 "Tax-free bonds are going cheap: should you buy them?")
Tax-free bonds have always been on the minds of smart investors and financial planners, and with the kind of returns the latest bond issues have been offering, why not?
Take, for instance, the latest bond issue offered by Power Finance Corporation.Retail investors get 8.43 percent for 10 years, 8.79 percent for 15 years and 8.92 percent for 20-year bonds. And the interest is tax-free. Thanks to these lucrative rates, which effectively give more than 12 percent pre-tax for investors in the highest tax brackets, already listed bonds are taking a beating in the market.
That’s bad news for those who bought them, but great news for those who can now buy them below par. Tax-free bonds issued by some companies last year are actually trading around 2.5-6 percent below their issue prices in the secondary market.
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Tax-free bonds have always been on the minds of smart investors and financial planners, and with the kind of returns the latest bond issues have been offering, why not?
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Why: When new bonds offer higher rates, older bonds fall in prices to match up to current yields. Sample this Rural Electric Corporation bond issued last year at a face value of Rs 1,000. It is now quoting around Rs 972 on the NSE, which is at a discount of 2.8 percent, giving a yield to maturity (YTM) of 8.7189 percent. On the NSE, the 10-year Indian Railway Finance Corporation tax-free bond issued last year with a face value of Rs 1,000 was quoting Rs 975 on Monday morning, with a discount of 2.5 percent and yield to maturity of 8.4599 percent. The original coupon rate was 8 percent. The 10-year National Highways Authority of India bond issued last year at 8.2 percent now yields 8.3917 percent at current market prices.
What should you do: For retail investors, this could be a good opportunity to buy directly from the market giving these higher YTMs. Remember, when you buy a bond in the secondary market you could land up paying more than the face value (premium) or less than the face value. Whenever YTMs are higher than the coupon rate, you have the additional benefit of making a capital gain assuming you hold the bonds to maturity.
If you are not sure, how to calculate YTMs read this. Most of the tax-free bonds are issued by government-owned companies, and thus their are practically risk-free. But do remember the basics of credit-rating. IRFC and NHAI are Triple A while Hudco is Double A.