Limited Preview of CFP Study Material of IMS Proschool

1. How to use Proschool Study Material?

2. Financial Planning Mathematics

3. Investment Planning – Risk & Return

4. Tax Planning- Income from house

property

CFP Study Material Preview

Introduction to Financial Planning & Investment Planning

136 Limited Preview Edition

It gives us lots of pleasure to bring 3rd

edition of the CFPCM

books. Its an earnest attempt done to

simplified all topics keeping in mind the understanding and the examination, as CFPCM

Exam is

the most dynamic exam in the country, since lots of changes come day in day out due to changing

marketing dynamics and regulatory requirement. In order to keep you abreast with these changes

we have made special emphasis on online learning system also.

How to read the study material:

The chapter contains 1. Concept reading, 2. Check your progress 3. Assessment Test, 4. Online

resources

1. Concepts Reading: Kindly make an attempt to understand the concept as such and not to read

them as subjects. Concept reading will familiarize you with the required knowledge/approach

to clear the exams. It also includes illustrations and concept checkers to give you the

approach to solve all the practical problems

2. Check your progress: For most of the chapters “Check your progress” is given ,which will

re-emphasize your learning. Solution of “Check your progress” is given at the end of every

chapter.

3. Assessment test: Before you move to the next chapter you should take the assessment test

and if you are scoring below 80% , then kindly again go through the concept again before

moving to the next chapter.

4. Online Resources: After completing all the assessment test please go the online resources.

How to use online resources:

1. Powerpoint Presentation: Summary of all the chapters is given in PPT format. This would

help you to brush up the topics before attempting the online unit test

2. Unit Test: Before taking Full length online simulated test papers, you should again take the

online unit test .

3. Simulated Test paper: Before you take the date of the exam, it is advisable to take the

simulated test paper , if you get above 70% , then you can take the date of the exam at NSE.

How to use IMS Proschool Study Program



This will help you to clear the exam in the first attempt. If you score below 70%, then please

go through the concept book again and then take the simulated test paper 2.

Other online resources:

1. News forum: Whenever you visit online please check the “news forum” first , this will keep

you updated with all the new announcement and changes in the syllabus & examination

structure etc.

2. Question & Answer Forum: If you have any doubt related to the questions given in the

concept books and the questions appearing in the exam then please ask your question using

this forum. You will get reply in three days from our faculty or from any other candidate who

knows the answer . You can also give answer to any other questions to make the forum

interactive

3. Share resources: If you come across any resources or questions which can be useful for other

students then you can share using “Share Resources”

Live Virtual Classroom (LVC)

Live Virtual Classroom is one of the most advanced feature of IMS Proschool study program.

This program is ideal for those who prefer real time learning of classroom, but have constraints in

attending the classroom sessions.

How to use LVC: Students those how are enrolled for this program, can see the online schedule

on their online learning homepage. As per your suitability , you can register online for the classes.

(Note: once register for particular class then you cannot attend same class again). Recorded

sessions are also available. After registering for the class, you will get online invitation with user

id and password to attend the class.

With Best Wishes,

Ankush Bhandari

Product Manager – IMS Proschool



1.Financial Planning Mathematics

Mr. Ravi is an investor who is going to meet his Financial Planner for advice. Before

meeting him, he has noted down few questions that he would like to ask his financial

Planner:

1. I want to go abroad for which I will need Rs.2 lacks after 5 years. How much I

need to invest every year to get the required amount after 5 years (assuming a

return of 12% p.a)?

2. How much I need to save every year to build a fund for my retirement expenses?

3. If I save Rs.5000 every month how much I will able to save in next 20 years for

my daughter marriage?

These are some of the most common questions that you face day to day life. To answer

these questions, knowing “Basics of Time Value of Money” or “Financial Planning

Mathematics” is very important.



Time Value of Money: Concept and Calculation

One of the most fundamental concepts in finance is that money has a “time value.” That is to say

that money in hand today is worth more than money that is expected to be received in the future.

This leads us to summarize the concept of time value: “A Rupee today is worth more than a

Rupee tomorrow."

The purpose of this chapter is to introduce you to the concepts, terminology, and mathematics of

the time value of money. Understanding this topic is crucial in understanding and calculating all

sorts of financial questions in personal finance in general and investments in particular.

Time Value of Money for Even Cash flows

Future Value (FV)

This term refers to the value of a present cash flow (or series of cash flows) at a future

date. Any cash flow that is scheduled to occur sometime later than today is referred to as a

“future value.” Literally translated, future value means “what would be worth of today’s

Rs 1 at some future point?” For example, if an investment promises to pay Rs.100 one

year from now, then the Rs.100 is the future value of the investment because that

investment will be worth Rs.100 at that point in time. Or if you deposit Rs.500 every year

for next ten years to get Rs.7000 after 10 years, then the Rs.7, 000 is the FV.

Present Value (PV)

This term refers to the current (today’s) value of a single or series of future cash flows. In

other words, it is the amount that you would be willing to pay today in order to receive a

cash flow (or a series of them) in the future. For example, if you invest Rs.50,000 and get

Rs.100,000 after 5 years, then Rs.50,000 is the present value of the investment or if you

deposit Rs.10,000 to get Rs.2000 for next 7 years, then Rs.10,000 is the present value.

Number of Periods (NPER)

The total number of periods is a key variable in all time value of money questions. It is

important to distinguish between the number of periods and the number of years. For

example, when we refer to a “30-year Home Loan” we are talking of 360 months or

periods of repayment and not 30 years.

Payment (PMT)

The payment is a series of cash flows. Typically, payment refers to all types of the cash

flow in an annuity. For example, if you deposit Rs.500 every year for next 10 years to get

Rs.20, 000. Then, Rs.500 is the payment (PMT). Common examples of Annuity/Payment

are EMI, Pension, and Systematic Investment Plan (SIP) etc

http://www.tvmcalcs.com/terminology#Annuity



Rate

This is the rate that is used for compounding or discounting the future values or present

values. For example, if you deposit Rs.10, 000 and earn 12% pa on your deposit, then

12% pa is the Rate.

Interest can be calculated in two ways:

a. Simple Interest

This is when interest is calculated only on the principal amount.

Where,

SI = Simple Interest

R = Rate of Interest

T = Time period

For example, if you deposit Rs. 100 for 2 years at an interest rate of 8% p.a., then after

one year, the interest you will earn would be: 100 x 8% = Rs. 8 and after 2 years : 100 x

8% x 2 =16

b. Compound Interest

This is when the earned interest is also reinvested along with the principal and one

receives interest on interest. For example, if you deposit Rs. 100 for 2 years at interest

rate of 8% p.a., then after one year, the interest you will earn would be: 100 x 8% = Rs. 8

For the next year, you will not only earn interest on Rs. 100 but also on the interest that

you earned in the first year i.e Rs. 8 and therefore you will earn interest on Rs. 108.

108 x 8% = Rs. 8.64

The generalized formula for calculating future value at compound interest can be stated as

below:

FV = PV (1 + R) T

= 100(1 + 8/100) ^2

= 108.64

SI = PV x R x T

Note:

In all the time value of money

calculation, if rate is given 8% pa

then it means 8%pa compounded

annually (Unless, Simple interest

is mentioned in the question)



How to Solve Time Value of Money (TMV) questions using Excel “Functions”:

Write the TMV terminology that you need to use to get the answer.

For Example: After how many years your deposit of Rs.12, 000 will become Rs.20,

000 @15%.

Answer: NPER

Now Solve:

1. You need Rs.5,000 after 5 years. How much you need to deposit today?

___________

2. You need Rs.500 every year for the next five years. How much you should deposit

today? ______________

3. You invest Rs.1, 000 every year for next 20 years. How much amount you will

have after 20 years? ___________________

4. How much you have to deposit every year to get Rs.5000 after 5 years @12%

pa_______________

Benefits of Excel over Financial Calculator

In the exam, you can use either Financial Calculator or Excel for solving TMV problems, but

we strongly recommend students to use Excel to solve TMV problems because

a. Easy to remember: All the formulas are given in Excel “Fx “

b. Faster approach:

c. Easy to verify

d. Critical problem: Problems like Loan amortization are easy to solve on Excel sheet.

e. Presentation Advantage: Financial calculations can be presented to the clients on Excel

sheet

f. Record keeping: All the calculation done on Excel sheet can be saved for future

reference. More over for similar problems you just have to change the figures.

Check Your Progress I



To start solving TMV problem using Excel Functions: open Excel on your Computer System

1. Click “Fx” on your excel sheet:

2. Select a category: Financial

Function (Fx)



3. Select a Function: Select a function as per the requirement of Question. For example, if you

want to find out the amount to deposit today so as to get Rs.10,000 after 5 years, then double

click on PV:

Time Value of Money Calculations:

1. How much amount you have to deposit to get Rs.10, 00,000 after 10 years @12% pa.?

Explanation:

PV =?

Rate: 12%

NPER: 10

FV: 1000000



Some pages are omitted from this chapter preview



2. How many years will it take to make Rs.20,000 if you deposit Rs.5,000 per annum @15%

pa.?

