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ICICI Safety Bonds: A reality check - Views on News from Equitymaster
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  • Aug 30, 2000

    ICICI Safety Bonds: A reality check

    The ICICI Safety Bonds issue opened on August 28, 2000. The issue has been sub-divided into 3 schemes. They are:

    • Tax Savings Bond, in which the investor gets the added benefit u/s 88 or u/s 54EA of the Income Tax Act. The scheme has been further segregated into 2 types viz. Annual Interest scheme and the Deep Discount Bond (DDB) scheme.

    Under the interest option, the investor gets an annual interest at the rate of 10.5% for three years, but the bond gets redeemed at face value (i.e. at the same value). The total absolute realisation from this scheme for both the options i.e. u/s 88 or u/s 54EA, works out to be Rs 6,575 at the end of 3 years.

    Tax Savings Bond
      Section 88 benefit Section 54EA benefit
      Annual Interest DDB Annual Interest DDB
    Issue price (Rs) 5,000 5,000 5,000 5,000
    Face Value* (Rs) 5,000 7,000 5,000 7,000
    Redemption period 3 yrs 3 yrs 4 mths 3 yrs 3 yrs 4 mths
    Interest (%) (p.a.) 10.5 - 10.5 -
    Annual interest (Rs) 525 - 525 -
    Total amount received 6,575 7,000 6,575 7,000
    *Face value means value of the bond on redemption

    Under the DDB scheme, the investor doesn’t get any interest, but at the end of 3 years and 4 months, the investor realises Rs 7,000. At the first look the DDB option looks more attractive compared to the annual interest option. But if we were to convert the interest option realisations for 3 years and 4 months (the same as DDB), realisation would become Rs 6,750 for annual interest investor. The absolute difference between the two options is hence, only Rs 250. But please note that under the annual interest option, the investor gets an annual interest of Rs 525 at the end of first year itself, Rs 525 again at the end of two and three years.

    If the investor decides to again reinvest this Rs 525 for the remaining 2 years and 4 months even at 8% current bank rate, he gets Rs 103.69 as interest at the end of it. The next annual interest of Rs 525 in second year, if invested for the remaining 1 year 4 months, will give an added Rs 57.12 to the investor. Hence under the annual interest option the investor can actually realise = 6,750+103.69+57.12 = Rs 6,911. So in effect, the difference is not really too much in between both options.

    • Regular Income Bond, under which if the investor invests Rs 5,000 for 4 years, he will still get Rs 5,000 at the end of it, but added to that he will also get interest. The scheme is similar in nature to the annual option under the tax savings bond but here the investor can choose from monthly, quarterly and annual interest options. The yields are more or less similar under all these 3 options.

    Regular Income Bond
      Monthly interest Quarterly interest Annual interest
    Issue price (Rs) 5,000 5,000 5,000
    Face Value* (Rs) 5,000 5,000 5,000
    Minimum application 3 bonds 2 bonds 1 bond
    Minimum application (Rs) 3*5000=15,000 2*5000=10,000 5,000
    Redemption period 4 yrs 4 yrs 4 yrs
    Interest (%) (p.a.) 10.4 10.7 11.0
    Yield to investor 10.9 11.0 11.0
    *Face value means value of the bond on redemption

    • Money Multiplier Bond is in the nature of a deep discount bond, where no interest or regular income accrues to the investor, but he gets the benefit of capital appreciation at the end of his or her maturity tenure.

    Money Multiplier Bond
      Double Triple Five times Ten times
    Issue price (Rs) 5,000 5,000 5,000 5,000
    Face Value* (Rs) 10,000 15,000 25,000 50,000
    Minimum application 1 bond 1 bond 1 bond 1 bond
    Minimum application in Rs 5,000 5,000 5,000 5,000
    Redemption period 78 mths 123 mths 180 mths 255 mths
    Yield to investor 11.3 11.3 11.3 11.4
    *Face value means value of the bond on redemption

    In this, one can invest Rs 5,000 for 78 months and double his money, or he can wait for 123 months to triple his money, or for 180 months to see his investments grow five fold. If one waits for 255 months (i.e. 21 years and 3 months) then your investments grow ten fold to Rs 50,000. The yields for all the four options are more or less same.

    So, which option you as an investor take? Well, it frankly depends on your investment outlook and also on your liquidity needs. If you are looking for capital appreciation, you can either go in for the Money Multiplier Bond or the DDB scheme under Tax Savings Bond. But if you are looking for regular incomes you can either choose the annual option under Tax Savings Bond or the Regular Income Bond.

    It is important to note that the Tax Savings Bonds (either DDB or annual interest) also double up as tax savings instruments. So in effect, the yields are higher in Tax Savings Bond scheme.



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