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What are Contra Funds?
The recent hike in repo rates by the Reserve Bank of India (RBI) has put the spotlight on floating rate or floating-rate term deposits (FRTDs) as an investment instrument.
As the name suggests, in FRTDs the interest rate is not fixed for the deposit tenure. Unlike regular fixed deposits, in floating-rate fixed deposits, the interest rate moves in tandem with a certain reference rate (repo rate, for instance), which is revised periodically. An investor gets the benefit from any interest rate changes without closing or re-booking the FDs.
A few of the terminologies regarding FRTDs include:
Mark-up/ Spread: It is the fixed premium or additional rate of interest that a bank offers over and above a base rate or benchmark, which could be the repo rate.
Benchmark rate: It is the rate that is used as a standard or base to pay the interest rate for deposits and loans.
Reset frequency: It is the frequency with which the floating-rate changes.
Penalties on premature withdrawal/ liquidation of deposits: Banks tend to charge a penalty when an investor withdraws from FRTD, which could range from 0.5-1% of the interest rate.
There are two options available under the floating-rate FD schemes.
For instance, Yes Bank offers a floating rate fixed deposit, where it has set a floating interest rate of 7.0% on deposits maturing in up to 18 months and 7.5% on those maturing in up to three years.
Similarly, IDBI Bank offers FRTD linked to the 91-day treasury bills (T-bills) and 364-day T-bills. An individual can deposit Rs 10,000-1 crore under this product and the interest is paid by the bank on a quarterly basis. Interest reset occurs every calendar quarter. The tenure for the floating rate deposits ranges from 1-20 years.
Practically speaking, for those with an investment time horizon of medium-term of up to three years, then opting for an FRTD may provide the advantage of above-average return during this period. There is a higher risk of interest rate reduction in the case for any period longer than this.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.
