Tax Free Bonds: Grab the attractive yield

Written on Monday, September 28, 2015
By Mohit Mittal- AVP & Head Fixed Income, Bajaj Capital Ltd.

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While going through news articles, discussions on TV and listening from your financial advisor, you must have got a fair idea about the tax free bonds. Now you know what they are and how they yield return which is completely tax free. NTPC has already closed its issue to raise 700 crore. Of the total issue, 40% has been reserved for retail investors and 25% for high net worth investors. The remaining will be for companies and qualified institutional buyers. For retail investors (with investment up to Rs. 10 lakh), interest rate for a duration of 10 years is 7.36% per annum, for 15 years it is fixed at 7.53% and 7.62% if you invest for 20 years.

For those who want to lock away money for the long-term and hedge the reinvestment risk, this is a good tool to grow their wealth. But somewhere in your mind you have a doubt which says 7.62% is even less than a Bank Fixed Deposit, then how come it is an attractive option. You have a valid question, so let's find out the logic.

Being a retail investor if you fall under 30% tax bracket, your Fixed Deposit investment at 8.25% per annum would offer a post-tax yield at close to 5.8%. Now, if you invest in tax free bonds, at 7.4-7.7 percent, the effective pre-tax return for a person in the highest bracket works out to 10-11 percent. Retail investors (With investment of up to 10 Lakhs) in the highest tax bracket can get 10.6-11 percent return. Considering the interest is entirely tax-free, the yields are attractive. 

After comparing Tax Free Bonds with other investment options, you can see that bonds have an upper hand for investors in 30% tax bracket.

NTPC's issue opened up for subscription on 23rd Sep and on the same day it got oversubscribed by more than 6 times. The allotment was on a first-come first-served basis only in demat form with a minimum application of Rs 5,000. But if you have missed it there are other issue coming soon. Power Finance Corporation (PFC) is coming up with public issue of Tax Free Bonds worth Rs. 700 Crores on 5th October 2015. Among other public service undertakings that would be coming up with issues in next 6 months are-National Highways Authority of India (NHAI), Indian Railway Finance Corporation (IRFC), Housing and Urban Development Corporation Limited (HUDCO), Indian Renewable Energy Development Agency (IREDA), Rural Electrification Corporation (REC) and National Thermal Power Corporation Ltd (NTPC).

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