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Why you should invest in Bhavishya Nirman Bonds

Why you should invest in Bhavishya Nirman Bonds

FD rates vary as per the interest rates in the economy.

The times are uncertain and investor sentiment tends to lean towards debt, most commonly bank fixed deposits (FD). But there's a catch. FD rates vary as per the interest rates in the economy. And with Reserve Bank of India's recent liquidity infusing measures, some banks are considering lowering their deposit rates.

A better option - Bhavishya Nirman bonds

Bhavishya Nirman Bonds (BNBs) are issued by NABARD. They give attractive return and offer better safety than FDs.

BNBs are essentially 10 year zero coupon bonds, and are currently available on tap at:

Bonds' issue price = Rs 8,500

Face value = Rs 20,000

The term = 10 years

This means for an investment of Rs 8,500, an investor will receive an amount of Rs 20,000 after ten years. In other words, the face value in this case is the maturity value.

Note: The usage of the term ‘face value’ in place of what is normally understood as maturity value is on account of the unique structure of zero coupon bonds (ZCB).

ZCB offer no interest ie, the coupon is actually zero. However, these are issued at a discount to the face value and the difference between the issue price and the face value is essentially the return that the investor gets.

That is, the issue price is Rs 8,500 whereas the face value is Rs 20,000. So, the discount of Rs 11,500 is the return for the investor.

The ten year tenure of the bond acts like a lock-in. Therefore, to provide liquidity, the bonds are listed on the BSE.

Next page: What is my tax liability?

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Form of BNBs

BNBs can be held in physical as well as the demateriliased form. The bonds held in physical form being negotiable instruments are transferable by endorsement and delivery by the transferor. Hence for safety considerations, it would be better if the bonds are held in demat form. Further for selling on the exchange, holding the bonds in demat mode is compulsory.

Tax Liability

The difference between the issue price and the maturity value would be taxed as capital gains. The investor has the option of paying capital gains tax at 10 per cent on the difference between the maturity value and the issue price or at 20 per cent on the difference between the maturity value and the indexed issue price. There is no Tax Deducted at Source.

An investor would be marginally better off opting for the 10 per cent rate. (This is based on a forecast of what the Cost Inflation Index could be in 2018 ie, the year of maturity. Actual numbers may differ depending on how inflation behaves over the next ten years.)

Rate of Return

The rate of return is 8.93 per cent per annum (Rs 8,500 growing to Rs 20,000 in 10 years). This return is subjected to tax ie, 10 per cent tax on Rs 11,500 = Rs 1,150.

The net gain = Rs 18,850, which is a post-tax yield of 8.29 per cent per annum.

Currently, FDs offer an interest of around 10.5 per cent per annum. But, note that is fully taxable at the slab rates applicable to you. That is, if you fall into 30 per cent and and 33.99 per cent tax slabs, you would be better off investing in the bonds. If you fall into tax slab of anything less than 30 per cent, bank deposits is a better alternative.

A word of caution

NABARD advertises a simple rate of 12.18 per cent per annum for these bonds. Investors should not be misled by this. Simple rate of return is not the correct method of calculating interest rate, the effective rate is always the compounded rate of 8.29 pr cent (as explained in the above para).

BNBs rate of return after tax is itself extremely attractive. In the current financial environment, long-term investors cannot ask for more.

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first published:November 24, 2008, 10:55 IST