Financial Glossary starting with Alphabet F

Fiscal Deficit

The government needs money for its huge expenses. We can broadly divide govt. expenses into two types:

1. Revenue expenses and 2. Capital expenses.

The money spent by the government for paying salary to its staff is revenue expense, and the money spent for constructing a hospital is capital expense.

The government finances its expenses from

1. Revenue by direct and indirect taxes.

2. Revenue by non-tax means, which includes:

(a) Revenue receipts :

These include dividends received from public sector companies, fees, fines, forfeitures etc.

(b) Capital receipts:

These include sale of PSUs, recovery of loans, borrowings of the government.

Revenue receipts are recurring in nature like the salary you earn while capital receipts are occasional in-flows like the proceeds you may receive on selling your house.

The expenses that the government incurs is always more than the income it makes. This difference or deficit is known as “Fiscal Deficit”. It is expressed as a percentage of GDP.

The financing of this deficit is known as “deficit financing”. Deficit Financing is done through government borrowings or through printing of additional currency notes.

Borrowing money from the market is a better option because if the government were to print more notes it would increase supply of money in the economy thereby reducing its buying power and causing inflation.

Inflation would hurt one and all making the government un-popular.

Therefore borrowing from the market is a better option as it does not alter money supply. But this too cannot go on endlessly.

Borrowing money from the market cannot be an endless strategy purely because there is limited money in the market and needs to be made available for other borrowers as well.

Too much of borrowings will drive up interest rates making credit expensive and thereby putting pressure on prices.

Hence the only way to control the deficit in the long run is by spending less and earning more.

Hope this lesson has helped you in understanding Fiscal Deficit. (Source: Tata Mutual Fund)

FMP Vs. FD

• A common feature of both FMPs (Fixed Maturity Plans) and FDs (Fixed Deposits) is that investors know in advance how much return they will earn on maturity.


• The difference here is that while the returns on FDs are assured, returns on FMPs are indicative


• FMPs are actually close-ended debt funds with fixed maturity offering an indicative yield. The keyword here is ‘indicative’


• That means, on maturity there is a possibility of actual returns deviating from indicative returns


• On the other hand, returns are guaranteed by an FD and investors are assured of receiving the same on maturity (assuming there is no default in payment of principal amount and interest)
  
  
  Why do FMP yields vary?



• FMP yields do not normally vary by a significant margin.


• For the same tenure, the yields on debt instruments (with comparable credit ratings) are usually in a range, which is why FMPs of similar tenure have comparable yields


• The difference in yields between two FMPs arises out of the risk taken on in the portfolio – a FMP having top rated instruments in its portfolio would deliver comparatively less than a FMP with lower rated papers.


• Higher return means that the fund manager has been taking on more credit risk in the portfolio
  
  
  Varying tax treatment



• The tax treatment on interest income for both FMPs and FDs are different


• Interest income from FDs is added to the investor’s income and is taxable at the applicable tax slab for that investor. Interest from FDs is categorized as ‘Income from other sources’ under Income Tax laws


• In the case of FMPs, tax implication depends on the investment option – Dividend or Growth.


• In Dividend option, investors have to bear dividend distribution tax , whereas in the Growth option returns earned are treated as capital gains (short-term or long-term depending on tenure of investment)


• Due to indexation benefit, FMPs end up becoming more tax efficient than a FD as indexation lowers tax liability (Indexation was covered in an earlier series)
  
  
  
  
  In a nutshell -
  
  
  Given the fact that returns from a FMP are not assured, FMPs are generally considered riskier than a FD. But FDs also have their own share of risks as they are usually rated. The credit rating of an FD is an indicator of the degree of risk associated with it. For instance, a rating of ‘AAA/FAAA’ offers the highest level of safety. So, an FD carrying a credit rating lower than this carries higher risk.

Futures Contract

One of the most exotic terms in trading is “Futures”. The common man has stopped worrying about understanding these concepts as he feels it is not meant for his understanding. However let us make an attempt to explain.

