# Power Finance Corporation Secured Tax Free NCD Issue

Shiv left a comment about PFC coming out with an issue of tax free bonds, and I thought it will be a good idea to do a quick post on them.

These bonds have a face value of Rs. 1 lakh so they are priced out of range for a lot of people, but otherwise with an interest rate of 8.09% for the 10 year bond, and 8.16% for the 15 year bonds – the yields are pretty good especially if you are in the 30% tax bracket, and these bonds will later on list on the stock exchange so that means you will have the ability to sell them at the exchange later if you don’t want to wait till the maturity.

For whatever it’s worth the issue has also been rated AAA by CRISIL and ICRA and PFC itself is a Navratna of course.

The PFC tax free bond issue opened on the 2nd November, and will close on the 25th November 2011.

Here are the interest rates and effective yields for both the maturities.

 Maturity Period 10 years 15 years Interest Rate 8.09% 8.16% Effective yield for people in 30.9% tax bracket 11.71% 11.81% Effective yield for people in 20.6% tax bracket 10.19% 10.28% Effective yield for people in 10.3% tax bracket 9.02% 9.10%

The interest is going to be paid every year on the 25th November.

Incidentally, someone emailed me the other day asking if there was a calculator to calculate the effective yields for tax free bonds, and while I have never seen a calculator to do this – it’s fairly easy to calculate it yourself.

Effective yield simply implies what coupon rate would you need to match this bond if it weren’t tax free.

For instance, if you got a fixed deposit for 11.71% per year then at the end of the year you would have to pay a tax of 30.9% on 11.71 i.e. 3.62 and you will be left with only 8.09 after tax.

So, the tax free yield of someone at the 30.9% tax bracket of the 8.09% bond becomes 11.71%.

The formula for this is fairly straightforward:

Effective Yield Â = {Interest Rate /Â (1 – Tax Rate)}

I’m not quite sure how you go about buying these bonds except for approaching someone like Shiv (who is a financial adviser based out of Delhi, Contact Number: +91-9811797407,Â Email Address: ojascap at gmail.com), or perhaps calling up your local advisor so I won’t be able to comment on that aspect of it. If you have invested in these in these type of issues in the past then please let me know and I’ll update the post.

Once again, thanks to Shiv for bringing the PFC tax free bond issue to my notice, and all questions and comments are welcome!

## 20 thoughts on “Power Finance Corporation Secured Tax Free NCD Issue”

1. Savio says:

My earlier comment assumed that the NCD was cumulative. However, I realized that it is 8.09% with an annual payout option. If you compare that NCD coupon rate with a bank FD with an annual payout, the equivalent bank FD rate for the 30.9% tax bracket is 11.23%. Note that the bank FD will pay you interest annually but calculate the interest payout quarterly, so you stand to earn more.

1. I see – okay – that’s a good point and I now understand a bit better what you are doing. Thanks for bringing that in the discussion.

I’d like to do these numbers some more but yeah basically I agree with you that if banks compound interest 4 times a year and this NCD does that only once then the effective interest can’t be calculated in the way I have mentioned – it will be lower.

2. Savio says:

Folks,
Math wasn’t my strongest subjects in class. I created an Excel calculator and it does the job for me. I think the effective yield of 11.71 for those in the 30% (rather 30.9%) tax bracket doesn’t seem right.
Note two things:
1. You need to compare the tax-free NCD yield with a bank FD with the income on the FD being taxable. For example sake, I have taken it at 30.9% (the highest slab).
2. The NCD interest is payable annually while the bank FD interest is payable quarterly. The more often the interest payout, the more you stand to earn.

So based on my calculation to earn a tax free NCD income of 8.09%, the equivalent bank FD rate (for the 30.9% tax slab and with with a quarterly interest calculation for cumulative interest) is 10.34%. For the 10.3% slab, the equivalent FD rate is 8.68% and for the 20.6% slab it is 9.42%.

So based on these calculations, the NCD doesn’t look attractive because banks are currently offering around 10% any way. These bonds are only useful if you want to lock in your money for a longer duration of time. But some banks do allow you to keep an FD for around 7 years plus. 🙂

If my calculations are wrong, please let me know. But I have back calculated with my Excel calculator and it turns out I might be correct.

