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How vyaj badla works for you

P Mehta

After working for 10 years in the United States, Rajeev Gupta decided to return to India. Having spent a decade in the US obviously meant that Rajeev had made good money-a cool Rs.20 lakhs.

Of the Rs.20 lakhs that he had saved, he intended to start a business that would require an investment between Rs.12-15 lakhs. Another Rs.5 lakhs was what he wanted to invest wisely so as to gain a steady source of income.

He was clear he did not want to put his money buying shares. There were a lot of hassles involved and he did not want to take the risk. But at the same time he wanted to earn returns higher than what a savings bank account could offer and keep his money liquid, if need be, for further investment in his business.

He considered various options like bank deposits, fixed deposits and debentures but felt each one unable to satisfy his needs. One fine day he accidentally happened to bump into Pravin Doshi, his old school friend. While talking to him Rajeev realised that Pravin was a big stockbroker in Mumbai.

Rajeev explained his situation to him. It was then for the first time that he heard about the concept of badla. Since it was associated with the stock markets, Rajeev had his usual worries. But then Pravin explained clearly to him what the instrument was.

What is Vyaj Badla ?
Vyaj badla is a financing mechanism where your investment is deployed in financing carry forward deals on the Bombay Stock Exchange (BSE) as permitted by the Securities and Exchange Board of India (SEBI). Carry forward deals are those in which a person buys shares for which a financier finances him. For the amount of shares that he has bought, he pays only a certain deposit as margin. This facility is permitted only in shares belonging to the Group A of the BSE. Currently there are 150 shares in this group of the BSE where this facility is permitted.

An individual buys or sells shares on the stock exchange within the settlement cycle. A settlement cycle on the BSE lasts for 5 days. At the end of the cycle, he must either give the shares that he has sold, or pay money for the shares that he has purchased.

A vyaj badla is a two-way transaction which is executed simultaneously. The first phase of the trade is a purchase transaction at the closing price of the share in the current settlement (trading cycle on the stock exchange). The second phase of the transaction is a sale transaction at the closing price plus badla or financing charge in the next settlement.

Depending on the relationship with the broker an individual can start with a minimum amount of Rs.50,000. The funds are invested for a settlement period, which is currently 7 days. Funds can be reinvested for as many settlement periods as the investor desires.

As far as the rates of return are concerned they vary from settlement to settlement depending upon the demand and supply for a particular scrip in a settlement. The rates are market driven and depend on the money supply and demand in the market. When the market is rising generally the badla rates are high; when the market is falling the returns are low. The badla rate for scrip is determined during the badla session which is fixed after one settlement period ends and before another settlement period begins. The rates are typically a function of interest rate in the economy, overall need for funds in badla and short or long position in a scrip.

The badla or interest earned in one settlement is automatically added to the investor's account and is reinvested in the next settlement period. Thus the interest is compounded automatically.

How safe is it ?
What are the risks involved? Very little. The transaction is completely hedged eliminating any risk. Hence it doe not matter if the prices of the scrip against which Vyaj Badla is provided go up or down. Morever, there is no counter party risk involved as the Stock Exchange guarantees settlements. In case the corresponding broker defaults, BSE will step in to honour your trade. In the worst case, that is if the broker himself defaults, one would have a lien on the assets of the broker. In case the assets of the broker are not sufficient, one would receive against loss a sum upto Rs.2.25 lakh from the investor protection fund. However, the probability of this happening is very low. There have been no defaults on the BSE since the last two years. All said and done, there is tremendous flexibility in Vyaj Badla as one can withdraw one's money at a short notice as and when required.

Having heard all this from Pravin, Rajeev had another doubt regarding the tax treatment of badla income. He thought that the income would be treated as short-term gain from shares and taxed accordingly. However, Pravin dispelled this doubt too. Since one earns interest from the transaction, badla income is similar to interest income and would be taxed accordingly.

Rajeev, fully convinced of the idea, decided to give badla a try and decided to commit a sum of Rs.1 lakh for the same.

He is still smiling.

Benefits of Badla

Instrument	Return	Market Risk	Default Risk	Liquidity	Tax Benefits	Comments
Bank Deposit	4.5% (savings) 9-10% (Fixed Deposit)	Nil	Low - Deposits are insured to the extent of Rs.30,000	Excellent - However there is a penalty for premature withdrawl	Nil	One should be careful while investing in private sector and co-operative banks
Fixed Deposit (Companies)	10-13%	Nil	Low to very high depending on the rating of the company	Nil	Nil	many finance companies have defaulted. Hence one should be cautious before investing
Tax Free Bond	10%	Moderate	Low	Low	Tax Free Income	Excellent for high tax payers
Debentures	11-16%	Moderate - It is a function of interest rate, rating and tenure of debenture	Low to High	Illiquid	Long term capital gains possible without benefit of indexation	Poor liquidity offsets gains
Open ended income fund	11-13%	Low	Moderate	Money can be received back in 3 days	Nil	Good for high tax payers
Vyaj Badla	18-25%	Low	Low	Money back in 15 days	Depends on strategy adopted	One of the best money market instrument

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