase price will be returned on the death of last survivor.
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