THE SCIENCE OF FINANCE : FAQ's (Frequently Asked Questions)

In this issue of Lakshmi Patrika we have taken up some FAQ's on costs and returns in chit schemes. This is a step-by-step approach to understand the various facets that affect the financial aspects of a chit system.

Q: What is Liquidity?

A: Liquidity refers to the ease with which an asset can be converted to cash. If we have a FDR with a bank which will mature after 20 months, then we can expect to have so much money after 20 months. If the bank gives a loan of 75% against the FDR then money is available to the extent the bank permits a loan. It is relevant to understand that the asset is not per se liquid, it is the bank or the market or the mechanism that imparts liquidity to the asset.

Q: What is this talk about liquidity? How does it affect us?

A: When you make an investment, you have to lock your money for some time. If you happen to require this amount then you feel handicapped. This is not the case with chits. Your investment in chits is small and disciplined every month and it is very liquid depending on auction intervals of a week, fortnight or a month. Not only is the chit very liquid it also makes the future instalments liquid. When you get the chit amount you get the entire amount. Supposing you have subscribed 5 instalments of Rs 2,500/- each in a Rs 100,000/- series. If you take the pool in this chit then you will have encashed your future 35 instalments in the chit. The liquidity in chits, therefore, does not restrict to the instalments you have subscribed but extends to all the instalments that you are supposed to subscribe in future.

Q: What is meant by 'return'?

A: Return may be measured in absolute terms or relative term. Rs 100 earned on an FDR of Rs 1000/- over one year, explains returns in absolute values. In relative terms we may put it as a return of 10% per annum. It is relevant to know that in the Indian conditions, the common man considers the interest received from nationalised banks to be the RISK FREE return on money. In chits, the returns are determined by forces of demand and supply of money and are market related.

Q: How is liquidity related to return?

A: If you had Rs 1000/- which you wish to deposit in a bank you have a few options. You may put it in a current account which is absolutely liquid, the return is nil. If you keep it in a savings account for 30 days you have a small return of around 5% per annum. For an FDR of 6 months the return may be 9% and for 3 years you might fetch 13%. In this example everything is constant except liquidity. You are the same in all cases, the borrower bank is also the same. Only the quality of money changes. Liquidity is inversely proportional to return and at 100% liquidity, the return is nil.

Q: What is the cost of liquidity?

A: Liquidity is fairly expensive. As in the example above a savings bank account (a 30 day lock-in account) earns just 5% as against a 3 year FDR which earns 13%.
As compared to banks where there is lock-in period for your investment, liquidity in chits is high. Auction intervals vary from a week to fortnight to a month and provide a system for encashing your chits after each auction interval. In addition the liquidity is extended to the instalments you have already subscribed as well as to the remaining instalments that you will subscriber in future. This kind of liquidity is obviously not available with banks. With all these added benefits chits provide a system in which the returns are still market related.

Q: What is the cost of Insurance?

A: Chit perform in the nature of buffer fund, a contingency reserve. The fund is replenished every month with the monthly contribution and the pool goes to the subscriber according to his needs and requirements. This lumpsum capital inflow works as an insurance at the time of uncertainty. There is a tremendous psychological appeal in chits. That funds en-mass will be available when needed. This psychological advantage must also be translated into financial terms to arrive at a coat-benefit analysis.
For this we look towards other forms of insurance. When we purchase a car, we are obligated to take insurance on the car and the premium approximates to Rs 3000/- per lac of asset. For an Esteem it works to about Rs 16,000/-. Considering that a very vast majority of car owners rarely take a claim every year, what is their benefit at the end of the year after they have spent Rs 16000/-. They have spent this money only for their psychological satisfaction, that in case of a mishap they are insured against any eventuality. Though chits cannot be termed insurance in the true sense, there is still a psychological advantage of calling a lumpsum loan amount whenever required. This is a big convenience and must be attributed some financial cost

Q: What is the cost to a person who gets his chit fund at the very beginning?

A: Cost is a variable function of the value of chit, the total duration, the period of time elapsed when you take the chit, the market conditions when you take the chit and the presence or absence of special events like deepawali, year end closing etc.
We take a selective case just to demonstrate the calculation of cost. In our Quarter Million Series of Rs 2,50,000/- and 40 month duration the monthly instalment is Rs 6,250/-. The subscriber who has taken right in the beginning gets Rs 1,50,000/- (after an initial bid of 40%). During the first few months of the chit (approximately 10 months) his instalments are a mere Rs 4064/- per month. His total instalments over a period of the entire 40 months total up to Rs 200,000/- approximately. Considering that the initial prize amount is Rs 150,000/-, the subscriber lands up with a cost of Rs 50,000/- for using Rs 1,50,000/- for a period of 40 months. The net interest to the first subscriber on reducing scale comes to approximately 17%. If we average out the sum of Rs 50,000/- over 40 months, then the average monthly interest is Rs 1,250/- on a principal sum of Rs 1,50,000/-. The flat rate is, therefore, only about 8 % and on a reducing scale it is about 17%. There are no filing charges in chits. This example is for a chit which goes at an initial bid of 40% and which has a duration of 40 months. These calculations will differ for each different kind of chit

Q: What is the return to a person who takes his fund after some time?

A: In the example quoted above, the subscriber has to make an instalment of Rs 4,064/- as against the face value of Rs 6,250/- p.m. The dividend earned is Rs 2,186/-. By investing a sum of Rs 4064/- you earn Rs 2,186/- or approximately 54% for an investment duration of 39 months. Next month again the instalment remains same and the investment duration is 38 months. In this manner we can calculate the return every month and the return corresponds to the balance duration of the chit. The return is slightly reduced to the extent of company commission.
The said financial return must be seen in the context of high liquidity of the chit schemes. In addition to the said return is the fact of liquidity in respect of future instalments and what we term as the insurance against event uncertainty, which is also an intangible psychological return.

Every-day questions that our subscribers ask us.

Q: Can I leave a massage after office hours?

A: The office of Chandra Lakshmi is open to queries and instructions 24 hours every day. After office hours you may leave your message on the tele-answering machine and your request will be attended by a friendly officer on the next working day. Kindly call up 5704356 to leave your instruction after the office hours. If you wish to leave a written message you may FAX us your document at the same telephone number.

Q: I don't receive my monthly statement by post?

A: You may give us your fax numbers and we will have your monthly statement faxed to you.

Q: Do you accept my monthly subscription by mail?

A: We welcome your subscription in the manner suitable to you. If you wish to mail us your subscription the office provides BUSINESS REPLY ENVELOPES for your convenience. Kindly ask for them.

Q: Whom do I contact in the office in case I have a query?

A: You may contact Mr. A. C. Kapoor, who is the manager. The accountant Mr. Narender Negi is available after banking hours. The computer systems are managed by Ms Rekha Arora and Ms Priya Arora. Our senior accounts officer Mr. Inder Kataria is available in the evening hours. Along with these we have a set of efficient field staff who visit you regularly and you may ask for the person who is responsible for your area. The field staff is available only in the mornings and evenings. Mr. Kamal Bhambhani and Mrs. Shakuntla Bhambhani are Director and Managing Director respectively.