Capital Protected Schemes are close-ended schemes, which are structured to ensure that investors get their principal back, irrespective of what happens to the market. This is ideally done by investing in Zero Coupon Government Securities whose maturity is aligned to the scheme’s maturity. (Zero coupon securities are securities that do not pay a regular interest, but accumulate the interest, and pay it along with the principal when the security matures).
Suppose an investor invested Rs 10,000 in a capital protected scheme of 5 years. If 5-year government securities yield 7% at that time, then an amount of Rs 7,129.86 invested in 5-year zero-coupon government securities would mature to Rs 10,000 in 5 years. Thus, by investing Rs 7,129.86 in the 5-year zero-coupon government security, the scheme ensures that it will have Rs 10,000 to repay to the investor in 5 years.
After investing in the government security, Rs 2,870.14 is left over (Rs 10,000 invested by the investor, less Rs 7129.86 invested in government securities). This amount is invested in riskier securities like equities. Even if the risky investment becomes completely worthless (a rare possibility), the investor is assured of getting back the principal invested, out of the maturity moneys received on the government security.
Some of these schemes are structured with a minor difference – the investment is made in good quality debt securities issued by companies, rather than Central Government Securities. Since any borrower other than the government can default, it would be appropriate to view these alternate structures as Capital Protection Oriented Schemes rather than Capital Protected Schemes.
It may be noted that capital protection can also be offered through a guarantee from a guarantor, who has the financial strength to offer the guarantee. Such schemes are however not prevalent in the market.
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How Capital Protected Schemes works ?
As detailed in the following example, the investment is structured, such that the principal amount invested in the zero-coupon security, together with the interest that accumulates during the period of the scheme would grow to the amount that the investor invested at the start.Suppose an investor invested Rs 10,000 in a capital protected scheme of 5 years. If 5-year government securities yield 7% at that time, then an amount of Rs 7,129.86 invested in 5-year zero-coupon government securities would mature to Rs 10,000 in 5 years. Thus, by investing Rs 7,129.86 in the 5-year zero-coupon government security, the scheme ensures that it will have Rs 10,000 to repay to the investor in 5 years.
After investing in the government security, Rs 2,870.14 is left over (Rs 10,000 invested by the investor, less Rs 7129.86 invested in government securities). This amount is invested in riskier securities like equities. Even if the risky investment becomes completely worthless (a rare possibility), the investor is assured of getting back the principal invested, out of the maturity moneys received on the government security.
Some of these schemes are structured with a minor difference – the investment is made in good quality debt securities issued by companies, rather than Central Government Securities. Since any borrower other than the government can default, it would be appropriate to view these alternate structures as Capital Protection Oriented Schemes rather than Capital Protected Schemes.
It may be noted that capital protection can also be offered through a guarantee from a guarantor, who has the financial strength to offer the guarantee. Such schemes are however not prevalent in the market.
Who should invest in these schemes?
A conservative investor who does not want to risk losing the money and also want to earn some extra interest. This extra interest which is received by investing in riskier market is like a bonus to the investor. You can invest in these schemes if you have a goal to be fulfilled after few years (in alignment with the maturity of scheme).
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