Tax-Free Bond: What Is It And Why There Is Difference In Yield?

Tax-Free Bonds: Tax-free bonds are also a type of fixed-income option, where the interest received is tax-free. This is a type of debt investment. These bonds are usually issued by public sector undertakings or government-backed companies. These include NTPC, NHPC, India Infrastructure Finance Company Limited (IIFCL), National Highway Authority of India (NHAI), Housing and Urban Development Corporation Limited (HUDCO), Indian Railway Finance Corporation Limited (IRFC), Power Finance Corporation Limited (PFC), Companies like REC, NABARD are also included.

Why are tax-free bonds issued?

The objective behind issuing these is to raise funds for a specific cause for a certain period. In these, when companies need money to expand their business, they issue such bonds at a fixed coupon rate. That means there is a guarantee of getting returns on these. These bonds are listed in the stock market and the returns from them are not taxed. A coupon rate is given on these. However, the yield on maturity may be different from the coupon rate.

Why does the difference in yield occur?

The yield of a bond can be calculated in different ways. The current yield compares the coupon rate to the current market price of the bond. So, if a Rs 10,000 bond with a coupon rate of 7 per cent sells for Rs 10,000, the current yield is also 7 per cent. However, because the market price of the bond can fluctuate, it may be possible to purchase this bond at a price higher or lower than Rs 10,000. If the same bond is purchased for Rs 8000, the current yield becomes more than 8 per cent. Whereas, if it is purchased at a higher price then the yield decreases. 

Types of bonds

• Infrastructure Bonds

• Housing Bonds

• Power Bonds

• Railway Bonds

• Public Sector Unit Bonds

Features of tax-free bonds

• Tax-Free Income

• Fixed Interest Rate

• Guaranteed Returns

• Low Risk

• Liquidity

• Long Maturity Period

• High Credit Rating

• Non-Convertible

• Tradable

• Lock-in Period

Who should invest?

Tax-free bonds are a better option for those who do not want to take much market risk. It can be said that those who do not want equity exposure, but by investing money in a safe place, expect more benefits from options like FD or RD. Those who want to invest their money in a risk-free investment option for the long term. Tax-free bonds can give better returns than RD or FD. There is no need to pay tax on the income either. This is a better option for those taxpayers who fall in higher tax brackets. Tax-free bonds are available on the exchange. You can buy these bonds from the Bombay Stock Exchange and National Stock Exchange. Although the yield on these bonds may be lower than taxable bonds, the real return may be higher due to the absence of tax.