NABARD Zero Coupon Bond Issue Details

by Manshu on July 17, 2012

in Fixed Deposits

NABARD Zero Coupon Bonds are available for subscription right now (the offer will close on 18th July), and I think this is the first time I’m ever writing about any zero coupon bonds on offer for sale.

Zero coupon bonds have no interest payments and instead they are issued at a discount to the face value so when you redeem them at face value during maturity, you get your returns during that time.

NABARD ZCB have a face value of Rs. 20,000 and will be issued to the subscribers as part of this offer at Rs. 11,980. When you redeem them, you will get Rs. 20,000 for every bond, and the maturity date is 1st January 2019.

The NABARD brochure says that the return on this bond is 8.25% but I’m getting a slightly lower return of 8.22%.

If you invested Rs. 11,980 for 6.5 years at 8.22% you would get Rs. 20,000 back which is what the return should be in my opinion. If anyone can let me know how they are arriving at 8.25%, I’d much appreciate that. In any case, the difference is not much at 0.03%.

Even though the face value of one bond is Rs. 20,000 – the minimum investment on this issue is Rs. 6 lakhs, and that makes it out of reach for most people.

The two big benefits of this kind of offer is lack of reinvestment risk and tax advantage. When the tax free bonds were issued, a lot of people had pointed out that since these bonds pay interest every year, it’s up to you to invest that interest and find an instrument that matches the return on that instrument or else the overall return will come down. This type of instrument eliminates that reinvestment risk since the return you get are compounded.

Second benefit is tax advantage because the bonds will be taxed using the formula for long term capital gains, either indexed or not indexed and that is usually lower than the tax rate on interest income.

To that extent, this is an interesting product for someone in the higher tax bracket who wants to lock in some investments only to use them after a certain period of time.

{ 13 comments… read them below or add one }

AB July 17, 2012 at 9:28 am

Surprising… but the IRR works out to 8.256% if i input the followig dates in excel:
18-Jul-12: -11980
01-Jan-19: 20000

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Shiv Kukreja July 17, 2012 at 10:11 am

Hi AB… you are right, it is coming 8.256%. Probably Manshu has taken the “Time to Maturity” closer to 6.5 years.

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ankurm July 17, 2012 at 10:03 am

This is a taxable bond right?. But yield at 8.25% is very low at almost G-Sec rates. They could have offered atleast 100 bps spread over GSec. Tax attractiveness will be only if you sell prior to maturity in market?. Otherwise, like a cumulative IDFC bond, interest is taxable on an accrued basis annually (I read that in my allotment letter). Any CA/tax expert who could clarify this?

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Shiv Kukreja July 17, 2012 at 12:08 pm

Hi Ankur… I think you are right that the interest rate of 8.25% is quite low. But I think NABARD bonds offer some kind of Capital Gains Indexation benefit. The last time they issued “Bhavishya Nirman Bonds” the investors were not required to pay any tax on the interest earned rather Capital Gain is payable on maturity with indexation benefits. So these bonds are somewhat similar to FMPs.

http://www.thehindubusinessline.com/todays-paper/tp-investmentworld/article1014242.ece

I’m not sure whether these bonds also fall in the same category as BNBs, whether there would be any listing of these bonds and if they trade at all, there would be any buyer for these bonds.

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ankurm July 17, 2012 at 12:21 pm

Thanks shiv, but if its not listed, can it be sold back to the company prematurely? Otherwise, it becomes an illiquid investment. All the other bonds (tax free/taxable) are freely traded on exchanges. Thats further more reason for NABARD to offer higher yield as liquidity risk premium. The only reason I see for bonds to have a lock in is when they are tax saving bonds (80C or 80CCF).

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Shiv Kukreja July 17, 2012 at 12:30 pm

:-)… yes you are right, these bonds will definitely face illiquidity, even if they get listed on the exchanges. First of all, they are offering very low rate rate of interest so no corporate would be interested and secondly, retail investors are totally unaware of such an issue. So, my point is, even if they are tradable there would be no investor to buy these bonds from the secondary markets. Moreover, these bonds dont offer any tax deduction for sure.

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ankurm July 17, 2012 at 12:40 pm

Since, NABARD lends for agricultural and rural devt, I guess it needs to keep its cost of debt low, as these sectors are lent at concessional rates. Thats the reason for yields close to G-Secs. Any idea, what could effective post tax yield work out to after factoring in indexation?. I suppose shouldn’t be much different from Tax free NHAI/PFC bonds, which are any day more liquid. The only advantage i see here is elimination of reinvestmnent risk.

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Shiv Kukreja July 17, 2012 at 1:17 pm

I think it should be between 7-8% depending on the rate of inflation. I see no advantage in investing in them.. πŸ˜‰

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Vikalp July 17, 2012 at 1:08 pm

Hi Shiv,
You can calculate the return in two ways –
Write both the dates in excel and substract it, you will get number of days (2358 in this case). Divide number of days by 365 and you will get number of years (6.46 years). Now calculate the return ((20000/11980)^(1/6.46)-1)%. Another way is to use =Yearfrac(18/07/2012, 01/01/2019,3) and get the number of years based on 365 year calculation and then use the formula to get the return.

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vikrant July 17, 2012 at 7:46 pm

Hi mansu,

i didn’t catch what you are speaking here, and from the comment section it looks like everyone got what you are speaking about. you mentioned in the post

“NABARD ZCB have a face value of Rs. 20,000 and will be issued to the subscribers as part of this offer at Rs. 11,980. When you redeem them, you will get Rs. 20,000 for every bond, and the maturity date is 1st January 2019.”

So are you saying that if we buy at 11980 after 6.5 years we get 20000, then whats the gain , rs 20?? and how would that correspond to 8.25% return?

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Manshu July 17, 2012 at 8:09 pm

11,980 not 19,980

πŸ™‚

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vikrant July 17, 2012 at 8:27 pm

ha ha ha, thanks for that, how silly of me πŸ™‚

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ankurm July 17, 2012 at 8:55 pm

Even i made the same mistake when i read the post first time. But upon reading again, i could catch it. This is called numerical illusion

Reply

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