Explanation:

Nper = ?

Rate: 15%

PV: -5000

FV: 20000

Ans: 9.9 years

Note:

Whenever one is depositing/investing money , an outflow of cash occurs from one’s pocket,

then a negative sign precedes the amount. For example, in the above question, we have

deposited Rs.100,000, so put negative sign before it i.e. -100,000. If you will receive some

amount, then you don’t have to put any sign before that, because any figure without sign is

always considers as positive. For example in the 1st Example, we have put 1000,000 in FV

rather than +1000,000.



3. At what rate of return will your investment of Rs.200,000 become Rs.500,000 in 12 years?

Explanation:

Rate:?

NPER: 12

PV: -200000

FV: 500000

Ans: 7.9%

5.A Calculate the amount you will get after 5 years, if you deposit Rs.100 at the end of every

year for five years at 12% pa. ?

Explanation :

FV = ?

PMT: Rs.100

Rate: 12%



NPER: 5

Ans: Rs.635.28

5.B Calculate the amount you will get if you deposit Rs.100 at the beginning of every year for

five years @ 12% pa.

Explanation:

Rate: 12%

NPER: 5

PMT: Rs.100

Type: 1



Ans: 711.52

Note:

In all Annuity/payment questions “Type” plays an important role.

a. In the question no 5 A, when you deposit Rs.100 at the end of every year for 5 years, then

in “Type” you have to put value “0 or simply omit it. This type of Annuity is called

“Ordinary Annuity”

b. In the question no. 5 B, when you deposit Rs.100 every year at the beginning for the next 5

years, and then in “Type” you have to put value “1”. Type 1 means payment at the

beginning of the year. This type of Annuity is called “Annuity Due”



Type 0 or 1 on Time Line

A.

B.

When to use Type

1. Type is used only with annuity (PMT) Calculations

2. Whenever you invest regularly consider it “at the end of the period” and type “0” (Unless

given in the question that investment “at the beginning of period” or “investments starts from

now/immediately)

3. Whenever you withdraw regularly , consider it at beginning of the period and use type “1”

(Unless given in the question that withdrawal at the end of period is given)

5.C: How much amount you need to deposit to get Rs.20000 for ever @10% pa

=Annuity amount/rate

=20000/10% = 20000*100/10 = 200,000

Note:

This type of Annuity is called “Perpetual

Annuity” .This type of Annuity will provide

you regular amount forever. In the above

example, if you deposit Rs.200,000 @10% pa

then, you will get Rs.20,000 forever.



Faster approach of solving TMV calculations on Excel sheets

In the examination, you have to solve TMV problems frequently, that is why opening the “Fx”

every time becomes time consuming. Another way of solving problem is to write the formulae

Functions with in the cell of Excel :

The table below shows various Excel Functions:

Solve questions using Excel Functions:

How much amount you have to deposit today to get Rs.10,00,000 after 10 years @12% pa.?



6. . X is planning to send his daughter to college 18 years from now and will need Rs.100,000

at that time in order to pay for her tuition fee. Given annual rate of return of 8% per year, how

much money he needs to invest every year to achieve the set goal?

___________________________

7. . X is planning to send his daughter to college 18 years from now and will need Rs.100,000

at that time in order to pay for her tuition fee. Given annual rate of return of 8% per year, how

much money he needs to invest in the beginning of every year ( start now)to achieve the set

goal?_________________________

8. You want to withdraw Rs.5,000 every year for next 20 years for your retirement expenses.

Assuming an return of 10% pa , how much money you need have to achieve your goal?

____________________________

9. You require Rs.10,000 forever . How much you invest today @12% pa to get the required

annuity?__________________________

10. Suppose that you are offered an investment that will cost Rs.925 and will pay you interest

of Rs.80 per year for the next 20 years. Furthermore, at the end of the 20 years, the investment

will pay Rs.1,000. If you purchase this investment, what is your compound average annual

rate of return?_____________________________



TMV for Uneven cash flows

Net Present Value:

How much amount you have to deposit to get an annuity of Rs.1,000 every year for next 20 years

@ 12% pa?

To solve this question, you will use Present Value: = pv(12%, 20,1000) =

Now, suppose you want to know how much you have to deposit to get Rs.4000 at the end of first

year, 6000 at the end of second year, 8,000 at the end of third year & 10,000 at the end fourth

year @12% pa?

To solve the above problem, you can’t use PV function as the cash flows are uneven. To get the

present value of uneven cash flow, you have to use Net Present Value (NPV) function

Answer: 20,404.

Internal Rate of Return:

You are investing Rs.20,000 in a fund which will give back Rs.5000 for next five years. How

much rate of return you are deriving from this investment?

To answer this, you will use Rate =rate (5,5000,-20000)

Now, suppose you are investing Rs.20,000 and will get Rs.6,000 after one year, Rs.8,000 after

two years and Rs.10,000 after 3 years. How much rate of return you are getting in the above

investment



To solve the above problem, you can’t use Rate function as the cash flows are uneven. To get

the rate of return of uneven cash flow, you have to use Internal Rate of Return (IRR) function

Illustrations:

What is rate of return in an investment, where you deposit Rs.10,000 in first year and get

RS.6,000 in third year,Rs.8,000 in 6 year and Rs.10,000 in seventh year.

Note:

If for any period there is no

investment/return, then put

Zero in the year when you will

not invest or get any amount.



1. If you make an investment of 1 lakh in a project initially and future cash flows at the end of

every year are given as :

25000

15000

18000

17000

35000

25000

What is the rate of return you earned ?___________________________

2. You have to make a following series of payments at the end of year (given rate of return 8

% pa)

12000

14000

18000

19000

29000

What amount should you deposit to take care of the payments ?______________________

3. You have the option of receiving following payments at the end of each year:

a.Given the rate of return is 9 % which option would you choose ?___________________

b.If you had to make these payments which option you would choose ?_______________

Check Your Progress III



As a financial planner, what option would you advice him to invest?

Your decision will depend on how much annual return your client will get from the various

options and this annual return is called” Effective Annual rate of Return”

CASE I

Consider a stated annual rate of 10%. Compounded yearly, this rate will turn Rs.1000 into

Rs.1100. However, if compounding occurs half yearly, Rs.1000 would grow to Rs.1102.50 by the

end of the year, rendering an effective annual interest rate of 10.25%. Basically the effective

annual rate is the annual rate of interest that accounts for the effect of compounding.

Calculation:

(1+ i/n)n

-1

i = stated annual interest rate

n = number of compounding periods

=(1+0.1/2)^2 -1=0.1025 or 10.25%

CASE II

Now suppose you are investing Rs.1000 every month in a Mutual Fund (SIP mode) for 1 year

which gives a return12% pa. Note that the given return is annual, but you are investing monthly.

Now if you apply rate = 12%/12 or 1%, (=fv (1%,12,-1000) it would be compounded every

month and effective rates becomes = 12.68% (1 + (.12/12)) ^12 -1.Then you will get a return

higher than the actual return.

Therefore your monthly effective rate will be less than 1%, which after compounding 12 times in

a year will become 12%.

Monthly effective rate= (1 + R/100) ^ (1/npery) -1

(npery = no. of periods in a year).

For the above calculation, monthly effective rate will be:

= (1+ 12/100) ^ (1/12)-1

= (1.12)^(1/12)-1= .009489 or 0.9489%

Then, future value of above mutual fund will be

=fv (.9489%, 12,-1000) =12,646

Note:

In the above question 10% will

be nominal rate and 10.25%

will be Annual Effective rate.



Inflation adjusted rate /Real rate of return

How much did your investments really earn last year? You can calculate a rate of return, but if

you don’t adjust it for inflation, you’re not getting the real rate of return.

This is the difference between the nominal interest rate (before adjusting for inflation) and the

real interest rate. You need to know the real rate, since that is the only number that means

anything.

Think of it this way: the nominal interest rate tells you the growth rate of your money, while the

real interest rate tells you how much your purchasing power is growing.

Growing Money

For example, if you make a Rs.1,000 investment that earns 8% in one year, you end the year with

Rs.1,080. In other words, your money has grown by Rs.80. This is called nominal rate of return.

However if inflation is 3% for the year, your Rs.1,080 is only worth Rs.1,050. Inflation devalues

your returns. Your real rate of return is approximately 5%. This is your inflation adjusted rate of

return

Note:

When to use effective rate of return?

When ever annual rate is given but you are investing or withdrawing

monthly/quarterly/daily/half yearly.For example you are investing Rs.1,000 monthly in a

Mutual Fund with rate of return of 12% pa

When not to use effective rate of return ?

Whenever calculation involves products such home loan, car loan etc or any other

products where it is mentioned that interest rate will be compounded .For example in

National Saving Certificate (where 8% pa is compounded half yearly)



Illustration

What is the real rate of return, if inflation rate is 5% and rate of returns for investments is 12%?

