Fixed-income instruments in India
Fixed-income securities represent the debt of domestic financial institutions, companies, banks, and government issues. In essence, when you buy a fixed-income security, you are lending money to the issuer for a specified period of time. In return, you expect the issuer to make regular interest payments (annually, semi-annually, quarterly, or monthly) and to pay back the face amount on the maturity date (the end of the specified period for the loan).
Fixed-income instruments in India typically include company bonds, fixed deposits and government schemes. One of the key benefits of fixed-income instruments is low risk i.e. the relative safety of principal and a predictable rate of return (yield). If your risk tolerance level is low, fixed-income investments might suit your investment needs better.
1. Company bonds
Corporate Bonds are issued by public sector undertakings and private corporations for a wide range of tenors normally up to 15 years. Over and above the scheduled interest payments as and when applicable, the holder of a bond is entitled to receive the par value of the instrument at the specified maturity date. Compared to government bonds, corporate bonds generally have a higher risk of default. This risk depends, of course, upon the particular corporation issuing the bond, the current market conditions, the industry in which it is operating and the rating of the company. Corporate bond holders are compensated for this risk by receiving a higher yield than government bonds. There are essentially two ways to make money from bonds:
(i) Capital gains, which are achieved by selling a bond for more than it cost to buy, and
(ii) The receipt of periodic interest payments.
Bonds are suitable for regular income purposes. Depending on the type of bond, an investor may receive interest semi-annually or even monthly, as is the case with monthly-income bonds. Depending on one’s capacity to bear risk, one can opt for bonds issued by top-ranking corporate, or that of companies with lower credit ratings. Usually, bonds of top-rated corporate provide lower yield as compared to those issued by companies that are lower in the ratings.
One can borrow against bonds by pledging the same with a bank. However, borrowings depend on the credit rating of the instrument. For instance, it is easier to borrow against government bonds than against bonds issued by a company with a low credit rating.
Companies issue bonds and debentures through public issues that are open only for a limited period of time. Application forms for these issues are available with primary market brokers.
2. Company fixed deposits
Corporate fixed deposits are similar to banking FD’s, except that the money invested is with a company and not a bank. Deposits under corporate FD’s are governed by the Companies Act under Section 58A.However, these deposits are unsecured.
The similarity between Bank FDs and Corporate FDs is that both have fixed tenures and have the same tax treatment. On the other hand, in the case of Corporate FDs since the investments are with private companies with no insurance protection, these investments are relatively riskier then bank fixed deposits and consequently offer better returns as well. Corporate FDs also have constraints in terms of the number of tenures that they offer deposits- usually short term deposits with 6 months and less are not found in company deposits.
Before investing in corporate FDs, an investor should look at the pedigree of the management and the fundamentals of the company. It is equally important to look at financial indicators like the interest coverage ratio, the debt-to-equity ratio and the free cash flow generated by the company. The interest coverage ratio will tell you whether the company can fulfill its interest obligations. Typically, look for a ratio of 2:1 and be skeptical of anything above this. Likewise, the debt-to-equity ratio of a company will tell you how leveraged the company is. Moreover, one should also look at the credit ratings assigned to these companies.
3. Bank Fixed Deposits
Nothing beats FDs when it comes to security. It is better to opt for bank deposits over company deposits, which do offer high returns but are risky. The advantage with FDs is that it provides higher interest rate than saving accounts and it is as safe also. If you think that you are going to need this money at a particular time, it is better to shift that money from your saving account to short-term fixed deposit as fixed deposits provide higher returns than saving accounts.
4. Fixed income mutual funds
Another fixed income instrument alternative can be mutual funds, especially the income funds. Mutual funds do away with one of the biggest drawbacks of other alternatives i.e. liquidity. An investor can exit from the fund anytime he wants. Also the income funds rate low on risk and default. The returns offered by most of the well managed funds are higher than the company or bank deposits. Thus, an investor who is willing to take some risk or rather divert the risk associated with corporate deposit towards the income funds can enjoy the benefits of income funds as well.
Income Funds in India provide to the investors regular income and also stability of capital. Income Funds in India usually invest their principal in securities of fixed income such as government securities, bonds, and corporate debentures. There are many mutual funds houses that have launched Income Funds in India. The advantage of Income Fund is that it provides regular income to the investor either on a monthly or quarterly basis. Further the advantage of Income Funds in India is that it also provides stability of capital to the investor. The bonds that are there in Income Funds are usually of the investment grade. The other bonds are of such credit quality that they assure the protection of the capital.
5. Public Provident Fund (PPF)
PPF is a good fixed-income investment for high tax payers. PPF is a very attractive fixed income investment option for small investors. Any individual may, on his own behalf or on behalf of a minor, of whom he is the guardian, can subscribe to the Public Provident Fund any amount not less than500 and not more than70,000 in a year.
Interest rate is notified by the Central Government in official gazette from time to time and is allowed for calendar month on the lowest balance at credit of an account between the close of the fifth day and the end of the month and shall be credited to the account at the end of each year. The current rate of interest is 8% which is compounded annually. The returns are compounded which means an investor can earn interest on the deposits as well as on the interest earned. Because of the tax rebate, the actual return works out to be much higher.
