A bond is a fixed-income instrument that embodies a loan made by an investor to a borrower. Bonds are generally handed out by companies, municipalities, states, and sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the issuer. A bond is also inferred as a fixed-income instrument since bonds are traditionally used to pay a fixed interest rate (coupon) to debtholders. Off late, looking at the volatility in the interest rate movements, variable or floating interest rates are also quite popular.
Investors generally feel bonds are safe and secured. Investors need to be cautious while investing in bonds. However, the issued bonds may be secured as well as unsecured in nature. In the case of unsecured bonds due to inherently higher risk, offer a higher interest rate as compared to secured bonds.
Investors need to note that, Bond prices are inversely associated with interest rates: when rates go up, bond prices fall and vice-versa. The effect of interest rate risk is directly proportional to the average maturity of the bonds, the greater the average maturity, the greater will be the impact of interest rate movements.
- State Government Bonds
State Government Guaranteed Bonds are safe and senior bonds generally propose a higher coupon rate as compared to their counterparts. The bonds can be both secured as well as unsecured.
There are many benefits in investing in State Government Guaranteed Bonds for both the issuer and the investors.
- Despite having lower creditworthiness, the issuer can raise capital via issuing State Government Guaranteed Bonds.
- As State governments do not collect the fee for guaranteeing the bonds hence borrowing cost reduces significantly.
For the investor:
- In the case of the State Government Guaranteed Bonds, the state government will pay the interest and principal amount if the issuer defaults. This gives an extra layer of security to investors.
- Most of the time, the State Government Guaranteed Bonds pay higher coupon rates than their counterparts.
- State Government Guaranteed Bonds are considered as senior debt securities as the guarantee given by the State Government is unconditional and irrevocable.
- A state-owned enterprise going bankrupt is very rare; nevertheless, if the issuer goes bankrupt, then bondholders of State Government Guaranteed Bonds are paid before the owners of non-guaranteed debts.
- The State Government Guaranteed Bonds are always in demand; hence liquidity of these bonds is comparatively high.
- These bonds pay coupons quarterly or biannually, helping investors with regular and frequent cash flows.
- Most State Government Guaranteed Bonds have staggered maturity. This means that on maturity, 25% of the face value is paid back to the investor per quarter over the entire year along with the outstanding interest payments.
Our wealth service also provides a brief idea of Perpetual Bonds to our clients. These are typical bonds that have a fixed tenure of maturity, but perpetual bonds, as the name suggests, can theoretically go on for as long as the issuer is a going concern. In practice, though, these bonds have a “call” option, which allows the issuer to reclaim the bond earlier.
Perpetual bonds are instruments mainly published by banks that do not have maturity dates as other bonds usually do. These bonds offer continual interest at a rate that is fixed at the time of allotment. Banks issue these bonds to meet their Tier 1 capital requirement.
Features of Perpetual Bond:
- Although Perpetual bonds are considered a very safe investment, they carry the credit risk of the issuer for an indefinite time. Banks can skip paying principal or interest payments if the bank’s capital adequacy ratio slumps below a specific threshold.
- Reliable fixed income stream.
- Paying the higher interest as compared to regular bonds.
- No need to engage in “reinvesting”.
A bond is a fixed income instrument delivering a coupon rate of interest and is issued for a fixed tenure. As the name suggests, interest earned from tax-free bonds is immune from tax. In simple terms, irrespective of the income, one need not pay any income tax on the interest income. Some of the public efforts which raise funds through the issue of tax-free bonds are IRFC, PFC, NHAI, HUDCO, REC, NTPC, and IREDA.
The tenure of the bonds is usually 10/15 or even 20 years. They are also documented on stock exchanges to offer an exit route to investors. The bonds are tax-free, secured, redeemable and non-convertible.
- Tax status: The interest income received is exempt from tax under Section 10 (15) (iv) (h) of the Income Tax Act, 1961. There will, nonetheless, not be any tax privilege on the amount of investment made in such bonds. Also, there is no bearing of TDS on interest income. TDS bearing will still be there on the application money while applying for them.
Tax-Free bonds are also documented on stock exchanges and traded only through Demat accounts. If there is any capital profit on transferring them on exchanges, that will be taxed. If the ownership period is less than 12 months, capital gains on the sale of tax-free bonds on stock exchanges are taxed as per the tax rate of the investor. If bonds are held for more than 12 months, the profits are taxed at 10.3 per cent. There will not be any benefit of indexation in them.
Tax-free bonds are hugely prominent with high-net-worth investors because they enable parking a huge lump sum at one place. They are discerned to be very safe as they are mostly issued by government societies and carry high investment-grade marks. Also, the effective pre-tax profit is high for those in the higher salary slab. Although tax-free bonds are low-risk commodities, the effective pre-tax yield seems to be high.
Liquidity is low in tax-free bonds. Usually, they are documented on stock exchanges to give an exit route to investors.
The tenure of tax-free bonds being long term, one should carefully invest in them keeping intermittent goals in mind. Investors should invest in them only if you are sure not to use the funds for such a long period.