Let’s say there’s a farmer who cultivates wheat and a bread manufacturer who needs wheat as an input for making bread.

The farmer thinks that the price of wheat which is currently trading at Rs. 100 could fall to Rs. 90 in 3 months. The bread manufacturer on the other hand feels that the price of wheat on the other hand might become Rs. 120 in 3 months.

In such a case both get together and sign a contract which says that at the end of 3 months the farmer would sell wheat to the bread manufacturer at Rs. 110. Thus the farmer is protected against possible fall in prices. And the bread manufacturer is protected against the price of his input going up beyond Rs. 110

Such a contract is called a “Futures” contract because it is a contract that has to be executed at some future date. Thus “Futures Trading” is nothing but having a point of view about the direction of the future price of a commodity/stocks/currency.

And when two parties have opposite views about future price movements they obviously are open to sign a mutually beneficial deal like the farmer and the bread manufacturer did in our example.

Now, let’s say that after 3 months the price of wheat reaches Rs 120. In this case the farmer will have to sell for Rs.110 as per the contract and undertake a opportunity loss of Rs. 10 as his call that prices would go down was not correct. The bread manufacturer on the other hand would be happy to receive wheat at Rs 110 due to the “Futures Contract” at a time when the prevailing market price is Rs 120.

Thus he clearly makes a profit of Rs 10 because his expectation on price movement turned out to be correct. However at the end of the period both parties achieve their goals of protecting their interests.

While there may be an opportunity loss of the farmer but still he lands up making a profit of Rs. 10. At least he would have been at peace for the period of 3 months since he remained protected against any price fall or loss.

The bread manufacturer on the other hand gets wheat at Rs 110 and makes a clear gain of Rs 10. He can now plan his manufacture more profitably than his competitors who would buy in the market at the spot price of Rs 120. Since his call was right about the price movement, he landed up making the gain of Rs 10 due to the futures contract.

Thus in a sense both parties landed up meeting their business objectives and the “futures contract” helped them plan their business well by protecting their interests against unpleasant price fluctuations.

Hope you have been able to understand that the so called exotic product which as you can see is a very logical protection tool for a buyer and seller of the “Futures Contract” having different views about price movements and both being keen to reduce their losses. Thus at the end one gains more and one gains less but both are happy that they could plan their business well. (Source: Tata Mutual Fund)

Fed Tapering

Fabian owns a small bakery shop in Goa. His wife Suzi is a home maker and takes care of their two kids Jonny and Julie who study in college.

Fabian with great difficulty sets aside Rs. 15,000 a month for household expenses. This amount is sufficient to run the house but not enough to fulfil Jonny and Julie's growing needs of entertainment and extra-curricular activities. Jonny and Julie remain dejected and left out from their peers as they don't have enough pocket money to spend.

Fabian cannot withstand his kids' sadness and decides to increase the monthly household expenses. He sets aside an additional Rs. 5,000 a month as pocket money as long as the kids behave well, study diligently and score good marks in exams. He wanted to fulfill all their wishes and hobbies even though he had to put an extra effort to earn that incremental Rs. 5,000 every month.

This made Jonny and Julie happy as they could now do everything that their friends could do or afford. This positive energy reflected into their studies and they scored well in their college exams.

Fabian and Suzi knew that their kids are now ready to take on the challenge to earn their own livelihood and become financially independent. So, they decide to gradually reduce Jonny and Julie's pocket money by 5% every month till the time they find a part-time job for themselves of their choice.

This process of gradual roll back of pocket money is similar to tapering under way by the U.S. Federal Reserve (popularly known as Fed).

What is tapering?

Tapering refers to the reduction in the quantum of the bond buying programme by the Fed.

The bond buying, also known as the Quantitative Easing (QE) program was launched to kick-start hiring and growth in the US economy. The Fed's first QE program was launched in the midst of the 2008 financial crisis.

But why is Fed tapering now?

The Fed's decision to taper its massive bond buying is due the recovery in the US job market and the confidence that the economy will continue to grow inspite of the tapering.
(Source: Tata Mutual Fund)