Fintotal News Analysis | REC Tax-free Bonds Issue: Should You Invest?
REC Tax-free Bonds Issue: Should You Invest?
Ruby Jacob, 01 Dec 2012

PSU power company Rural Electrification Corporation Ltd (REC) is up with its 2012-13 tax-free bonds issue. The Rs 4500 crores issue will be open for subscription between 3 December and 10 December. For retail investors the 10 year series bonds carry a coupon rate of 7.72% and 15 year series bonds carry a coupon rate of 7.88%.

REC tax-free bonds have face value of Rs 1000 per bond and minimum of 5 bonds have to be purchased. Allotment is on first come first served basis but 40% of the issue is allotted to retail investors in this issue indicating that most small investors might succeed in getting the bonds.

Should small investors take tax-free bonds serious?

For long term fixed-income investments small investors have bank FDs and tax-free bonds to choose between. The point of comparison in these two is the effective yield and this depends on what tax bracket one falls under. Fixed deposit interest is taxable whereas interest on REC bonds is tax-free.

Effective yield is calculated as coupon rate/ (1- tax rate).10 year fixed deposits interest is in 8.5-9% range. Compared to this interest effective yield of 10 year REC tax-free bonds is 11.2% for investors in 30.9% tax slab. For those in 20.6% slab effective yield is 9.7% and for those in 10.3% slab it is 8.6%. So the verdict is clear- if you fall in higher tax brackets tax-free bonds is more productive than FDs. 

Apart from yield tax-free bond investors stand to benefit in one more way compared to fixed deposit investors. These bonds will be listed on exchanges where investors can find interested buyers and sell them for capital gains. If yields go down (as interest rate comes down, which is expected soon) price of the bonds would rise. But this is not a big reason for investing in these because tax-free bonds are not traded as much as the usual bonds.

If you are an investor in higher tax brackets and have funds to park for the long term in safe fixed-income securities REC tax-free bonds are a good bet. They are top rated (AAA) ones but keep a watch on its rating if you don't intend to hold it to maturity.

The government has given nod for as many as 9 more infrastructure companies to raise funds through tax-free bonds before March 2013. More issues are expected in the next months. But with most experts anticipating RBI to go in for interest rate cuts next year, yields on forthcoming issues can be lower. So if you have the funds now is the time to invest in tax-free bonds. You can apply through any of the 5 named brokers. Visit http://recindia.nic.in/taxfree.html for application form for REC tax-free bonds 2012-13.

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