= (1+.12/1+.05)-1

= .06667 or 6.6%

Alternatively, Real rate of return = (interest rate – inflation rate)/ (100+ inflation rate)

Illustrations: (12-7)/(100+5) = 7/105 = .06667 or 6.6%

Bond Valuation:

Bond Valuation and TMV

A bond is a debt instrument issued with the purpose of raising capital by borrowing. Generally, a

bond is a promise to repay the principal along with interest (coupons) on a specified date

(maturity). Some bonds do not pay interest, but all bonds require a repayment of principal. A

bond may be described in terms of par value ( the value stated on the face of the bond), coupon

rate (interest rate payable to the bondholder) & maturity date ( the date when the principal amount

is payable to the bondholder). For example, an issuer may sell a bond with a par value of

Rs.1000, a coupon rate of 8% and maturity period of 5 years. The buyer of such bond would

1. You are taking a home loan of Rs.20 lac for 20 years at 12% pa. What will be your EMI?

2. You are investing in a mutual Fund Rs.1,000 monthly at 15% pa . What amount you will

get after 5 years?

3. You are investing Rs.1,00,000 in a Bank Fixed Deposit for a term of 5 years at the rate of

9% pa ( Compounded Quarterly). What will be your maturity amount?

4. Rajendra has a retirement Fund of Rs.10 lac. How much annuity(Annuity Due) he can

withdraw monthly for the next twenty years, if he is expecting the rate of return of 8% pa.

5. You are investing Rs.5,000 quarterly in a Mutual Fund SIP at the rate of return of 12% pa.

How much amount you will get after 10 years?

6. You are investing in a fund which is giving a return of 12% pa. If inflation rate is 6%, then

what would be real rate of return?

Check Your Progress IV

http://www.investorwords.com/1320/debt_instrument.html

http://www.investorwords.com/694/capital.html

http://www.businessdictionary.com/definition/borrowing.html

http://www.businessdictionary.com/definition/promise.html

http://www.investorwords.com/7199/repay.html

http://www.investorwords.com/3839/principal.html

http://www.investorwords.com/5331/with_interest.html

http://www.investorwords.com/3017/maturity.html

http://www.investorwords.com/3626/pay.html

http://www.investorwords.com/2531/interest.html



To calculate the present value of the bond paying coupon half yearly you have to:

1. Divide rate by 2 i.e. 10%/2 = 5%

2. Multiply NPER by 2 i.e. 5 * 2 = 10

3. Divide Coupon by Rs.2 i.e 8/2 = 4

= pv (10%/2, 5*2,4,100)= 92.28

Zero Coupon Bond:

In a Zero coupon bond, there will not be any coupon rate which means bond holder will not

receive any regular payouts like Rs.8 in earlier question, but only Rs.100 or par value on maturity

.

Valuation of Zero Coupon Bond:

A bond is available with a par value of Rs.100, maturing after 5 years. If you are expecting a

yield of 10% pa, then how much will you pay for this bond?

= PV(12%,5,,100)=56.74

Note:

No value in PMT, because you

will not get any regular amount

in Zero Coupon bond.



Solution of Check your Progress

1.

Sr.No Answer

1 Present value

2 Present value

3 Future value

4 PMT

2.

Sr.no Answer Formula

1 161.051 =FV(10%,5,,-100)

2 -25024.90 =PV(8%,18,,100000)

3 8.043 =NPER(9%,,-1250,2500)

4 0.093 =RATE(18,,-20000,100000)

5 -6417.65 =PV(9%,10,1000)

6 -2670.20 =PMT(8%,18,,100000)

7 -2472.41 =PMT(8%,18,,100000,1)

8 -46824.600 =PV(10%,20,5000,,1)

9 83333.33 =10000/0.12

10 0.08 =RATE(20,80,-925,1000)

1. A bond (Face value Rs.1000) with 10 % coupon paying interest on a semi annual basis,

is trading at 890 with maturity after 5 years . What is its Yield to Maturity (YTM) ?

2. You need a return of 12 % p.a. A 1000 rupee bond is trading at 925 with 3 years of

maturity pays a coupon of 7%.At what price should you buy it ?

3. A bond with face value of 1000 coupon of 7.5% paying semi annually , will mature in

17.5 yrs.Similar bond in market with yield of 8 % would be available at what price ?

4. A Zero coupon bond of Rs.100 maturing after 4 years is available, how much price you

will pay to buy the Bond , if your expected yield is 12%?

5. A Bond (face value Rs.1000), with 12% coupon paying interest on a quarterly basis, is

trading at Rs.800 with maturity after 4 years. What is its Yield to Maturity?

Check Your Progress V



3.1.

A B C

11

12 =IRR(F13:F19)

13 1 -100000

14 2 25000

15 3 15000

16 4 18000

17 5 17000

18 6 35000

19 7 25000

20

Ans:8.733%

2.

A B

11

12 =NPV(8%,F13:F17)

13 1 12000

14 2 14000

15 3 18000

16 4 19000

17 5 29000

18

19

20

Rs.71,105

3.

E F G H I

11 option 1 option 2 option 3 option 4

12 8845.64159205786 9289.15473757128 9364.98811428976 8175.22693569237

13 =NPV(9%,F14:F17) =NPV(9%,G14:G17) =NPV(9%,H14:H17) =NPV(9%,I14:I17)

14 1 5000 0 5000 0

15 2 2000 4000 3000 0

16 3 1500 4000 2000 6000

17 4 2000 4000 1000 5000



Assessment Test:

1. Salim expects to pay out the following in next few years: to pay out these amounts how much

should he have now, assuming an annual rate of 10%?

End of Year 1: Rs. 25,000





a) 65908

b) 66905

c) 68868

d) 74184

2. A 10 year bond pays a coupon of 10% p.a. with interest paid semiannually. The Yield on the

bond is 11%. Find its current price assuming Face Value of 1000.

a) 956.91

b) 1,050.43

c) 986.36

d) 940.25

3. If the pre tax return on a security is 10.00%, the real post-tax return would amount to

_______% if the inflation rate is 3% & income tax rate is 20%.

a) 4.85%

b) 3.51%

c) 4.30%

d) 3.12%

4. If you borrow Rs.500000 for a house @ 8.25% p.a.(compounding monthly) for 20 years, what

is your monthly payment?

a) 5,343

b) 4,260

c) 5,433

d) 3,134



5. In 1971, a breakfast used to cost Rs. 10. If the cost has increased to Rs. 55 now, what is the

effective annual rate of inflation over the period from 1971 to 2010?

a) 4.47%

b) 6.63%

c) 7.84%

d) 450.00%

6. At an interest rate of 8%, compounded semi-annually, how long does it take a given sum to

triple in value?

a) 14.5 years

b) 16 years

c) 28 years

d) 29 years

7. Chris wants Rs.300,000. She currently has a balance of Rs.100,000 and earns 8% per year,

compounded quarterly. How long will it take for Chris to accumulate the money

a) 13 years and 10 months

b) 18 Years and 9 months

c) 29 years

d) 19 years

8. Which of the following selections has the lowest present value if the discount rate is 5%? The

first cash flow occurs at the end of the first period, the second cash flow at the end of the

second period, and so on.

a) Rs.100; Rs.100; Rs.100; Rs.100

b) Rs.0; Rs.0; Rs.0; Rs.500

c) Rs.350; Rs.0; Rs.0; Rs.0

d) Rs.50; Rs.50; Rs.50; Rs.375

9. Arijit has taken a home loan of 30 lakhs @ 8.25% p.a. for 20 years. What is the EMI?

a) 23416

b) 25387

c) 25006

d) 25,561



10. A bond pays a coupon of 10% annually with interest paid semiannually. The bond has a

duration of 6 years. The Yield on the bond is 11%. Find its current price assuming Face Value

of 1000.

a) 956.91

b) 1,050.43

c) 922.83

d) 986.36

11. If the pre tax return on a security is 8.00%, the real post-tax return would amount to

_______% if the inflation rate is 3% & income tax rate is 20%.

a) 2.97%

b) 3.51%

c) 3.30%

d) 3.12%

12. If you want to spend a sum equivalent to Rs. 5000 p.a. for the next 5 years when the rate is

5% you need _________ today.

a) Rs. 22647

b) Rs. 20647

c) Rs. 21647

d) Rs. 23647

13. Raju wants to go on a foreign holiday at the end of every alternate year. It is expected to cost

him Rs. 2 Lakh per trip. How much corpus will Raju require to invest so that he can take care

of this requirement till perpetuity? Rate of return is 8%. (Round off to nearest lakh)

a) 2500000

b) 5100000

c) 1200000

d) 1000000

Lots of time investor would ask for an avenue having maximum returns with minimum risk. Is it possible for a Financial Planner to provide maximum return with minimum risk? , it’s like asking for S Class Mercedes with a CNG fittings!

Chapter - 3

889999

Measurement of Risk







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No, all returns come with some risk and we know the axiom “Higher the return, Higher the risk, and vice-versa”.

For example, Capital market offers return of 18% pa (Historical return) but it comes with the huge risk of negative return at times, on the other hand, PPF offers only 8% return, but come with almost no risk.

