Tax Free Bonds – An Alternative to FD – Who should buy this?

Hi

In the next few months, it is going to rain Tax Free bonds to the tune of 40000 crores.   Know what is in it for you–

a.  What are tax free bonds?

Tax free bonds are debt instruments issues by Public Sector Enterprises , who are authorised to issue bonds to customers to raise capital for their expenses / working capital?

b. What is the duration of these bonds?

These come with duration of 10, 15 and 20 years.  That is if you buy a bond with a maturity of 20 years, you will get your capital after 20 years.

c. What is the rate of interest?

These come with interest rates as desired by the companies and  it is expected to be in the range of 7.25 to 7.35% per annum.

d. What is the credit risk? or risk to the capital?

These are bonds issued by public sector enterprises and have crisil rating of AAA which means they are very stable. These are backed by the government of  India as the Government is the majority stake holder in these companies.

e. Who can apply?

Any resident individual or HUF and corporates can apply.

f. What is the minimum amount?

The minimum amount would be Rs 5000. Normally these bond come with a face value of RS 1000 each and this can vary based on the issue.

g This should be bought in physical form or Demat form?

One has the option to buy in any form they desire to buy. However there is a difference one should know.

In physical form, an investor will continue to get the interest annually. However this cannot be sold in between. Capital will be returned on Maturity based on duration.

h.  Can I surrender this or sell this before Maturity?

This cannot be surrendered before maturity. However if one wants to sell before maturity, this can be sold in the BSE (Bombay Stock Exchange) trading platform, through an authorised broker.

IN order to do this, you must have a demat account.

i. How will the interest be paid?

The interest will be paid to the bank account opted by the customer in the application through electronic transfer.

j. Is this a good time to buy these bonds? Who should buy these bonds.

This is an ideal investment vehicle for investors, who want safety and assured returns without loss of capital.  Many of these investors invest in FDs in bank.

With the interest rate coming down as the RBI is reducing the interest rates, there is a reinvestment risk.

Reinvestment risk, is that when you reinvest the FDs you do not get the same interest as the previous period but lower than that. This is called reinvestment risk

The tax free bonds have the same rate of interest and hence it has no capital risk or reinvestment risk.

Especially retired persons, who seek, regular cash flows with least risk can opt for this.

Also others as a diversification in asset allocation can have this in their portfolio.

k. What will be the rate of these bonds if I were to sell this in between maturity say two or three years later?

The bonds will be traded on the stock exchange and the bond prices will vary from the face value. Depending upon the interest rate outlook, the bond prices may be higher or lower.

For example, the bonds issued in 2013 are trading at a premium of 20% ie. a 1000 face value bond is now available at 1200. So an investor who has bought this two years back, would have got 2×8.5% plus 20% if he sells it today.

l. Is there capital gains tax, if sold later?

In the example given above, on 20% a 10% capital gains is charges if sold after one year. ie you pay 2% tax. However if you sell before one year, the entire gains is added to your income and taxed as per your income slab.

g. What is the scope for appreciation or capital gains in the short term?

As long as the interest rates are downward biased the bond prices will be higher. with the next one to two years, we are expecting more rate cuts there is a high probability of capital gains.

However if the interest rates were to raise, it is possible that the bond prices may be sold even below face value of RS 1000.

REcommendation.

It is recommended for the customer cited above that this could be a good option and a very good alternative to FD at the least for the next 2 to 3 years.

For details do contact me

Varadharajan

ckar.vsv@gmail.com

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