Tax free bonds have been a hit with retail investors given both tax free coupon and rising prices as yields have fallen in these bonds. Retail investors have issues of transacting in Tax Free bonds as there is no continuous quotes available on these bonds. Many investors also do not understand yields, prices, accrued interest, step down coupons, day count conventions that these bond carry.
INRBONDS.com is providing transparency in secondary market quotes on Tax Free bonds for investors who want to buy or sell these bonds. The details are available on the following Twitter #.
NTPC Tax Free Bonds Issued in September 2015 and Allotted on 5th October 2015
Investors and intermediaries can indicate their buy/sell preferences at the dedicated NTPC Tax Free Bond #.
The term Tax Free attracts investors who do not realise what they are getting into. In this Tax Free issue, NTPC is issuing 10, 15 and 20 year bonds at coupon rates of 7.36%, 7.53% and 7.62% respectively. Institutional investors receive lower coupon rates of 7.11%, 7.28% and 7.37% respectively.
The first thing that investors should note is that in terms of absolute returns for every Rs 100 invested they will receive only the coupon rate, which is 7.36%, 7.53% and 7.62% i.e Rs 7.36, Rs 7.53 and Rs 7.62 respectively. The coupon is fixed for 10, 15 and 20 years. Do investors believe that India’s inflation rate will be below the coupon rates on the tax free bond for 10, 15 or 20 years? If they do believe that inflation will stay down, they may as well invest in 30 year Government of India bond that is yielding 8.10% on an annual basis.
The effective yield that is shown for the tax free bond is the yield that is adjusted for tax rates. However, investors will not receive the effective yield they will only receive the coupon every year. Hence for Rs 100 invested, if the effective yield is 10.65%, the investors does not receive Rs 10.65, he or she will only receive 7.36%.
Tax free bonds are illiquid. Institutions such as Insurance Companies, Provident Funds, Mutual Funds and Banks do not buy them. When interest rates rise, selling the bonds will become difficult and investors will be left holding low coupon bonds that are yielding less than inflation. Interest rates rise largely on rising inflation expectations or worries of debt servicing.
Invest in tax free bonds to sell out if yields fall but do not invest to hold to maturity.
NTPC (National Thermal Power Corporation) is issuing tax free bonds in September 2015. The details of the issue are:
Credit Rating: AAA by CRISIL, ICRA and CARE.
Face Value: Rs 1000
Issue Size: Rs 700 crores.
Issue Dates: 23rd September 2015 to 30th September 2015
NTPC is central government owned PSU and is strategically important to the government in its power policy. NTPC has been consistently rated AAA and credit risk is low for the issuer.
Tax free bonds are not frequently traded in the bond market. Retail investors can buy and sell tax free bonds through the stock exchanges, but given that liquidity is low, pricing can be an issue with high bid-ask spreads.
Corporate and institutional investors will be able to buy and sell tax free bonds more easily given that large ticket sizes have a more liquid market for tax free bonds.
Tax Free Return
NTPC tax free bonds have no tax payable on coupon payments. For example, if you invest Rs 1 lakh in the ten year tax free bond that has a coupon rate of 8.66%, you will receive Rs 8660 tax free every year.
The coupon rate on the bond will have to be compared to taxable investments in fixed deposits, government bonds and corporate bonds. Fixed deposits yield between 9% and 10% for longer maturities while government bonds and corporate bonds yield around 9.5% and 9.8% for ten year maturities.
The tax benefit equates out liquidity and credit mis-pricing risk for those who are in the higher tax brackets.
Tax free status does not extent to capital gains and short term and long term capital gain rates are applicable to the NTPC tax free bonds.