It is the job of a Financial Planner to measure the risk and return of any of Financial Products, and then suggest products to the client according to the suitability.

Now big question is how to measure Risk.



Measuring Risk:

One of the ways to measure risk is using the statistical tool called as “Standard Deviation”

1. Measuring standard deviation of Historical Returns:

Let’s examine two scenarios where the scores of two players are mentioned:

Match Wall Prince

Match 1 45 12

Match 2 34 45

Match 3 54 60

Match 4 12 42

Match 5 17 54

Match 6 87 54

Match 7 45 45

Match 8 26 23

Match 9 16 10

Match 10 26 17

Total Runs 362 362

We are calculating the Standard Deviation (In order to find out who is more consistent)

Step 1: Calculate the average score

Total score / no. of matches

362/10=36.2



Step 2: Calculate the deviation of individual score from the average score, square it & then calculate the sum of

Squares

Match Wall Score Average

run

Deviation

(Wall score – Average

Score)

Square

Match 1 45 36.2 8.8 77.44

Match 2 34 36.2 -2.2 4.84

Match 3 54 36.2 17.8 316.84

Match 4 12 36.2 -24.2 585.64

Match 5 17 36.2 -19.2 368.64

Match 6 87 36.2 50.8 2580.64

Match 7 45 36.2 8.8 77.44

Match 8 26 36.2 -10.2 104.04

Match 9 16 36.2 -20.2 408.04

Match 10 26 36.2 -10.2 104.04

Total Runs 362 4627.6

Step 3: Divide the total by total number of matches less one

=4627/ (10-1)

Variance = 514.17

Standard Deviation = 514.17^ (1/2)

or square root of 514.17 = 22.67



Now thankfully we have excel also

Standard Deviation on Excel Function:

Select the STDEV from Statistical Functions:

=

= 22.67

In the same way, for Prince Standard Deviation is:

=18.866

Therefore, we can observe that Standard Deviation of Wall is more than Prince , it means that Prince is more

consistent than Wall.

Run



In the case of investments where the returns are market dependant, for example a stock, one will

have to estimate the possible returns and the probability of getting the same, as given here below:

Returns Probability of getting the returns

4% 0.1

8% 0.2

12% 0.4

16% 0.2

20% 0.1

In this case, the expected return is calculated as under:

Expected return = Sum (returns*probability)

= (0.04*0.1+0.08*0.2+0.12*0.4+0.16*0.2+0.2*0.1)

= .004+.016+.048+.032+.02

= 0.12 or 12%

It is a normal distribution curve as pictorially depicted below:

Normal Distribution

Returns

Pro

ba

bili

ty



Variance= Probability * (actual return – expected return) 2

So, based on the figures in the table we can work out the variance as under;

Expected return already calculated to be 12%

Actual return Expected

return minus

actual return

Difference

squared

Probability Square of

difference *

probability

4 -8 64 0.1 6.4

8 -4 16 0.2 3.2

12 0 0 0.4 0

16 4 16 0.2 3.2

20 8 64 0.1 6.4

Variance = sum of last column = (6.4+3.2+0+3.2+6.4) = 19.2

Standard deviation = Square root of variance = 4.3817

(Please note here we cannot use the STDEV function as there are probabilities attached to each event)



Calculating a standard deviation using probability distributions involves making subjective

estimates of the probabilities and the likely returns. However, we cannot avoid such estimates

because future returns are uncertain. The prices of securities are based on investors' expectations

about the future. The relevant standard deviation in this situation is the ex ante (estimated before

the event) standard deviation and not the ex post (calculated after the events/historic) based on

realized returns.

Although standard deviations based on realized returns are often used as proxies for projecting

standard deviations, investors should be careful to remember that the past cannot always be

extrapolated into the future without modifications. Historic (ex post) standard deviations may be

convenient, but they are subject to errors. One important point about the estimation of standard

deviation is the distinction between individual securities and portfolios. Standard deviations for

well- diversified portfolios are reasonably steady across time, and therefore historical calculations

may be fairly reliable in projecting the future. Moving from well- diversified portfolios to

individual securities, however, makes historical calculations much less reliable. Fortunately, the

number one rule of portfolio management is to diversify and hold a portfolio of securities, and the

standard deviations of well-diversified portfolios may be more stable.

Something very important to remember about standard deviation is that it is a measure of the total

risk of an asset or a portfolio, including therefore both systematic and unsystematic risk. It

captures the total variability in the assets or portfolios return whatever the sources of that

variability. In summary, the standard deviation of return measures the total risk of one security

or the total risk of a portfolio of securities. The historical standard deviation can be calculated

for individual securities or portfolios of securities using total returns for some specified period of

time. This ex post value is useful in evaluating the total risk for a particular historical period and

in estimating the total risk that is expected to prevail over some future period.

The standard deviation, combined with the normal distribution, can provide some useful

information about the dispersion or variation in returns. In a normal distribution, the probability

that a particular outcome will be above (or below) a specified value can be determined. With one

standard deviation on either side of the arithmetic mean of the distribution, 68.3 percent of the

outcomes will be encompassed; that is, there is a 68.3 percent probability that the actual outcome



will be within one (plus or minus) standard deviation of the arithmetic mean. The probabilities are

95 and 99 percent that the actual outcome will be within two or three standard deviations,

respectively, of the arithmetic mean.

In a bell shaped normal distribution the probabilities for values lying within certain bands are as

follows:

+ 1 S.D. 68.3 %

+ 2 S.D. 95.4 %

+ 3 S.D. 99.7 %



Sum of Product of Deviation of Individual Security and Market / (n-1)

How to calculate Beta –

Case 1 – when Probabilities are not given

Here we use a Statistical concept called as “Co-Variance” – this talks about what is called as Co-Movement

between the individual stock and its benchmark.(More on Co-variance in the coming chapter)

Beta = Covariance between Stock and Market / Variance of Market.

And Covariance between Stock and Market is given by

Consider the following

Concept Question:

Year Return of Security

(%)

Return of Benchmark (%)

1 15 12

2 12 15

3 13 18

4 -6 4

5 24 18

6 22 20

7 -14 -12

8 -10 -18

9 12 16



10 6 8

Solution:

Now lets’ first calculate the Covariance between the Security and the Benchmark.

Recall- when probabilities are not given, Co-Variance is

Sum of Product of Deviation of Individual Security and Market / (n-1)

Step 1- Calculate the Average Return of Individual Security and also that of Market.

Step 2- Calculate the Product of the deviation

Step 3 – Calculate the Sum of the above product.

Step 4 – Divide the above value (as obtained above) by number of observations less 1 (this is called as Loss of

Degrees of Freedom). So the result that is obtained is known as the Co-Variance (this is an absolute value)

Step 5 – Calculate the Variance of the Market

Step 6 - Calculation of Beta = (Step 4/Step 5)



Deviation of Individual Security

from its Average (A)

Deviation of

Benchmark from its

Average (B)

Product of Deviation

(AxB)

7.6 3.9 29.64

4.6 6.9 31.74

5.6 9.9 55.44

-13.4 -4.1 54.94

16.6 9.9 164.34

14.6 11.9 173.74

-21.4 -20.1 430.14

-17.4 -26.1 454.14

4.6 7.9 36.34

-1.4 -0.1 0.14

Total of Product of

Deviation

1430.6

Covariance 158.9555556

(1430.6/(10-1))



Calculation of Variance of the market.

Return of

Benchmark (%)

Deviation of Benchmark

from its Average

Square of Deviations

12 3.9 15.21

15 6.9 47.61

18 9.9 98.01

4 -4.1 16.81

18 9.9 98.01

20 11.9 141.61

-12 -20.1 404.01

-18 -26.1 681.21

16 7.9 62.41

8 -0.1 0.01

Total 1564.9

Variance (Total/(10-1) 173.877

So Beta = Covariance / Variance of Market = 158.95/173.87 = .914

You can also use the Excel function “Slope” to determine the value of Beta, where the Y axis represents the

Returns from Security and X axis represents the Returns from the market.

(Kindly use the excel function Slope on the above values and check t he value of Beta)



Now we calculate the Covariance

Probability (A) Deviation of

Security (B)

Deviation of

Benchmark (C)

Product of Deviation times

probability (A*B*C)

0.05 -3.25 -7.9 1.28375

0.5 1.75 0.1 0.0875

0.3 6.75 10.1 20.4525

0.15 -18.25 -17.9 49.00125

Total 70.825

(this is Covariance)

Then we calculate the Variance of the market

Probability

(A)

Deviation of

Benchmark

Square of

Deviation (B)

Product of Deviation times

probability (A*B)

0.05 -7.9 62.41 3.1205

0.5 0.1 0.01 0.005

0.3 10.1 102.01 30.603

0.15 -17.9 320.41 48.0615

Total 81.79

(this is Variance)

So Beta = Covariance between Security and Market / Variance of Market

=70.825 / 81.79 = 0.865



How to interpret Beta –

As said earlier Beta represents what is called as systematic risk, Beta values can be more than or less than 1.

