BackDYK: PSU tax-free bonds have a portion reserved for retail investors
And often retail individual investors get the benefit of an enhanced coupon rate
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Tax-free bonds are back in the market. While public issues for these bonds are yet to happen this financial year, private placements are being made successfully. The government has allowed at least seven public sector entities to raise 40,000 crore through such bonds.
WHAT ARE THEY?
These bonds are going to be issued by seven public sector companies, who can raise up to a specified amount through these instruments. The interest earned on these bonds is entirely tax-free. This makes it a simple product to own and the government ownership of these companies also gives a sense of security to the buyer.
The interest coupon is typically linked to the current yield of a government security with a similar tenor. For example, tax-free bonds with a 10-year tenor will have an interest coupon linked to the yield of the 10-year government security (g-sec). So far, the private placement of some such bonds have seen coupon rates 50-60 basis points (bps) lower than the prevailing benchmark 10-year g-sec yield for bonds with a 10-year tenor (applicable for individual investors). One basis point is one-hundredth of a percentage point.
For bonds with higher tenor, the coupon rate is 20-25 bps more, in-line with g-sec yield of similar maturity. This is in case of AAA rated tax-free bonds. These bonds are usually issued with two or three different tenors; 10, 15 and 20 years. Longer the tenor, higher is the coupon.
However, there is no option to redeem bonds prematurely; one has to hold till the end of the specified period.
A specified portion of any public issue of tax-free bonds is reserved for individual investors. And often retail individual investors get the benefit of an enhanced coupon rate.
HOLDING
You can invest in these bonds in physical or in dematerialized form. Demat holding is preferable as the bonds usually get listed on notified on exchanges. Listing allows for secondary market transactions. If, for any reason, you aren’t able to hold the bonds till maturity, you can sell them in the secondary market.
MINT MONEY TAKE
The current coupon on these bonds is 7.17-7.43% for AAA rated bonds, depending on the tenor. This compares to a pre-tax return of 10.37%. This kind of pre-tax return is higher than what fixed deposits, savings certificates and short-term bond funds offer. Issuers being public sector enterprises also ensures security of investment.
While the lure of such bonds is high due to the interest being tax-free, you must consider the liquidity profile as well. These bonds are only suited for long-term allocation, and should be bought with the intention to hold till maturity. Although secondary market exit is a possibility, a lot depends on the volumes being traded when you want to exit. If there isn’t enough demand, you may not get the price you want in the secondary market.
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