Deposits on Public Provident Fund account qualify for tax deduction under Section 80C of Income Tax Act. The balance held in the Public Provident Fund account is fully exempt from Wealth tax without any limit. The interest earned from Public Provident Fund is totally exempt from tax under Section 10(a) (i) of the Income Tax Act. Moreover, it has low risk – risk attached is Government risk. PPF is available at selected post offices and banks.
The problem with PPF is its lack of liquidity. You can withdraw your investment made in Year 1 only in Year 7. However, loan against investment is available from 3rd financial year. If you are willing to live with poor liquidity, you should invest as much as you can in this scheme before looking for other fixed income investment options.
6. Post Office Monthly Income Schemes
The post-office monthly income scheme (MIS) provides for monthly payment of interest income to investors. It is meant for investors who want to invest a sum amount initially and earn interest on a monthly basis for their livelihood. The MIS is not suitable for an increase in your investment. It is meant to provide a source of regular income on a long term basis. The scheme is, therefore, more beneficial for retired persons.
Only one deposit is available in an account. Only individuals can open the account; either single or joint. (two or three). The minimum investment in a Post-Office MIS is1,000 for both single and joint accounts. The maximum investment for a single account is5 lakhs and10 lakhs for a joint account. The duration of MIS is six years.
The post-office MIS provides specified interest rate per annum payable monthly. Premature closure of the account is permitted any time after the expiry of a period of one year of opening the account. Investors can withdraw money before three years, but at a discount of 5%. Closing of account after three years will not have any deductions. Monthly interest can be automatically credited to savings account provided both the accounts standing at the same post office. The interest income accruing from a post-office Moreover, no TDS is deductible on the interest income.
7. National Saving Certificate
National Savings Certificate, also known as NSC, is a tax saving instrument that combines adequate returns with high safety. NSCs are an instrument for facilitating long-term savings. It provides A specified interest rate per annum compounded half yearly. Period of maturity of a certificate is six years. Premature encashment of the certificate is not permissible except at a discount in the case of death of the holder(s), forfeiture by a pledge and when ordered by a court of law. They not only save tax on their hard-earned income but also make an investment which is sure to give good and safe returns.
A NSC can be bought by an adult in his own name or on behalf of a minor, a minor, a trust, two adults jointly or Hindu Undivided Family. NSC is available for purchase/issue at all Post Offices in India. Nomination facility is available for NSC. Certificates can also be transferred from one post office to any other post office. Transfer from one person to another person permissible in certain conditions.
Certificates are available in denominations (face value) of100, Rs.
500,1000,5000 &10,000. The minimum amount of investment under NSC is100/-. There is no maximum limit for purchase of the certificates. Interest accrued on the certificates every year is liable to income tax but deemed to have been reinvested. NSC can be encashed/discharged at the post office where it is registered or any other post office.
Income Tax rebate is available on the amount invested and interest accruing every
year under Section 80C of Income tax Act, as amended from time to time. Income tax relief is also available on the interest earned as per limits fixed vied section
8. Fixed Maturity Plan
Fixed maturity plans are similar to FDs in that they have a pre-determined tenure (say 3 years like the maturity of an FD) ranging from a few weeks to a few years. The money is invested in fixed-income assets like certificate of deposits, commercial papers, money market instruments, corporate bonds; debentures of reputed companies or in securities issued by government of India and fixed deposits selected by the fund manager. These have lower risk of capital loss due to their investment in debt and money market instruments and are least exposed to interest rate risk as the fund holds the instruments till maturity getting a fixed rate of return. Here, fund managers primarily invest in AAA or such kind of good rated credit instruments with maturity profile of the securities in line with the maturity of the plan so there is also low credit risk with minimal liquidity risk involved. FMPs are schemes with a pre-specified tenure. The basic objective is to generate steady returns over a fixed period. Thus, investors are assured of returns if they stay in these products for the entire period.
Since these products are of different maturities, investors have the option of buying schemes that suit their requirements. FMPs have better tax efficiencies whether you invest in the short term or in the long term. The long-term capital gains (investment of more than a year) enjoy indexation benefit (Indexation is a technique to adjust income payments by means of a price Index , in order to maintain the purchasing power of the public after inflation).Importantly, if you stay invested for just over a year, there are double indexation benefits. For instance, if you buy an FMP of 14 months in February 2010, scheme will mature in April, 2011. In this case, the investor will get inflation indexation benefits for the years 2009-10 and 2011-12. So, the main advantage of FMP’s is that you can take into account inflation while calculating your taxes which means that your after-tax return may be superior to FDs, especially if you lie in the top income tax bracket. In case of short-term capital tax, it is similar to interest income from bank fixed deposits. The returns are added to the income of the investor and taxed as per his/her slab.
The major drawback with FMPs is that the latter does not assure you any guaranteed returns. However, while buying it, one can look at the returns that are being offered at a particular time. Moreover, these schemes are not-so liquid since they have to be listed at the stock exchanges, exiting before the scheme matures is difficult.
FMP’s are investment options for sure if you want to park your money for short term. They are more tax efficient and give better post-tax returns. Though returns are not 100% guaranteed, they are almost risk free (remember almost). One may ask if FMP does really give better than returns then FD’s and practically as safe as FD’s why people don’t invest in these. The answer is that there is no awareness among people and they have less risk taking attitude.
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