How to get benefit from interest rate cut?

How to get benefit from interest rate cut?

These types of questions commonly asked and discussed in the investors or fund managers forums. What should you do in current scenario when majority of analyst expect rate cut within a year as government’s fiscal deficit number and Indian rupee dollar exchange rate also improving. We have already seen rupee dollar exchange rate around 60 and expected even below from current 60.

As a gilt fund are most interest rate sensitive so to take advantage from interest rate cut investor should go with these types of fund. Although it is tough to predict when rate cut will happen so there may be some wild moment happen in NAV of these types of fund. But if you have time horizon around 2 year you should definitely go with long duration fund to take advantage of interest rate fall. There are chances of double digit return from the long duration fund.

For example, if fund’s yield to maturity (YTM) is 10% and modified duration is 3 year. In this case if interest rate cut by 100 bps point then the total return would be (YTM+Modified Duration) 13% and if interest rate go up by 100 bps then the return would be 7%. If the interest rate remain unchanged, in that case investor earn around 10%. The return is totally depend on interest rate movement.

Many fund house like Franklin Templeton, Birla Sunlife, IDFC, HDFC etc. offering very attractive debt funds. Investor should have the patience to wait for the rate cut. For those who do not have risk appetite and cannot wait for one and half or 2 year, those investor should invest in short term bond fund.

If you have more than one year time horizon and do not want take any risk in that case you should go with FMPs (Fixed Maturity Plan) as it give indexation benefit also.

For all our investors and readers Happy Navratri, Happy Nav Vikrami Samvat and Happy Gudi Padwa. I wish for all of you happy and prosperous life. If you want more information regarding investment or you have any other query about investment feel free to ask us.

Warm regards,

Arvind Trivedi

Certified Financial Planner

arvind.trivedi79@gmail.com

www.artofinvest.com

www.arvindtrivedicfp.blogspot.in

Understanding Bond – Part 3

In the part-2 we had learned the basic characteristics of bonds. Today we will understand about price fluctuation of bonds. Often we investor confuse about bond pricing. Bonds price fluctuate with prevailing market interest rate. For understand bond pricing, first we need to understand concept of yield.

Yield Concept:

Yield is a figure that shows the return you get on a bond. The formula of calculating simple yield is : yield = coupon amount/price. When we buy a bond at par or face value, yield is equal to the interest rate. When we purchase it below or more from face value then yield change accordingly our trade price.
For an example : If you buy a bond with a 10% coupon at its Rs 1,000 par value, the yield is 10% (100/1,000). But if the price goes down to Rs 800, then the yield goes up to 12.5% (100/800). This happens because you are getting the same guaranteed Rs100 on an asset that is worth Rs 800. Conversely, if the bond goes up in price to Rs1,200, the yield reduce to 8.33% (100/1,200).

Yield to Maturity (YTM):

In the above yield concept we have learnt calculation in very simple form. In real yield is calculated as YTM. YTM is a more advanced yield calculation that shows the total return you will receive if you hold the bond till maturity.

YTM consider all the interest payments (coupon payment) you will receive and assumes that you will reinvest these interest payments at the same rate as the current yield on the bond plus any gain or loss according to purchase rate. Calculation of YTM we learn in next part of this series. Now at this point we should understand that YTM is more accurate and enables us to compare bonds with different maturities and coupons.

Bond's price and its yield are inversely related. When price goes up, yield goes down and when price goes down the yield goes up.

As we have discussed the factors of face value, coupon, maturity, issuers and yield in past bond series. All of these characteristics of a bond play a role in its price. But there are one more important factor that influences a bond more and that is prevailing interest rates in the economy. When interest rates rise, the prices of bonds in the market fall, older bond’s yield increase and newer bonds being issued with higher coupons. When interest rates fall, the prices of bonds in the market rise, older bond’s yield decrease and newer bonds being issued with lower coupons.

I hope till now we have learnt about YTM concept in initial level. In next part we will discuss about different types of bonds.

Regards,

Arvind Trivedi

Certified Financial Planner