Regards,
Savio

1. I’m sorry I’m unable to follow this calculation. You are just compounding this 4 times right? Or are you doing something else? Because if I do that then at 10.43% the effective income after tax is 7.49 not 8.09.

Here is how:

Principal 100
Interest Rate 2.61%
Period 4
Amount \$110.85
Interest Income \$10.85
Tax Slab 30.90%
Effective Income \$7.49

Yes compounding will have a difference, but not by that much. What am I missing?

3. chand says:

Manshu, I think I missed the boat and the last date for this was 15th November. Probably I will buy it from the market. Do you know whether they had any cumulative option rather than yearly interest disbursement?

Also, what would have been the yield if there was a cumulative option available?

1. No, as far as I know they were going to pay the interest every year, which makes sense as well because the big thing about these bonds is that the interest is tax free.

4. Why you should buy this NCDs of Power Finance Corporation?
1) Well if one thinks that the interest rates will subside over the next few years and will come down to 6-7 % or even lower as in western countries. (Which is very less likely)
2) If you fall in higher tax bracket then you can think of going for it, but the situation will change once the DTC comes in to place.
3) If you wish to invest bigger amount.

Why you should completely avoid applying for PFC NCD?
1) History has shown one must avoiding buying NCDs on intial public offerings, but only post listing!
2) If your timeframe is not of 10 year but are looking for less time frame then their are better NCDs available on market.
3) Some NCDs with ratings of AA and AAA are giving yield as high as 14% on stock exchanges !

If you need to know more about high yielding NCDs , you can have a look here.
http://reformistindia.blogspot.com/2011/11/debentures-better-interest-than-fd.html

5. Ramesh says:

has any of the readers actually bought these PFC tax free bonds yet? and why? If not why not. it appears a good investment.

Has any one bought it online and how?

6. Vijay says:

Dear Manshu, I am quite weak in Mathematics and so, wanted to clarify a couple of things with you ! The SBI Retail Bonds (for 10 & 15 years) which were in the market a few months earlier were offering close to 9 % annual interest (which was taxable) – Simple Interest rite? And here, you have the PFC Tax Free Bonds (for 10 & 15 years) offering 9-11% interest (Simple interest) which are tax free. And then you have Banks esp. Corporation Bank which are offering Fixed Deposits @9.25% (with quarterly compounding) which are taxable. Assuming that one keeps on renewing their FD’s every year (with the risk of fluctuating FD rates and taxability on returns), which one do you think gives the best return on investment?

1. Dear Vijay – I’m sure it is not Maths but the plethora of options and lack of clarity among them that makes the comparison a little weird. The key is to loo for your after tax returns, and that’s make the comparison simple.

Just assume that you are in the 30% tax bracket and with the surcharge your effective tax rate becomes 30.6%, so in this case that if you earn 9% interest you have to pay 30.6% of 9 viz. 2.75 in taxes and you effectively only get 9 – 2.75 = 6.25 income.

However with tax free bonds that yield 8.06% every year – you get to keep all of that 8.06 with you as income.

For 9.25% compounded quarterly, you make 9.58 in a year but you then pay 30.6% or 2.93 as taxes and effectively get to keep only 6.65 with you.

So you see that the tax free bonds are the better ones for someone at the higher tax rate.

This is actually a good idea to do a post for and make a calculator for that as well. But I guess since you have seen the methodology now you can replace the interest rates and tax rates for your own purposes.

1. Vijay says:

Thanks a lot Manshu !!! You have made it simple !!! You should do a post on that Manshu – for lazy guys like me who prefer sweet guys like you to do the tough jobs for them !!!!

7. Samy says:

Under what section of the IT act are these bonds tax free?

1. The term sheet that I have just says that it is tax free but not what section it is. But I googled and saw that the bonds are exempt under Section 10 (15) (iv) (h)

8. Ramesh says:

Good investment for long term for senior citizens with surplus cash. better than bank FDs if liquidity not an issue.