With inflation running in 2 digits now and at an average of 7% over the past decade, the return of just above 7% from the bond, makes it a good hedge for inflation. This aspect of the bond along with the potential exit route by trading in BSE may be attractive for those who need a inflation hedging tool in their portfolio. Inflation hedging components may vary from 5 to 10% of the portfolio for large investors.
It has been many years since a deep discount bond was launched in India. The last time such a bond was released was in 2001 for tax saving purpose by ICICI Bank and IDBI Bank. Recently Nabard has come up with a deep discount bond.
What is a Deep Discount Bond?
Deep Discount Bond is technically called a Zero Coupon Bond. This means the deposit does not give any interest payouts. Instead the interest is accumulated and paid out at the time of maturity. This way it is similar to a fixed deposit with cumulative option.
The Deep Discount Bond is however different from a cumulative deposit in the much longer tenure. Where a standard cumulative deposit scheme has a maximum tenure of 5 years in India, the deep discount bond has a minimum of 5 year tenure.
Previous Deep Discount Bonds
Deep discount bonds were a rage India during the early 1990s. There was the Narmada bond, which on an investment of Rs.3600 promised to give Rs.1.10 lakhs, 20 years after 1993 . The ICICI Children’s Bond promised Rs.1 lakh on an investment of Rs.7,000/-, 18 years after 1995. These bonds were at very attractive interest rates of 18% and 16% respectively.
Most of these bonds were subscribed by retail investors. The bonds served the purpose of long term planning well as they offered very good guaranteed returns.
Early Redemption
Most of these bonds were called back for early redemption by the issuers by the year 2000, when the market interest rate dropped to less than 10%. This left the investors in the bonds ending up with Rs.20,000 to Rs.25,000/- much earlier than the maturity dates. They also did not have other option in the market where they could get similar guaranteed returns.
NABARD Deep Discount Bond (Bhavishya Nirman Bonds)
The deep discount bond issued by NABARD is a first of sorts for this decade. The bond is being issued at Rs.9,750/- for a maturity value of Rs.20,000/- after 10 years. This gives it a return of 7.45%. The bond issue opens on March 23rd 2010. The bond can be traded on the BSE. This means that the bond holder can also make some capital gains in case the interest rate during the period drops below 7.45%.
The capital gains will enjoy indexation benefits too. This means that the tax liability of the capital gains will be much lesser.
On maturity, NABARD will not withhold TDS. This is a positive, particularly for senior citizens.
Who Could Invest in Bhavishya Nirman Bonds?
Based on the low returns and the long tenure, the deep discount bond – Bhavishya Nirman Bond is an asset class mismatch. Hence is not suitable for retail investment. This bond is definitely not for the youth of India looking for wealth creation.
With inflation running in 2 digits now and at an average of 7% over the past decade, the return of just above 7% from the bond, makes it a good hedge for inflation. This aspect of the bond along with the potential exit route by trading in BSE may be attractive for those who need a inflation hedging tool in their portfolio. Inflation hedging components may vary from 5 to 10% of the portfolio for large investors.
Senior citizens with portfolios requiring inflation hedging can also consider investing in these bonds.