Suppose we have a security whose Beta say is 1.2 , then we say that the security is aggressive i.e. if the

benchmark moves up or down by 10% , then this security will move up or down by 12%.

Suppose the security has a Beta of less than 1 (say .8), then say that the security is defensive ,i.e. if the

benchmark moves up or down by 10%, then this security will only move by 8%.

Suppose the Beta is equal to 1, then we say that the security is Neutral. Market will have a Beta of 1.



1) Calculate the Beta in the following case

Period Return % (Security) Return % (Benchmark)

1 10 12

2 15 14

3 18 13

4 14 10

5 16 9

6 16 13

7 18 14

8 4 7

9 -9 1

10 14 12

11 15 -11

12 14 12

13 6 8

14 7 7

15 -8 10

Check Your Progress II



Understanding Beta through Graph

Securities with different slopes have different sensitivities to the returns of the market index. If

the slope of this relationship for a particular security is a 45-degree angle, the beta is I. This

means that for every one percent change in the market's return, on average this security's returns

change I percent. The market portfolio has a beta of I. A security with a beta of 1.5 indicates that,

on average, security returns are 1.5 times as volatile as market returns, both up and down. This

would be considered an aggressive security because when the overall market return rises or falls

10 percent, this security, on average, would rise or fall 15 percent. Stocks having a beta of less

than 1.0 would be considered more conservative investments than the overall market.

Betas can be negative or positive. But generally betas have been found to be positive: which

means that the direction of the movement of individual stock generally tends to be in line with the

market; falling when the market is falling and rising when the market is rising; the rates are

different.

Beta is useful for comparing the relative systematic risk of different stocks and, in practice, is

used by investors to judge a stock’s riskiness. Stocks can be ranked by their betas. Because the

variance of the market is a constant across all securities for a particular period, ranking stocks by

beta is the same as ranking them by their absolute systematic risk. Stocks with high betas are said

to be high-risk securities.

Given below are different scenario how the portfolio return moves relative to market for Beta

equal to 1, 0.5 and 2



Beta = 1.0

-15

-10

-5

0

5

10

15

-15 -10 -5 0 5 10 15

Market

Po

rtfo

lio

Beta = 0.5

-8

-6

-4

-2

0

2

4

6

8

-14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14

Market

Po

rtfo

lio



The beta of a security is a historical measure and it is arrived at by plotting the actual returns on

the security over long periods of time with market returns as shown in the above the above charts.

A line is drawn which depicts beta of the security.

To determine the beta of any security, you'll need to know the returns of the security and those of

the benchmark index you are using for the same period. Using a graph, plot market returns on the

X-axis and the returns for the stock over the same period on the Y-axis.

Upon plotting all of the monthly returns for the selected time period (usually one year), we draw a

best-fit line that comes the closest to all of the points. This line is called the regression line.

Beta = 2.0

-14

-12

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

-14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14

Market

Po

rtf

olio



Solutions of Check Your Progress 1

1)

State of

the

economy

Probability Returns Deviations Deviations^2 Sum of Product of Deviations and

Probability

Boom 0.5 18% 10.0% 1.00% 0.50%

Gloom 0.2 10% 2.0% 0.04% 0.01%

Doom 0.3 -10% -18.0% 3.24% 0.97%

Expected

Returns

8.0% Variance 1.48%

Standard

Deviations

12.17%

1. The Risk Free rate of return of security A is 8% and you expect that the market will give you a

return of 14%. What will be the expected return of the security if the Beta is 0.7

2. Will your values change if the risk free rate of return goes to 6% and the market return remains at

14% and Beta also the same?




2)

State of the

economy

Probability Returns Deviations Deviations^2 Sum of Product of

Deviations and

Probability

Boom 0.4 18% 6.8% 0.46% 0.18%

Gloom 0.5 10% -1.2% 0.01% 0.01%

Doom 0.1 -10% -21.2% 4.49% 0.45%

Expected

Returns

11.2% Variance 0.64%

Standard

Deviations

8.01%

3)

S.No Probability Returns Deviations Deviations^2 Sum of Product of Deviations and

Probability

1 0.05 16% 13.9% 1.92% 0.10%

2 0.1 12% 9.9% 0.97% 0.10%

3 0.08 6% 3.9% 0.15% 0.01%

4 0.11 -10% -12.1% 1.47% 0.16%

5 0.15 5% 2.9% 0.08% 0.01%

Expected

Returns

2.1% Variance 0.38%

Standard

Deviations

6.16%



Period Return %

(Security)

Return %

(Benchmark)

Deviation

of Security

Deviation of

Benchmark

Product of

Deviation

Variation of

Market

1 10 12 0 3 0 9

2 15 14 5 5 25 25

3 18 13 8 4 32 16

4 14 10 4 1 4 1

5 16 9 6 0 0 0

6 16 13 6 4 24 16

7 18 14 8 5 40 25

8 4 7 -6 -2 12 4

9 -9 1 -19 -8 152 64

10 14 12 4 3 12 9

11 15 -11 5 -20 -100 400

12 14 16 4 7 28 49

13 6 8 -4 -1 4 1

14 7 7 -3 -2 6 4

15 -8 10 -18 1 -18 1

Using Slope 0.3541666

67

Total 221 624

Average of

Security

10 Covariance

(total/(n-1)

15.7857142

9

Average of

Benchmark

9 Variance 44.57142857

Beta (15.785/44.

57)

0.354166667

Solutions of Check Your Progress II



2)

Probability Returns

of ITC

(%)

Returns

of

Sensex

(%)

Deviation

of ITC

from its

Average

Deviation of

Sensex from

its average

Sum of

Product of

Deviation

times

Probability

Variance of

Market

(Deviation

of Market

square

times

probability

0.2 30 20 11 6.1 13.42 7.442

0.5 20 15 1 1.1 0.55 0.605

0.3 10 8 -9 -5.9 15.93 10.443

Average of

Security

19 Covariance 29.9

Average of

Sensex

13.9 Variance of

Market

18.49

Beta 1.617090319



3)

Probability Returns of

Rohini

Enterprises

(%)

Returns

of

Sensex

(%)

Deviation

of

Security

from its

Average

Deviation of

Sensex from

its average

Sum of

Product of

Deviation

times

Probability

Variance of

Market

(Deviation

of Market

square

times

probability

0.15 30 20 13.25 7.1 14.11125 7.5615

0.5 20 15 3.25 2.1 3.4125 2.205

0.3 10 8 -6.75 -4.9 9.9225 7.203

0.05 -15 -18 -31.75 -30.9 49.05375 47.7405

Average of

Security

16.75 Covariance 76.5

Average of

Sensex

12.9 Variance of

Market

64.71

Beta 1.182197497



Assessment Test:

1. Mr. Joshi has analysed a stock for a one-year holding period. The stock is currently quoting

at Rs 100/- and is paying no dividends. There is a 50-50 chance that the stock may quote

Rs100 or Rs 120 by year-end. What is the expected return on the stock?

1. 12%

2. 10%

3. 15%

4. 20%

2. A stock is quoting at Rs 100 and is paying no dividends. The possible year end price and the

probabilities are given below:

Year end price Probability

110 0.1

115 0.2

120 0.3

125 0.2

130 0.1

What is the expected return on the stock?

a. 10%

b. 15%

c. 18%

d. 20%



3. What is the standard deviation of the stock based on the above figures in problem 2?

a. 14.45

b. 5.79

c. 16.30

d. 33.60

4. Stocks A and B are not paying any dividends. Stock A is quoting at Rs 100 while B is quoting

at Rs 50. There is a 50-50 chance that stock A will quote at Rs 120 and Rs 140 while there is a

50-50 chance that the stock B will quote at Rs 60 and Rs 70 at the end of the year. Which

stock will you buy considering the return and the risk?

a. I shall buy B because it is cheaper

b. I will buy Stock B because the risk is less

c. I will buy Stock A because the risk is less

d. The risk and the return in both are same; I shall buy any one

5. Compute the expected return for the stock when the risk free return is 8% and the expected

return from the market is 12% for a stock with Beta of 1.2.

a. 15.6%

b. 12.8%

c. 16.4%

d. 22.2%

6. Beta of stock A is 1.5 while that of stock B is 1. If the market is expected to rise then an

aggressive investor would buy:

a. Either A or B; because in a rising market all stocks will rise



b. Stock A because it may deliver superior returns compared to B

c. Stock B because the risk will be less compared to A while the returns would be the

same

d. Stock B because it may deliver superior returns compared to A

7. The following are the assessment of the probabilities of each of the five economic scenarios:

i) What is the expected return on shares?

a) 20%

b) 25%

c) 15.8%

d) 13.2%

ii) What is the expected return on bonds?

a) 9%

b) 10%

c) 1.9%

d) 3.0%

iii) What is the standard deviation of stocks?

a) 29.44%

b) 28.34%

c) 25.44%

d) 17.95%

Growth with low inflation

0.05 6

Growth with high inflation

0.2 6

Normal growth 0.5 6

Recession with low

0.2 6

Recession with high

0.05 6

CashEconomic scenario Probability

Holding period

Shares Bonds

4

-10

9

35

0

74

20

14

0

-30



iv) What is the standard deviation of bonds?

a) 17.96%

b) 14.56%

c) 9.7%

d) 15.71%

8. Modern "asset allocation" is based upon the model developed by Harry Markowitz. Which of

the following statements is/are correctly identified with this model?

