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Monday, November 3, 2008

Fixed Maturity Plan

In this market scenario, investors are quite skeptical about investing in Equity & equity related funds. When most of the investors are in loss – FMPS come as a relief. 

Fixed Maturity Plan is a close-ended pure debt fund that is for a pre-stated tenure, ranging from 1 month to 36 months. The objective is to invest only in fixed income securities (with high quality credit ratings) like debentures of reputed companies or in securities issued by Government of India. These securities have a defined interest rate and a defined period of maturity. We receive this interest, typically every 6 months or a year, and at maturity, we receive the amount we originally invested and the due interest. Each AMC has a series of Plans, with different maturity periods. More Tax-efficient than other taxable fixed income options like bank deposits, from the point of view of post -tax returns depending on your (Investors) tax bracket. Pre-defined returns and maturity with varying maturity periods like 3 months, 6 months, 1 year, etc, subject to credit risk. The fund manager invests in fixed-income securities with high credit instruments in a manner, which ensures that the fund's holdings mature exactly when the fund is due for redemption, hence minimizing market/price/interest rate risk. 

FMP is the most friendly investment option if an investor is seeking- 
• Post tax returns that may work out to be higher than in other taxable fixed income instruments/bank deposits. 
• Pre-defined returns over a defined period of time comparable with high-grade taxable fixed income instruments/bank deposits. 
• Flexibility to withdraw your investments before maturity on specified dates at applicable exit load.

If you are wondering what is meant by Yield and Coupon Rate then lets clarify it. Coupon Rate is the fixed rate of interest on a debt security. Yield- is the rate of return on any financial instrument, normally expressed as a percentage. It is a measure of return on an investment, stated as a percentage of price. Yield can be computed by dividing coupon by current market price. Thus yield on the underlying instrument is the rate of return on any any tradable instrument which has a defined market price. Post-tax returns for long-term FMP (FMP of maturity more than 1 year) - Income from traditional fixed income instruments like bank fixed deposits are fully taxable, and attract the marginal rate according to the individuals personal income tax bracket. In comparison, since it is a mutual fund instrument, gains from investment in FMPs, if held for over one year and redeemed afterwards, are considered long-term capital gains. In the case of long-term capital gain, the investor is given the option of choosing between- 20 per cent tax rate with indexation benefit, and 10 per cent tax rate without the benefit of indexation. 

The Indexation Benefit allows you to reduce the extent of capital gains to be taxed, by adjusting it for the inflation between start and end period of the FMP. For calculating long-term capital gains, the amount invested is multiplied by the inflation multiple (Inflation Index for Redemption Year/Inflation Index for Investment Year) and then this inflated indexed cost is subtracted from the amount realized at redemption. The extent of capital gains gets reduced, and so does the tax liability.


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