This is a series of short questions and answers that will help you with a working knowledge of economics so that you can manage your money better

What does Prime rate/Prime lending rate means – The interest rate that commercial banks charge their most creditworthy customers. Generally a bank’s best customer consist of large corporatations. The prime interest rate, prime lending rate is largely determined by the federal funds rate, which is overnight rate which banks lend to one another. The Prime rate is also important for retail customers, as the prime rate directly affects the lending rates which are available for mortgage, small business & personal loans. (Source : Investopedia)

Though some banks charge their best customer more and some less than the official prime rate, the rate tends to become standard across the banking industry when a major bank moves its prime up or down. The rate is a key interest rate, since loans to less creditworthy customers are often tied to the prime rate. For example, a Blue Chip Company may borrow at a prime rate of 5 % but a less well established small business may borrow from the same bank at prime plus 2% i.e. 7% .

Many consumer loans, such as home equity, automobile, mortgage & credit card loans are tied to the prime rate. Although the major bank prime rate is the definitive “Best Rate”. Reference point, Many Banks, particularly, those in outline regions have a two tier system whereby smaller companies of top credit standing may borrow at an even lower rate.

A reader asked us about our recommendations on buying a Gold ETF. Manshu has done a fair bit of research and has posted a detailed post on performance and volumes of Gold ETF in India.

Manshu writes, There are a total of 11 gold ETFs currently present in India, and 4 out of these 11 were launched within the last year. The big change in this space has been the reduction in the expenses that sponsors charge their customers, and now you can see that almost all of them are on the same footing.

The returns do not show any significant variations and the expense ratio also hovers around 1% for most of the funds.

Benchmark's Gold ETF leads with the biggest volume.

So taking a decision on buying a Gold ETF should not be difficult. Anyone would do! Depends on your comfort and convenience of service.

Question: As a government employee, I earn approx. Rs 35000 per month and my monthly expenses are around Rs 25000/-. I want to buy a house. Please suggest a financial plan on how to buy a house.

Answer: First, understand the difference between wants and needs. Do you really need a house? Or more importantly, can you afford to buy a house?

Second, borrow money only when the thing you buy goes up in value. You will say that the house will increase in value. But will you be able to take advantage of the increase? The increase is of notional value to you.

Third, you also need to contribute 15-20% of the house value upfront. Nobody gives you a 100% home loan. Do you have the amount ready?

To our mind, you need to focus on building a corpus through investment rather than think of buying a house. Decide on your priority.

ETFs are just what their name implies: baskets of securities that are traded, like individual stocks, on an exchange. Unlike regular open-end mutual funds, ETFs can be bought and sold throughout the trading day like any stock.

Most ETFs charge lower annual expenses than index mutual funds. However, as with stocks, one must pay a brokerage to buy and sell ETF units, which can be a significant drawback for those who trade frequently or invest regular sums of money.

They first came into existence in the USA in 1993. It took several years for them to attract public interest. But once they did, the volumes took off with a vengeance. Over the last few years more than $120 billion (as on June 2002) is invested in about 230 ETFs. About 60% of trading volumes on the American Stock Exchange are from ETFs. The most popular ETFs are QQQs (Cubes) based on the Nasdaq-100 Index, SPDRs (Spiders) based on the S&P 500 Index, iSHARES based on MSCI Indices and TRAHK (Tracks) based on the Hang Seng Index. The average daily trading volume in QQQ is around 89 million shares.

Their passive nature is a necessity: the funds rely on an arbitrage mechanism to keep the prices at which they trade roughly in line with the net asset values of their underlying portfolios. For the mechanism to work, potential arbitragers need to have full, timely knowledge of a fund's holdings.

Link to ETFs available in India and on BSE, NSE