1. The risk, return and covariance of assets are important input variables in creating

portfolios.

2. Negatively correlated assets are necessary to reduce the risk of portfolios.

3. In creating a portfolio, diversifying across asset types (e.g., stocks and bonds) is less

effective than diversifying within an asset type.

4. The efficient frontier is relatively insensitive to the input variable.

a) 1 and 2 only.

b) 1, 2, and 3 only.

c) 1 only.

d) 2 and 4 only.

e) 1, 2, and 4 only.

9. KM, Inc. has a beta of 1.5. The risk-free rate is 5%, and the market risk premium is 8%.

a) KM has a required return of 6.5% and an expected return of 8%.

b) KM has a required return of 15.5%.

c) KM has a required return of 17%



10. Mahesh is keen to invest in any of the four securities A, B, C or D whose betas are 0.70, 1.00,

1.15 and -0.30 respectively. The risk free rate of return being 8% and expected rate of return

on market being 14%, which security would you recommend to Mahesh? (4)

a. Security C, as expected return is highest.

b. Security D, as expected return is least.

c. Either Security A or Security B as their return is moderate.

d. More data as to the time horizon is required before passing advise to Mahesh.

Chapter - 5

Income from house property

Tax Planning

108 Tax Planning





Exam is











chapter.





5. Estate Planning: All the content related to Estate Planning available online. It carries the

weightage of 10- 15% in the Tax & Estate Planning Exam





online unit test .






Tax Planning

109 Tax Planning




structure etc.





interactive

3. Additional Resources: You will get additional resources file with each chapter, this will

provide you the content and link available on the internet. These additional resources will be

helpful to you for both the exam and practical purpose.



Tax Planning

110 Tax Planning

Introduction

This lesson deals with income, which falls under the head 'Income from house property'. The

scope of income charged under this head is defined by section 22 of the Income Tax Act and the

computation of income falling under this head is governed by sections 23 to 27. All the provisions

relating to tax treatment of income from house property are explained in this lesson.

Objectives

After going through this lesson, you will be able to understand:

o The meaning of house property

o Who is treated as owner of house property

o The treatment of rental income from properties under different

o circumstances

o Determination of the annual value of a house property

o The expenses deductible from rental/notional income from house property

o Special treatment given to self-occupied house property

o Treatment of income/loss from house property.

Basis Of Charge (Section 22)

The annual value of a property, consisting of any buildings or lands appurtenant thereto, of which

the assessee is the owner, is chargeable to tax under the head 'Income from house property'.

However, if a house property, or any portion thereof, is occupied by the assessee, for the purpose

of any business or profession, carried on by him, the profits of which are chargeable to income-

tax, the value of such property is not chargeable to tax under this head.

Thus, three conditions are to be satisfied for property income to be taxable under this head.

1. The property should consist of buildings or lands appurtenant thereto.

2. The assessee should be the owner of the property.

3. The property should not be used by the owner for the purpose of any business or profession

carried on by him, the profits of which are chargeable to income-tax.

Applicability Of Section 22

Buildings or lands appurtenant thereto

The term 'building' includes residential houses, bungalows, office buildings, warehouses, docks,

factory buildings, music halls, lecture halls, auditorium etc. The appurtenant lands in respect of a

residential building may be in the form of approach roads to and from public streets, compounds,

Tax Planning

111 Tax Planning


Tax Planning

112 Tax Planning

1. A member of a co-operative society, company or association of persons, to whom a property

(or a part thereof) is allotted or leased under a house- building scheme of the society,

company or association, is deemed to be the owner of such property.

2. A person who has acquired a property under a power of attorney transaction, by satisfying the

conditions of section 53A of the Transfer of Property Act, that is under a written agreement,

the purchaser has paid the consideration or is ready to pay the consideration and has taken the

possession of the property, is the deemed owner of the property, although he may not be the

registered owner.

3. A person who has acquired a right in a building (under clause (f) of section 269UA), by way

of a lease for a term of not less than 12 years (whether fixed originally or extended through a

provision in the agreement), is the deemed owner of the property. This provision does not

cover any right by way of a lease renewable from month to month or for a period not

exceeding one year.

Ownership must be of the superstructure. It is not necessary that the assessee is also the owner of

the land. Thus, when a person obtains a piece of land on lease and constructs a building on it, the

income from such building will be taxed in his hands as income from house property.

Property used for own business or profession

The owner of a house property is not liable to tax under this head if the property is used by him

for his own business or profession. But the business or profession should be such whose income

is chargeable to tax. Chargeability to tax does not mean that the income is actually taxed. It is

possible that in a particular year the profits are not sufficient enough to attract tax liability. What

it means is that the income from such business or profession is not exempt from tax.

If an employer builds quarters for residential use by his employees and the letting out of these

quarters is considered as incidental to his business, the income from such property is not taxable

under this head, because the property in this case is considered to be used by the owner for his

own business. It shall, therefore, be taxed as business income.

The above position will not change even if the buildings are let out to government authorities for

locating their undertakings like Banks, Post Office, Police Station, Central Excise Office, etc.,

provided the dominant purpose of letting out the accommodation is to enable the assessee to carry

on his business more efficiently and smoothly. Also, income from paying-guest accommodation

is taxable as income from business.

Where house property owned by a partner is used by the firm (neither it is let out to the firm nor

any rent is obtained for it) for its business purposes, the partner is entitled to the exemption.

Tax Planning

113 Tax Planning


Tax Planning

114 Tax Planning

House property in a foreign country

A resident assessee is taxable under section 22 in respect of annual value of a property in a

foreign country. A resident but not ordinarily resident or a non- resident is, however, chargeable

under section 22 in respect of income of a house property situated aboard, provided income is

received in India during the previous year. If tax incidence is attracted under section 22 in respect

of a house property situated abroad, its annual value will be computed as if the property is

situated in India.

Property Incomes Exempt From Tax

Some incomes from house property are exempt from tax. They are neither taxable nor included in

the total income of the assessee for the rate purposes.

These are:

1. Income from a farm house [section 2(1A) (c) and section 10(1)].

2. Annual value of one palace in the occupation of an ex-ruler [section 10(19A)].

3. Property income of a local authority [section 10(20)].

Explain whether the income from house property will be taxable or not u/s 22 in the hands of

X in the following circumstances:

1. X owns a building. It is given on rent to Y, who uses it as his office.

2. X owns a house property. He uses it as the godown for the goods produced by his

factory.

3. X rents out his property as residential quarters to the workers in his factory at a

nominal rent of 500 p.m.

4. X enters into a written agreement to purchase a property from Y for 25, 00,000. He

has paid the consideration and taken the possession of the property but the property is

yet to be registered in the name of X.

5. X owns a property, which is given on lease to Y for a period of 6 years, lease rent

being 10, 000 per month. Y has a right to get the lease renewed for a further period of

6 years.

6. X owns a property, which is given on lease to Y for a period of one month, rent being

5, 000. Y has a right to get the lease renewed for a period of one month, in each

subsequent month, and such renewal is possible with mutual consent till 2020.

7. X owns a property, which is given on rent to Y. Y annually pays 1,50,000 as rent of

the building as well as the charges for different services (like lift, security, etc.)

provided by X.

8. X owns an air-conditioned furnished lecture hall. It is let out, annual rent being 5,

00,000, which includes rent of building as well as rent of air- conditioner and furniture.

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4. Property income of an approved scientific research association [section 10(21)].

5. Property income of an educational institution and hospital [section 10(23C)].

6. Property income of a registered trade union [section 10(24)].

7. Income from property held for charitable purposes [section 11].

8. Property income of a political party [section 13A].

9. Income from property used for own business or profession [section 22].

10. Annual value of one self occupied property [section 23(2)]

Computation Of Income From Let Out House Property

Income from house property is determined as under: xxxxxxx

Gross Annual Value xxxxxxx

Less: Municipal Taxes xxxxxxx

Net Annual Value xxxxxxx

Less: Deductions under Section 24 xxxxxxx

Statutory Deduction (30% of NAV) xxxxxxx

Interest on Borrowed Capital xxxxxxx

Income from House Property xxxxxxx

Determination Of Annual Value

The basis of calculating Income from House property is the 'annual value'. This is the inherent

capacity of the property to earn income and it has been defined as the amount for which the

property may reasonably be expected to be let out from year to year. It is not necessary that the

property should actually be let out. It is also not necessary that the reasonable return from

property should be equal to the actual rent realized when the property is, in fact, let out. Where

the actual rent received is more than the reasonable return, it has been specifically provided that

the actual rent will be the annual value. Where, however, the actual rent is less than the

reasonable rent (e.g., in case where the tenancy is affected by fraud, emergency, close relationship

or such other consideration), the latter will be the annual value. The municipal value of the

property, the cost of construction, the standard rent, if any, under the Rent Control Act, the rent of

similar properties in the same locality, are all pointers to the determination of annual value.

