ABC Wealth Advisors

ABC Wealth Advisors Ref.No.: FM0009

ABC Wealth Advisors “A bird in hand is worth two in the bush”, is a famous adage applicable aptly to the concept of time value of money. Value of money today is more than the value of money tomorrow. One would opt to invest money today, as there would be substantial return for it in the future. It is also because the value for money in the present is more than its future value. As such, everyone considers the time value of money for making investment decisions. Recently, many consulting firms came into being to advise people on the best investment options. One such firm is ABC Wealth Advisors, a wealth management and personal financial planning firm that advises on various investment options, taking into account the time value of money.

ABC Wealth Advisors: Client Portfolio ABC Wealth Advisors has many departments of which one is the personal finance-planning department. It advises its clients on various ways of investing their money in order to maximise their returns and save for future needs/expenditures. John Hardy (John) joined the department 3 years ago as a consultant and is now the head of the department. As per his daily routine, he checks out his appointments diary the previous evening to analyse different clients’ needs and be ready with appropriate solutions when he meets the clients personally, the next day. The client list for one particular day is as follows: The first client who has an appointment with John is Anirudh, a college student. He had won a prize amount of INR 10,000 in a quiz competition. He wants to invest the amount for a period of 5 years so that he can use the amount from the investment for joining a computer course. He wants to know the amount he would receive at the end of the tenure in order to meet his expenses. Akhil is the next client on the list. He is working with a BPO. He is expecting that he would receive INR 2,500 as an increment every year. He wants to invest INR 2,500 every year for a period of 6

This case study was written by Swapna Pragada (Research Associate), IBSCDC and D. Satish (Professor of Finance), IBS, Hyderabad. It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. The case was written from generalised experiences. © 2009, IBSCDC. No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoever without the permission of the copyright owner.

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ABC Wealth Advisors

years so that he can receive INR 18,000 at the end of the tenure. He wants to know the interest rate at which he should invest in order to meet his criterion. Jones is the third person on the client list. Jones had just started his career. Expecting that his salary would increase at a certain rate every year, he worked out his savings on an average. He wants to invest INR 36,000 per year for the first 4 years, INR 48,000 per year for the next 5 years and INR 60,000 per year for 6 years thereafter. He wants to know how much he would be able to earn after 15 years in order to make a real estate investment at that time. The next client on the list is Frank. He is working as a sales executive in an MNC. He received sales incentives of INR 5,000. He wants to invest the amount in any deep discount bond. He wants to know the interest rate he would be paid for the investment. Surya is the fifth client, scheduled to meet John. Surya is going to retire after 6 months. He is expected to receive a sum of INR 40,000 on retirement. He wants know if it is better to take the lump sum amount or opt for an annual pension of INR 10,000 as long as he lives. The life expectancy of Surya is 20 more years and the interest rate on the pension scheme is 9%. Rohan is the sixth client on the list. Rohan had invested in his friend’s business and receieved a share of INR 1 lakh (0.1 million) out of the profit. He wants to deposit the money in a bank for a period of 5 years. He wants to know how much money he can draw every year so that there would be no balance left at the end of the period. James is the next client scheduled to meet John. He has a piece of land and expects to receive a certain rate of return every year. After working out his returns, he wants to invest INR 10,000 at the end of the first year, INR 15,000 at the end of the second year and INR 20,000 each year from the third year to the fifth year. He wants to know the present value of the stream of investment. Varun, the next client, is about to retire and he wants to receive pension every year. He expects to receive INR 12,000 per year for 8 years and INR 48,000 per year thereafter. He wants to know the present value of the income stream if the discount rate is 10%. Vishal is the next client who has an appointment with John. He is a university student. He had received INR 20,000 as a part of the scholarship. He wants to invest the money in any bond instrument for a period of 10 years. He wants to know the amount he would receive from the investment. The tenth person on the client list is Ravinder. He is scheduled to retire after 14 years. He wants to invest in a retirement plan that would give him a perpetual annual income of INR 30,000 from the beginning of the 15th year. So, he wants to know the amount he should invest now so as to meet his criterion. Amit the next client, who would meet John, is an employee in a software company. He received a bonus of INR 25,000. He wants to invest the amount for a period of 7 years. He wants to know the end amount of the investment. He also wants to know the worth of his investment at the end of the tenure, keeping the inflation rate of 5% in view.

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ABC Wealth Advisors

David is the next client on the client list. He needs an amount of INR 15,000 at the beginning of each year from the 10th to 14th year in order to meet his child’s educational expenses. He wants to know the amount he should invest at the end of each year from the 1st to 5th year from now at an interest rate of 8%. Sujit is the last client to meet John. He wants to know if it is advisable to invest in a mutual fund scheme on a Systematic Investment Plan (SIP) basis or deposit his amount in a recurring deposit scheme for a period of 3 years. He wants to invest INR 1,000 every month. He wants to know the value of the investment, if a person had invested in a mutual fund 3 years ago. After going through all the clients’ details, John analysed the various options, which can be chosen for making investments (Exhibit I). For investment in the deep discount bond, John considered IDBI deep discount bond which would give a maturity value of INR 2 lakh (INR 0.2 million) for an investment of INR 5,300 for a period of 25 years. To make an investment in mutual fund scheme, he analysed the Net Asset Values (NAVs) of HDFC Mutual Fund Scheme (Annexure I). The major task before John is to guide his clients in making efficient investment decisions.

Exhibit I Various Investment Options Investment Option

Investment Type

Interest Rate (%)

Duration (years)

Time Deposit

7.50

5

State Bank of India (SBI) Fixed Deposit Scheme

Fixed Deposit/ Recurring Deposit

8

2–5

National Savings Certificate (NSC)

Recurring Deposit

8

6

Public Provident Fund (PPF) Account

Recurring Deposit

8

15

Fixed Deposit

8

4–5

Oriental Bank of Commerce (OBC) Recurring Deposit Scheme

Recurring Deposit

9

Not less than 5

Nabard’s Bhavishya Nirman Bonds

Bond

9.5

10

Oriental Bank of Commerce (OBC) Fixed Deposit Scheme

Fixed Deposit

9

Not less than 5

Post Office Time Deposit Scheme

ICICI Term Deposit Scheme

Compiled by the author

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ABC Wealth Advisors

Annexure I NAVs of HDFC Mutual Fund Month and Year of Investment

NAV (in INR)

May 2006

51.9101

June 2006

36.842

July 2006

40.9813

August 2006

42.5981

September 2006

47.475

October 2006

48.6142

November 2006

51.7745

December 2006

54.0606

January 2007

53.7199

February 2007

55.7486

March 2007

48.8455

April 2007

49.355

May 2007

53.1501

June 2007

55.2344

July 2007

58.8726

August 2007

60.643

September 2007

61.3966

October 2007

65.2109

November 2007

71.5012

December 2007

75.4613

January 2008

78.6222

February 2008

66.227

March 2008

62.3267

April 2008

59.4898

May 2008

63.7144

June 2008

59.339

July 2008

52.3037 Contd...

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ABC Wealth Advisors

August 2008

58.1061

September 2008

58.6318

October 2008

45.3646

November 2008

39.9359

December 2008

35.6461

January 2009

37.3913

February 2009

35.2276

March 2009

32.0125

April 2009

39.3572

May 2009

44.155

Note: At the inception of the fund, the par value is INR 10 Compiled by the author

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