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Still craving for Tax Free Bonds?

As you may be aware, public issues of tax free bonds came to an end with the end of Financial Year 2013-14. 

And those who have read my earlier blog 'Issues of tax free bonds to end soon' would have noted that the next series of such issues, if any, is unlikely to hit the markets before Nov / Dec 2014.

So what should the investors with surplus money... and interested in tax free bonds... do during this inordinately long gap?

Simple... they can buy such bonds from the secondary market. Equity shares are not the only securities listed and traded on the stock exchanges viz. BSE and NSE; bonds and debentures too are bought and sold at these exchanges. 

You must, however, note the following points before hitting the 'buy' button. 

1. Liquidity of such bonds is quite limited and poor. Therefore, you must be reasonably sure that you will not need this money for the next 8-10 years, till these bonds mature.

2. Since the liquidity is poor, there could be a huge difference in the bid and offer prices. As such, be extremely careful of the price that you pay for such bonds. Too high a price would directly and sharply curtail your returns.

3. Look for issues with large corpus size only, as these are likely to provide better liquidity than small-sized issues.

4. When buying from secondary markets you don't have to look at the coupon rate. Rather you have to consider the YTM (i.e. Yield to Maturity). Currently the average yields are at around 8% to 8.5% per annum. 

5. Given the yields, these bonds make sense for investors in the higher tax brackets only. Other investors, in the nil / low tax brackets, could earn better post-tax returns from the all-time favourite bank FDs.

6. Tax-free bonds issued in FY 2012-13 had a step-down clause, wherein the investors buying these bonds from the secondary market would get 0.5% lower interest rate than the original allottees in the public offer. Issues in FY 2013-14 (and earlier in 2011-12) had no such step-down clause. So make sure that you buy tax-free bonds issued in 2013-14 / 2011-12. And if buying the 2012-13 bonds, ensure that the price suitably compensates for the lower interest rate.

7. You will need demat and broking accounts to buy bonds from the secondary market, which was not a necessity when buying physical bonds during the public offer.

8. Remember! Only the interest earning is tax free. However, if you buy and sell in the secondary market, the gains would be taxed as capital gains. Short-term gains would be taxed as per your slab rate; while long-term capital gains will attract 10% tax (without indexation).

9. Normally, credit rating of the bonds matter a lot. However, since nearly all issuers of tax free bonds are Public Sector Companies, the risk of default is pretty low. We can expect the Govt. of India to pitch in, should there be any financial problems with these companies.

10. If the inflation cools down and the interest rates soften, you would also benefit from the capital appreciation in the bond prices.

So, lack of public offers, does not mean lack of investment opportunities. You always have the option of secondary markets for tax free bonds.

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