Gross Annual Value [Section 23(1)]

The following four factors have to be taken into consideration while determining the Gross

Annual Value of the property:

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(a) The defaulting tenant is not in occupation of any other property of the assessee;

(b) The assessee has taken all reasonable steps to institute legal proceedings for the recovery of

the unpaid rent or satisfied the Assessing Officer that legal proceedings would be useless. (We

will discuss about it later in the topic of Unrealised rent)

So in a nut shell there are four parameters namely

1) Municipal Value

2) Fair Rental Value (FRV)

3) Standard Rent

4) Rent Received

Please note that we need to follow the principal of “High”, “Low”, and “High” to determine the

FRV

So its “Higher” of 1 and 2 , say that is “A” and then “Lower” of A and 3, say that is “B” and

then “Higher” of B and 4, that will be the Gross Annual Value of the House Property.

Say for example the following is given

Municipal Value = 25,000, Fair Rent Value = 30,000 , Standard Rent = 27,000 and Actual

Rent = 32,000,

Then the Gross Annual value will be

Remember the steps High, Low, High

Step 1 – Higher of – Muncipal Value and Fair Rent in this case it will be Higher of 25,000 or

30,000, so it will be 30,000, (lets call it as A)

Step 2 – Lower of A and Standard Rent so it will be Lower of A (i.e. 30,000) and 27,000

(Standard Rent) so will be 27,000 (lets call it B)

Step 3 – Higher of “B” and Actual Rent, so it will be Higher of B (i.e. 27,000) and 32,000

(Actual Rent) so the GAV will be 32,000.

Concept Question

1) Find the Gross Annual Value in the case of the following properties:

Particulars 1 2 3 4 5 6

Municipal Value 20000 24000 36000 42000 48000 45000

Fair Rental Value 24000 24000 40000 42000 50000 50000

Standard Rent N.A 24000 50000 30000 N.A 48000

Actual Rent/Annual Rent 18000 36000 48000 36000 54000 42000

Answer : Kindly recall the rule of “High, Low, High”

GAV 24000 36000 48000 36000 54000 48000

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Now let’s talk about the situation where the House Property was part let out and part vacant.

In accordance to section 23(1), the annual value of such property shall be deemed to be

(a) The sum for which the property might reasonably be expected to let from year to year (i.e.

what could possibly be the expected rental income if the property was let out throughout the

year). Now here two different “SITUATIONS” can emerge

1. Where the property or any part of the property is let out and the actual rent received is MORE

than clause (a) above

2. Where the property or any part of the property is let out and the actual rent received is LESS

than clause (a) above.

Let’s see how the evaluation will happen in both the cases

Situation 1 – where the property was let out and the rental received was more than the expected

rent, then in that case the Gross Annual Value will be “Higher” of the two i.e. “the actual rent

received”

Concept Question

Suppose the municipal value of a house is 1, 00,000. Fair Rent is 1, 50,000. Standard Rent is

1, 30,000. The house property was let out for 13,000 per month and the house was vacant for

one month. What will be the GAV in this case?

Answer : Once again lets list down all the values

Particulars Amount ( )

Municipal Value 100000

Fair Rental Value 150000

Standard Rent 130000

Actual Rent/Annual Rent (13000*11) 143000

GAV 143000

(We will once again apply the “High, Low, High” principle till the Standard Rent and then

compare it with the Actual Rent (considering that fact that its situation 1 of above)

1) What will be the GAV in the following cases

Particulars 1 2 3 4 5

Municipal Value 52000 100000 60000 75000 180000

Fair Rental Value 60000 102000 68000 70000 185000

Standard Rent N.A 90000 70000 60000 175000

Actual Rent/Annual Rent 55000 95000 72000 72000 168000


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Situation 2 – where the property was let out and was vacant partially and the actual rent received

is less than the expected annual rent then in this case the GAV of the property will be the “actual

rent that is received”

Concept Question

Continuing with the above example, what if the property was vacant for 3 months, and then the

GAV will be




Standard Rent 130000


GAV 117000

Recap- In the Story so far we have seen the following cases and have calculated the GAV.

1) Where the House Property was Completely Let out for the entire year.

2) Part Let out and Part Vacant. (Here we had examined two scenarios)

(a) Where the rental income was more than the expected rent

(b) Where the rental income was lesser than the expected rent.

Another Twist in the “Tale” What if the house property is let out part of the year and part “Self

Occupied?”

Here the story line changes a bit.

In such cases the period of self occupancy is ignored and it will be assumed as “Part Let out”

property.

Concept Question:

Navjot Singh Bidhu has a house property in Chandigarh whose Municipal Value is 10, 00,000

(Chandigarh hai bhai, mehenga hai) and the Fair Rental Value is 12,00,000. It was Self

occupied by Bidhu from 1st April 2009 till 31

st July 2009 and then from 1

st August 2009 was let

out at 90,000 per month. Compute the annual value of the house property for the assessment

year 2010-11

Answer: Lets take down all the values again




Standard Rent NA


GAV 1200000

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Here the Fair Rent will become the Gross Annual Value so in a snapshot to calculate the

Gross Annual Value, follow the diagram given below :

Step 1- Compare M.V with F.R Whichever is higher is considered as F.R.

Step 2-Compare F.R. of Step 1 with S.R.Which ever is lower is considered as F.R

Step 3-Compare F.R. determined above with A.

A.R > F.R. When A.R < F.R

When A.R < F. R (due to vacancy) A.R < F.R (other factors)

A.R. is the annual Value F. R is the annual value

Deduction of Municipal Taxes

From the annual value as determined above municipal taxes are to be deducted if

the following conditions are fulfilled:

o The property is let out during the whole or any part of the previous year

o The Municipal taxes must be borne by the landlord (If the Municipal taxes or any part thereof

are borne by the tenant, it will not be allowed).

o The Municipal taxes m us t be paid during t he year (Where the municipal taxes become due

but have not been actually paid, it will not be allowed. Similarly, the year to which the taxes

relate to, is also immaterial).

Concept Question

Suppose you own the following three houses the details of which are

Bungalow 1 Bungalow 2 Bungalow 3

No of Residential Units 2 1 3

Municipal Value 150000 72000 70000

Fair Rental value 170000 75000 85000

Standard Rent 160000 80000 82000

Rent Per Unit Per Annum 50000 84000 84000

Municipal Taxes 15000 (due

but not paid)

8000 for last

year paid this year

and 9000 of

current year due

but not paid

90000 (it

includes

84000 paid as

advance for the

next 9 years)

What are the GAV and the Net Annual value in each case?

Answer:

Gross Annual Value (80000*2) (84000*1) (84000*3)

Gross Annual Value 160000 84000 252000

Municipal Taxes 0 8000 90000

Net Annual Value ( ) 160000 76000 162000

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Treatment of Unrealised Rent:

As per the explanation, the actual rent received or receivable mentioned in section 23 (1)(b) and

(c ) , shall not include the amount of rent which the owner cannot realize subject to the rules made

in this behalf.

Rules of Unrealised rent

a. The tenancy is bona fide;

b. The defaulting tenant has vacated, or steps have been taken to compel him to vacate the

property.

c. The defaulting tenant is not in occupation of any other property of the assessee;

d. The assessee has taken all reasonable steps to institute legal proceedings for the recovery of

the unpaid rent or satisfied the Assessing Officer that legal proceedings would be useless So

the amount of unrealised rent is shown as deduction after computation of the gross annual

value.

Concept Question:

P. K Manmani submits the following details about his house property owned by him in Sangli


Fair Rental value 340000

Rent Per Month 31000

Municipal Taxes 30000 (paid)

The tenant vacated the property on the 31st of October and thereafter the property was let out at

35,000 per month as rent.P.K could no realize the rent for the months of September and October

2009 due to the death of his tenant.What will be the annual value of the property?

Answer:

Amount ( )

Step 1

(Determine the value of the property)

Higher of M.V or F.R.V

( 3,00,000 or 3,40,000) 340000

Step 2

Actual Rent Receivable

(31000*7+35000*5) 392000

So GAV 392000

Less Un Realised Rent (31000*2) 62000

Less Municipal Taxes Paid 30000

Net Annual Value 300000

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Computation Of Income From Self - Occupied House Property

The annual value of one self-occupied house property, which has not been actually let out at any

time during the previous year, is taken as 'Nil' [Section 23(2) (a)]. From the annual value, only the

interest on borrowed capital is allowed as a deduction under section 24. The amount of deduction

will be:

o Either the actual amount accrued or 30,000/- whichever is less

o When borrowal of money or acquisition of the property is after 31.3.1999 - deduction is 1,

50,000/- applicable to A.Y 2002-03 and onwards.

o However, if the borrowal is for repairs, renewals or reconstruction, the deduction is restricted

to 30, 000. If the borrowal is for construction/ acquisition, higher deduction as noted above

is available.

