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How does chit works

A chit scheme generally has a predetermined value and duration. Each scheme admits a particular number of members (generally equal to the duration of the scheme), who contribute a certain sum of money every month (or everyday) to the "pot?. The "pot? is then auctioned out every month. The highest bidder (also known as the prized subscriber) wins the "pot? for that month. The bid amount is also called the "discount? and the prized subscriber wins the sum of money equal to the chit value less the discount and the fixed fee to the foreman. The discount money is then distributed among the rest of the members (or the non-prized subscribers) as "dividend? and in the subsequent month, the required contribution is brought down by the amount of dividend.

To illustrate the above, let us consider an example of a chit scheme with the following characteristics. Chit Value = Rupees (Rs) 500000 Duration = 50 months and Members = 50. The contribution in this case would be initially Rs.10000 per month per member. In the first month, the collection would, therefore, be Rs.10000 multiplied by the number of members i.e. Rs.500000. This amount is called the "pot? which is auctioned out at the end of the month. Now let us assume that the highest bid in the first month auction is Rs.100000. This is called the "discount?. The highest bidder now gets the amount equal to the chit value, less the discount, less 5% commission to the foreman1, i.e. Rs.375000. The discount amount is then divided among the 50 members equally (the dividend for the 50 members work out to roughly Rs.2000 each). For the subsequent month, therefore, the contribution of these members reduces by the amount of dividend (i.e. the contribution in the second month for the members would be Rs.8000). This process gets repeated for all months till the end of the scheme. The contributions are the same for each member, but the total amount taken out or bid by each member varies. For instance, in a 20 month chit scheme, the cash flows of a member who takes the loan in the second month and the cash flows of a member who takes the loan in the nineteenth month would be as follows