FMPs are exposed to interest rate risk and credit risks
07-Jan-2011 •Research Desk
I would like to know about the risks regarding investments in FMPs.
Fixed maturity plans or FMPs are closed-end in nature and it does not really protect them against risks including market, credit and liquidity risks. But the two significant risks to which FMPs are exposed to are interest rate risk and credit risks.
FMPs are designed to immunise investor against interest rate risk. However, as a plan is launched and money is collected, interest rates can fall before the money is invested and the funds will have to be invested at a lower rate. The non availability of a forward rate market in India is a chief contributor to interest rate risk in a FMP.
The credit portfolio in the plan can suffer in case of downgrades by rating agencies. Downgrades bring down the price of the securities as investors demand a higher risk premium on the asset leading to higher credit spreads. If the fund manager is forced to liquidate the security if it crosses a threshold rating levels, the scheme will suffer capital loss.
Hence, FMPs have the potential for capital depreciation and investors should take a closer look at the risks in FMPs before making an investment decision.