DEBT/Fixed Income FAQ
Debt instruments are contracts in which one party lends money to another on pre-determined terms with regard to rate of interest to be paid by the borrower to the lender, the periodicity of such interest payment, and the repayment of principal amount borrowed (either in installments or bullet). In the Indian securities market we generally use the term ‘bond’ for debt instruments issued by the central and state governments and public sector organisation, and the term ‘debentures’ for instruments issued by Private corporate sector.
The principal features of a bond are:
"In the bond markets, the terms maturity and term-to-maturity are used quite frequently."
Maturity of a bond refers to the date on which the borrower has agreed to pay (redeem) the principal amount to the lender, the borrowing is extinguished with redemption, and the bond ceases to exist after that date. Term to maturity, on the other hand, refers to the number of years remaining for the bond to mature. Term to maturity of a bond changes everyday from the date of issue of a bond until its maturity. Coupon rate refers to the periodic interest payments that are made by the borrower (who is also the issuer of the bond) to the lender (the subscriber of the bond) and coupons are stated upfront either directly specifying then number (e.g. 8%) or indirectly tying with a benchmark rate (e.g. MIBOR+0.5%). Coupon rate is the rate at which interest is paid, and is usually represented as a percentage of the par value of a bond. Principal is the amount that has been borrowed, and is also called the par value or face value of the bond. The coupon is the product of the principal and coupon rate. Typical face values in the bond market are Rs.100 though there are bonds with face values of Rs.1000 and Rs.100000 and above. All government bonds have the face value of aRs.100. In many cases, the name of the bond itself conveys the key features of a bond. For example a GS CG2008 11.40%. Since the central government bonds have a face value of Rs.100, and normally pay coupon semi-annually, this bond will pay Rs.5.70 as six-monthly coupon, until maturity when the bond will be redeemed.
The term to maturity of a bond can be calculated on any date, as the distance between such a date and the date of maturity, when the bond will be redeemed. The term to maturity of a bond can be calculated on any date, as the distance between such a date and the date of maturity. It is also called the term or the tenor of the bond. For instance on February 17,2004, the term to maturity of the bond maturing on May 23, 2008 will be 4.27 years. The general day count convention in bond market is 30/360, European that assumes total 360 days in a year and 30 days in a month.
There is not rigid classification of bonds on the basis of their term to maturity. Generally bonds with tenor of 1-5 years are called short-term bonds; bonds with tenors ranging 4 to 10 years are medium term bonds and above 10 years are long-term bonds. In India central government has issued upto 30-year bonds.
Bonds can be issued in secured or unsecured form. Normally bonds issued in the form of debentures are secured. Bond issued by Financial Institutions offer attractive returns. Interest under the scheme is paid monthly, quarterly, half yearly, annually and on maturity. Most of the bonds provide flexibility, liquidity and safety. The flexibility can be seen from the range of options provided (i.e.) frequency of return/tenure/tax benefits etc. Bonds provide good liquidity, option to withdraw on pre-specified dates, listing on major stock exchanges, avail loans from banks by pledging bonds/securities.
- Regular Income Bonds.
- Tax-Saving Bonds.
Regular Income Bonds
Regular-Income Bonds, as the name suggests, are meant to provide a stable source of income at regular, pre-determined intervals, examples are:- Fixed Rate Bond.
- Floating Rate Bond.
- Public Sector Bonds.
- Inflation Linked Bond.
- Bonds from Public Financial Institutions.
- Money Multiplier Bonds/Deep Discount Bond.
