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Earning higher rates of return

One important thing that has to be considered is the nature of the return and the way in which the instrument is actually structured, writes Arnav Pandya. Read on...

india Updated: Oct 29, 2007 23:42 IST
Arnav Pandya

Various debt instruments are offered by different entities in the market so that investors can put their money into these areas. One important thing that has to be considered is the nature of the return and the way in which the instrument is actually structured. This will enable a person to know whether they can consider investing in such an instrument and the kind of cash flow that this will generate.

The traditional way of issuing a debt instrument is to have an instrument that pays a certain rate of interest and this is then bought by the investor. The couple of factors that are considered by the individual with regard to this investment are the time period when the interest payment is made and the rate of interest. Both of these will determine the exact amount that is received by the individual from the investment that they have purchased.

There is another way in which the debt instruments are issued and here the idea for the issuing institution is to have the funds for a longer point of time. This would involve a situation where the earnings and the capital are paid out only at the end of the time period of the instrument. This means that the returns are compounded for the entire duration of the investment.

This benefit of compounding means that the investor is able to earn a return that is slightly higher than normal and this means that there is an extra benefit for not receiving the cash payout from the investment at regular intervals. The second thing that has to be checked is the time period for which the compounding is done because this determines the exact returns for an investor.

A very good example of this is the situation where the return on an instrument is say 8 per cent per annum. This is the return that is mentioned on the investment and the investor will expect to receive this amount. If the compounding is done twice a year then the return for the investor will be 8.16 per cent. This is one way in which the compounding will give a higher return figure for the investor. In some other case, there might not be clarity about the return but the investor will have to find this out on his own.

If for example if the money doubles in a certain time frame then the investor will be able to know the return that this is generating. For example the Kisan Vikas Patra, which doubles in eight years and seven month, gives a compounded annual return of 8.41 per cent.

There are reports about similar instruments that are likely to be issued by various institutions and one has to keep these in mind while calculating the exact benefits.