1) Ms Manpreet constructed a house property for which she took a home loan of 2 Lacs at

12% per annum on the 1st Oct 2006. The construction of the home was completed by the

end of January 2008.The house property has been let out for 6000 per month from

September 2008.Muncipal taxes paid during the previous year 2009-10 is 7500.Repairs

incurred was 12,500. Insurance Premium due for the year but outstanding is

1500.Collection charges incurred is 100 per month. Current year interest on the loan is

outstanding.

Compute the Income from House Property for the assessment year 2010-11

2) Mr. Ekagra owns a building which has 3 apartments, construction of which was completed

on December 2005. The apartment was let out on rent of 1500 each per month. The

annual municipal valuation of the house is 50,000. Annual municipal tax is

10,000.However in the previous year 2009-2010 he paid 15,000 which included the

municipal taxes of 5,000 in respect of the previous year 2008-09.Ground rent of 1800

and Insurance premium of 1100 was paid. Ekaga had to pledge his jewellery in order to

repair the property. Interest of 3000 is payable for the current year on the said loan. He

has appointed Munnabhai (a local goon) to collect the rent on a monthly salary of

50.One of the apartment was vacant for 6 months during the year. Compute the income

from House Property for the AY 2010-11.

(lamba sawal hai, happy solving!!)


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If a person owns more than one house property, using all of them for self- occupation, he is

entitled to exercise an option in terms of which, the annual value of one house property as

specified by him will be taken at Nil. The other self occupied house property/is will be deemed to

be let out and their annual value will be determined on notional basis as if they had been let out.

Annual Value of one house away from work place [Section 23(2) (b)]

A person may own a house property, for example, in Bangalore, which he normally uses for his

residence. He is transferred to Chennai, where he does not own any house property and stays in a

rental accommodation. In such a case, the house property in Bangalore cannot be used for self-

occupation and notional income, therefore, would normally have been chargeable although he

derives no benefit from the property. To save the tax payer from hardship in such situations, it has

been specifically provided that the annual value of such a property would be taken to be nil

subject to the following conditions:

o The assessee must be the owner of only one house property.

o He is not able to occupy the house property because of his employment, business etc., away

from the place where the property is situated.

o The property should not have been actually let or any benefit is derived therefrom.

o He has to reside at the place of employment in a building not belonging to him .

Annual Value of a house property which is partly self - occupied and partly let out

If a house property consists of two or more independent residential units, one of which is self -

occupied and the other unit(s) is let out, the income from the different units is to be calculated

separately. The income from the unit which is self - occupied for residential purposes is to be

calculated as per the provisions of Section 23(2)(a) i.e. the annual value will be taken as nil and

only interest on borrowed capital will be deductible upto the maximum limit of 1,50,000 or

30,000, as the case may be. The income from the let out unit(s) will be calculated in the same

manner as the income from any let out house property. 6.5 SOME SPECIAL PROVISIONS

Taxability of Unrealized Rent recovered later (Section 25A) Where any rent cannot be realized,

and subsequently if such amount is realized, such an amount will be deemed to be the income

from house property of that year in which it is received. We have seen earlier that the basic

requirement for assessment of this income is the ownership of the property. However, in the cases

where unrealized rent is subsequently realized, it is not necessary that the assessee continues to be

the owner of the property in the year of receipt also.

House Property

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1) GAV will be

Particulars 1 2 3 4 5

GAV 60000 95000 48000 72000 175000

1. Yes, Income from House Property.

2. No

3. Income from Business and Profession

4. Yes it will be treated as Income from House Property (A person who has acquired a

property under a power of attorney transaction, by satisfying the conditions of section

53A of the Transfer of Property Act, that is under a written agreement, the purchaser

has paid the consideration or is ready to pay the consideration and has taken the

possession of the property, is the deemed owner of the property, although he may not

be the registered owner.)

5. Yes , Income from House Property

6. Yes, Income from House Property

7. If, it can be bifurcated (rental and other services) then rent will be taxed as Income

from House Property and others as Profit and Gains from Business and Profession or

Income from other sources.

If it cannot be bifurcated then it will be treated as Income from Business and

Profession or Income from other sources.

8. Since nothing is mentioned we will treat that as Income from Business and Profession.

Answer of check Your Progress I


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1) Income from House Property of Ms Manpreet.

Particulars Amount

Gross Value ( 6000*12) 72000

Less Municipal Taxes paid 7500


Less Deductions u/s 24

30% of Net Annual Value 19350

1/5th of Interest (preconstruction period) 2400

Interest on Loan 24000

Income from House Property 18750

2) Computing the income from House Property of Mr. Ekagra The crucial part of this

question is to compute the GAV of the property and the same is

Amount

Municipal Valuation 50000

Rent Received (1500*2*12)+(1500*6) 45000

Due to the vacancy the GAV will be 45,000.(Remember the chart)

Particulars Amount

Gross Value 45000

Less Municipal Taxes paid 15000


Less Deductions u/s 24

30% of Net Annual Value 9000

Interest on Loan 3000

Income from House Property 18000

Assessment of arrears of rent received (Section 25B)

When the owner of a property receives arrears of rent from such a property, the same shall be

deemed to be the income from house property in the year of receipt. 30% of the receipt shall be

allowed as deduction towards repairs, collection charges etc. No other deduction will be allowed.

As in the case of unrealized rent, the assessee need not be the owner of the property in the year of

receipt.


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As per Section 23(2) of the Income Tax Act, the annual value of one self- occupied house

property is taken to be nil. No deductions are permissible from the annual value of such property,

except the interest on borrowed capital, subject to the maximum limit of 1, 50,000 or 30, 000

as the case may be.

The above provisions may result in loss from house property, which may be set off against

income from another house property or against incomes under the other heads. The balance loss

may be carried forward, to be set off against the income from house property, upto a maximum of

eight assessment years.

Please note that this is the only head (as of now since DTC has not come into play, where the

Income from Salary can be adjusted against Loss from House Property)

Assessment Test:

1. Mr. Arun gifted his house property to his wife in 2007 which she let out on a monthly rent of

5,000/- The income from such house property will be taxable in the hands of:

a. Mrs.Arun

b. Mr. Arun. However, income will be first computed as his wife’s income and thereafter

clubbed in his income.

c. Mr.Arun – as he will be treated as deemed owner of the house property and liable to tax.

2. Mr. Raj gifted house property to his minor son which was let out @ 5,000/- p.m. Income

from such house property shall be taxable in the hands of:

a. His minor son;

b. Mr.Raj – however, it will be computed as minor’s income and thereafter clubbed in Raj’s

income;

c. Mr.Raj – as he will be deemed owner of such property and liable to tax.

3. Mr. X transferred his house property to his wife under an agreement to live apart. Income from

such house property shall be taxable in the hands of:

a. Mr. X as deemed owner ;

b. Mr. X – however, it will be computed as Mrs. X’s income and thereafter clubbed in the hands

of Mr. X provided the income of the father is higher than the income of her mother.

c. Mrs. X

4. A has taken a house property on lease for 15 years from B and let out the same to C. Income

from such house to A shall be taxable as:

a. income under the head other sources

b. income from house property as A is the deemed owner.

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5. Ram gifted his house property to his married minor daughter. The income from such house

property shall be taxable in the hands of:

a. Ram, as deemed owner.

b. Ram. However, it will be first computed as minor daughter’s income and clubbed the income

of Ram provided the income of the father is higher than the income of her mother.

c. income of married minor daughter.

6. Govind is a member of house building Cooperative Society who is the owner of flats

constructed by it. One of the flats is allotted to him. The income from such house property shall

be taxable in the hands of:

a. The Cooperative Society

b. Govind, as deemed owner.

7. X is the owner of superstructure although the land was taken by him on lease. The income of

such property shall be taxable under the head:

a. income from other sources

b. income from house property.

8. A has taken a house on rent and sublets the same to C. Income from such house property shall

be taxable under the head:

a. income from house property

b. income from other sources.

9. Municipal valuation of the house is 1,00,000/- whereas the fair rent of house property is

1,20,000/- and standard rent is 1,10,000/-; actual rent received or receivable is 1,40,000/- ;

municipal tax paid 10%. The annual value in this case shall be:

a. 90,000/-

b. 1,00,000/-

c. 1,30,000/-

10. Municipal valuation of the house is 1,20,000/-, fair rent is 1,40,000/-; standard rent is

1,30,000/- whereas actual rent received or receivable is 1,25,000; municipal taxes paid are

40,000/- The annual value in this case shall be:

a. 1,00,000/-

b. 85,000/-

c. 90,000/-

11. Fair rental value of a house is 1,50,000/-, standard rent 1,20,000/-, actual rent

1,30,000/-. Municipal tax paid during the previous year for the past 7 years is 1,40,000/-. The

annual value shall be:

a. 20,000/-

b. Nil

c. (-)10,000/-

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