Fixed Rate Bond
These Bonds carry fixed rate of interest which is declared at the time of issue and remains same till maturity.Floating Rate Bond
These Bonds carry interest rate which is linked to independent reference rates, independent index, commodities etc. and the rate is fixed for next period at the beginning of the period itself.Deep Discount Bonds
This bond is issued at a discount to the face value. The face value is paid at the maturity. These bonds are also know as Zero coupon bonds or "Zeros".Public sector bonds
These bonds are medium and long term obligations issued by public sector companies where the Government shareholding is 51% and more. Most of PSU bonds are in form of promissory notes transferable by endorsement and delivery. No stamp duty or transfer deed is required at the time of transfer of bonds transferable by endorsement.Inflation linked bonds
These are bonds for which the coupon payment in a particular period is linked to the inflation rate at that time – the base coupon rate is fixed with the inflation rate (consumer price index-CPI) being added to it to arrive at the total coupon rate. Investors are often loath to invest in longer dated securities due to uncertainty of future interest rates. The idea behind these bonds is to make them attractive to investors by removing the uncertainty of future inflation rates, thereby maintaining the real value of their invested capital.Bonds of Public Financial Institutions (PFIs)
Apart from public sector undertakings, Financial Institutions are also allowed to issue bonds, that too in much higher quantum. They issue bonds in 2 ways – through public issues targeted at retail investors and trusts and also through private placements to large institutional investors. Usually, transfers of the former type of bonds are exempt from stamp duty while only part of the bonds issued privately have this facility. On an incremental basis, bonds of PFIs are second only to GOISECs in value of issuance.Retail bond issues of PFI bonds have become a big rage with investors in the last three years. PFIs have also been offering bonds with different features to meet differing needs of investors eg monthly return bonds (which pay monthly coupons), cumulative interest bonds, step up coupon bonds etc.
Tax-Saving Bonds
Tax-Saving Bonds offer tax exemption up to a specified amount of investment, examples are:- RBI Tax Relief Bonds.
- Section 54EC Capital Gains Tax Exemption Bonds.
- ICICI Infrastructure Bonds under Section 88 of the Income Tax Act, 1961.
RBI Savings Bonds
RBI Savings Bonds are an instrument that are issued by the RBI, and currently has two options – one carrying an 8 percent rate of interest per annum, which is taxable and the other one carries a 6.5 percent (tax-free) interest per annum. The interest is compounded half-yearly and there is no maximum limit for investment in these bonds. The maturity period of the 8 percent (taxable) bond is six years and that of the 6.5 percent (tax-free) bond is five years.Tax Implications: In case of the 6.5 per cent RBI Savings Bond, the interest received is completely exempt from income tax as per the provisions of the Income Tax Act, 1961. But, In case of the 8 percent RBI Savings Bond, the interest will be taxable under the Income-Tax Act, 1961 as applicable according to the relevant tax status of the bondholder. RBI Savings Bonds are exempt from Wealth Tax. However, there is no tax benefit on the amount invested in these bonds.
Section 54EC Capital Gains Tax Exemption Bonds
Investments in bonds issued by the Rural Electrification Corporation (REC) and NHAI are at present eligible for capital gains tax savings. Gains made out of a capital transfer need to be invested in the above bonds within six months of sale of capital assets in order for the proceeds of such sale to be exempt from capital gains tax.REC Capital Gain Tax Exemption Bonds
Nomenclature | REC Capital Gain Tax Exemption Bonds |
Face Value | Rs, 10,000/- |
Mode of issue | Private Placement |
Minimum Application | One Bond of Rs.10000/- |
Maximum Application | 500 Bonds of Rs.10000/- as per the conditions laid in the Finance Act, 2007 |
Mode of subscription | 100% on application |
Deem date of allotment | Last day of each month in which the subscription money is realized and credited to REC account. |
Coupon Rate & Payment of Interest | 6.00% (payable annually on 30th June) from the date of realization of cheque/draft in account of REC. Ist interest will be payable on 30th June, 2009. |
Tap Period | Upto 31st March, 2009. However, the corporation would have a right to close the issue any time by giving a prior notice of 5 days in any two leading dailies. |
Tenor | 3 years from the deemed date of allotment. |
Redemption | At par, at the end of 3 years from the deemed date of allotment. |
Transfer | Non-Transferable |
Nature of Security | English mortgage creating pari-pasu charge over REC’s immovable property and charge on receivables of REC to the satisfaction of the trustee. |