Bonds

On the lines of the IFCI Infra Bonds , Larsen and Toubro have Infra bonds out for subscription too, which save you tax upto 20,000 per year. This is separate from the 100,000 limit on 80C investments. (Technically, it’s the 80CCF deduction, if you want to search and read more)

Details: (http://www.ltinfrabond.com/)

• Rs. 1,000 per bond. Min: Rs. 5,000 invested.
• Interest: Annual payout, or reinvested.
• Maturity: 10 years
• Interest rate: (A) 7.5% to (B) 7.75%.
• Closes on Nov 15, 2010
• Buyback: (A) option has a 7 year buyback option, and the (B) bond, 5 year.
• Lock-in: 5 years. Post that, traded on stock exchanges.
• Where can you buy? Download form online, fill it and put in a cheque, and deposit it at the collection centers.

You’ll only get 20K per year on this, by the way, so if you’ve already invested in the IFCI bonds this is not available to you.

The interest is taxable. If you invest Rs. 20,000, and you’re in the 30.9% tax bracket, you save 6,180 in taxes, meaning you’ve invested 13,820. On the cumulative 7.75% option you make Rs. 42,200 in 10 years, but you would have paid about Rs. 6,850 in taxes, so your net return is 35,350. That is not too shabby really – about 9.84% as yield.

Of course the actual amount isn’t all that great – nets you around 1,000 per year as interest, and that doesn’t go too far for the person in the 30.9% interest bracket.

Buyback: L&T Infra can buy the bonds back in 5 or 7 years, but you can’t ask them too. Effectively it’s a call option they have. The yield then increases substantially – net of taxes (saved and paid on the interest), the yield on the 7.75% 7 year cumulative bonds goes to 11.44%. (Don’t bother with what the prospectus says – they don’t cut the amount you pay in taxes on the interest)

In comparison the net tax yield of an 8% Fixed deposit for the highest tax bracket investor is about 5.6%. So this is very nice. Only pain is that amounts are tiny. Will I invest? I don’t know yet. The yield is nice, but will there be better yields coming along? Are stock markets simply better, regardless? Very undecided. Also the debt equity ratio is scary – L&T infra has 340 cr. in debt till now and they’re absorbing 700 cr. in this issue; perhaps I shouldn’t be worried, after all, everything is too big to fail now.

IFCI has some infrastructure bonds open for purchase, and they give you a tax exemption on a limit of 20,000 per year.

Scheme: http://www.ifciltd.com/Portals/0/IFCI%20Infra%20Bond%20Series%20I_IM_web.pdf

10 year bond, with no exit till five years, but will trade on the BSE – but you can’t exit before 5 years are over. Purchasing these bonds on the BSE is unlikely to provide the same tax benefit (it probably only applies for a purchase directly from IDFC, a primary purchase – not secondary purchases). To be honest it all depends on when they list the bonds and whether on listing such bonds will still have a lock-in etc. 

Rates: 7.85% if you want to sell them back after 5 years, 7.95% otherwise.

Options: Cumulative (interest reinvested annually) or Annual Interest Payout.

Issue Closes: August 31, 2010. You have a week from today.

Issue details: http://www.ifciltd.com/IFCIBonds/InfrastructureBonds/Issue201011/tabid/212/Default.aspx

You need a demat account. Business standard says no harm waiting for other such bond offers for the 20K tax benefit.

Let’s now analyze the non cumulative schemes.

If you’re in the 30.9% tax bracket, investing 20K will save you Rs. 6,180 in tax in the first year, and give you Rs. 1570 in taxable interest, which means a net income of Rs. 1,085 per year. Over five years that’s a total return of 11,604 or about 10% a year, which is nice. Unfortunately the Rs. 20,000 cap on the tax exemption makes it uninteresting for the people in the 30% bracket.

At the 20% bracket the net return, calculated the same way, is 10,352 or 10.35% per year. For the 10% tax bracket it means about 9.1% net yield per year. (Net yield = total interest/investment)

At the cumulative option interest goes to 12.92% net yield per year, which is definitely very interesting. I might be tempted to wait for more as the year goes by, but to people in the 20% tax bracket this could be invested in immediately, with say 10K (leave the rest for a later offering).

Update: There is an awesome comment by reader Kaho Pyare, who specifies that the return is higher because you can reduce the tax from the investment amount. For someone in the 30% bracket, the cumulative option works out to a return of 13.77%, since your investment is about 13,820 (20K minus the tax benefit) and the return after five years post tax is 26,345. Just don’t overpay taxes.

The absolute amounts are small for the 30% bracket (>8 lakhs a year) and perhaps only marginally more significant at the 20% bracket (>5L). It does make sense at the 10% bracket, surely, even if calculated returns are just 9.5% net of taxes over five years.

This isn’t investment advice, just my opinion.

RBI’s latest notification:

In terms of our Master Circular No. DBOD.BP.BC.18/21.04.141/2010-11 dated July 1, 2010 on ‘Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Banks’, securities acquired by banks with the intention to hold them up to maturity may be classified under Held to Maturity (HTM) category. Banks are, however, allowed to shift investments to/from HTM with the approval of the Board of Directors once a year. Such shifting is normally allowed at the beginning of the accounting year and no further shifting to/from HTM is allowed during the remaining part of that accounting year.

2. In this connection, it has been observed that many banks are resorting to sale of securities held under HTM category, that too frequently, to take advantage of favourable market conditions and to book profits. It needs to be reiterated that securities under HTM category are intended to be held till maturity and accordingly are not required to be marked to market.

3. In view of above, it has been decided that if the value of sales and transfers of securities to/from HTM category exceeds 5 per cent of the book value of investments held in HTM category at the beginning of the year, bank should disclose the market value of the investments held in the HTM category and indicate the excess of book value over market value for which provision is not made. This disclosure is required to be made in ‘Notes to Accounts’ in banks’ audited Annual Financial Statements.

Funda – banks buy stuff and can say listen I won’t mark these to market because I will hold them to maturity. Why? If you buy a 6% bond at Rs. 100 when interest rates are 6%, but soon interest rates spike to 12% then your bond will probably trade for Rs. 50 in the market (to provide a 12% yield). You have basically “lost” Rs. 50.

Note: The calculations are slightly more complex, so the price won’t exactly halve; the above example is simplified for clarity.

But you can say that boss, I lost nothing – my hundred rupees will come back because I’m not selling right now. That is, to an extent, true – a bond price will not matter if you hold till the end, because you’ll get your money back. (Caveat: the bond seller should not default). Here’s a demo – imagine the 7.46% bond expiring in 2017, at different yields today:

In 2008, From a price of Rs. 110 at 6%, if the yield were to rise to 9% the price would drop to 90. At 12% , the price would have been 74.42; but you notice that as the years pass by the difference in prices due to the yield changes gets smaller and smaller, and by 2017, it disappears completely – the price converges to 100.

Technically if you hold to maturity (HTM) there should be no need to “mark-to-market” – each bond can be said to be worth Rs. 100 (face value).

Banks move securities to HTM to take advantage of a rising yield market – where in a trading bond portfolio they would have to mark the bonds to market, and the market prices fall as yields rise. A HTM portfolio doesn’t need to be marked, so banks would move bonds from a trading portfolio to HTM – yet, when interest rates softened, even temporarily, they would sell the bonds from the HTM portfolio. What RBI has said is – you can’t trade bonds and still “hold to maturity”, so if you sell too much of the HTM portfolio, you have to report it separately.