Currently the yields offered by short term debt instruments are extremely attractive but the markets are very volatile. Short term bond funds and Income funds offer attractive returns but carry interest rate risk. Investors who wish to lock in at these high yields but do not want to take the volatility require a product suited to their needs. FMPs offered by mutual funds are the apt solution for such a need.

What is an FMP?

FMP stand for Fixed Maturity Plan. These are essentially close-ended income schemes with a fixed maturity date i.e. that run for a fixed period of time. This period could range from 1 month to as long as two years or more. Just like an income scheme, FMPs invest in fixed income instruments i.e. bonds, government securities, money market instruments etc. The tenure of these instruments depends on the tenure of the scheme.

Elimination of Interest Rate Risk

FMPs effectively eliminate this interest rate risk. FMPs invest in instruments that mature at the same time their schemes come to an end. So a 90-day FMP will invest in instruments that mature within 90 days. Holding the underlying instruments up to their maturity effectively mitigates the interest rate risk as there is no buying and selling of the instrument needed.

Taxation of FMP’s

FMP is primarily a debt product and so, the tax incidence would be similar to that on traditional debt schemes. The distribution tax that is payable by the MF on the dividend is fixed at 14.1625%, which is much better than paying tax at the highest rate.

A strategy popularly known as double indexation can also be used. Double indexation gives an investor the advantage of indexing his investment to inflation for two years while remaining invested for a period of slightly more than a year. This can be done if the investor puts in his money just before the end of a financial year and withdraws it immediately after the end of the next financial year. For instance, if an investor put in money in a fund on 25 March 2008 (6 days before the end of FY on 31 March 2008) and withdrawn it on 4 April 2009 (after the end of FY 2008-2009) he would be benefited for two financial years (2007-08, 2008-09) since the investment was made in the FY before last (2007-08). Depending on the quantum of gains in the scheme and the inflation index, the tax liability could be lowered by availing of double indexation.

An Illustration to explain the Double Indexation Benefits of investing in a FMP whose maturity falls in the second financial years post issuance.

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