Wednesday, May 29, 2013

How is it different from a normal bond ?

for this consider this exmple !!!
***Consider a bond with a face value of 10,000 rupees ($180), which pays a coupon of 5% and matures after 10 years.

  • Case of a NORMAL BOND ----> This means, the bond pays 500 rupees as interest every year until the bond matures after 10 years. On maturity, the investor gets the principal 10,000 rupees back.
  • Case of a Inflation indexed Bond ----->  the principal, or face value, of the bond will change with inflation, while the interest rate or coupon rate will remain fixed

Why investers alwayzzz  preferred investing in GOLD ?

  • Gold, has scored over other investment avenues for many reasons: it has consistently beaten inflation, gives capital gains, requires no documentation, no TDS or capital gains and, most importantly, confers anonymity.
  • The existing financial instruments — bank deposits, mutual funds and other capital market instruments — have not been attractive enough to a large number of investors.

Why are they being introduced ....and will it really help ?

  • The government has a much larger objective this time in launching the bonds. It expects the bonds to wean the retail investors away from their preference for gold.
  • However ,it is extremely doubtful whether the IIBs can divert money going into gold jewellery. According to reliable estimates, two-thirds of the gold imports go into the making of jewels, with only a portion of the balance getting invested in gold-backed instruments

What are the other salient features of the inflation indexed bonds?

(1) the IIBs will have a fixed real coupon rate and a nominal principal value that is adjusted for inflation. Periodic coupon payments are paid on adjusted principal.

another example !
let’s say that the bonds are issued at a face value of Rs.1,000 and a coupon of 5 per cent. If the indexed-inflation rate is 5 per cent, the interest will be calculated on Rs.1050 for that year. If inflation climbs to 10 per cent, the 5 per cent coupon pay-out will be on an adjusted principal of Rs.1155. Thus, it is claimed, the IIBs will give protection to both principal and interest.

(2) On maturity, the adjusted principal or the face value, whichever is higher, is paid to the investors.

(3) The first series of these bonds will be called Capital Indexed Bonds (CIBs), and will be offered primarily to institutional investors. Subsequent tranches will target retail investors to a much larger extent. The involvement of institutions is necessary for market development and price discovery. The IIBs will be part of public debt. Banks can invest in them to meet their statutory liquidity ratio (SLR) requirements.

(4) Individual investors can invest from Rs.10,000 to Rs.2 crore. Interest will be paid half-yearly. There are no tax concessions for investing in these bonds. Presumably, tax will be deducted at source on these investments. This could be a major shortcoming.

Which inflation rate will be used?
  • Inflation will be measured by changes in India’s wholesale price index, which includes wholesale prices of food, fuel and manufactured products among other things. 
  • But WPI doesn’t include things like telephone and other services that are commonly used by people in cities.  (Govt. is considering about CPI...letz see wat happens !! )
  • So it might not reflect the inflation that people feel in their home budgets and bonds linked to the wholesale index might not be so attractive to individuals.

What will be the interest rate?
  • The interest rate will be decided at the time of the bond’s issuance, based on bidding by interested investors. 
  • The RBI says it will allow banks and other financial institutions to bid for the bonds in the first couple of auctions to help establish a coupon, which savers can use as a reference before they invest in the bonds. 
  • From October onwards, the bonds will only be sold to individuals.

  1. If prices increase you get a higher interest as well as a higher principal on maturity. 
  2. If prices fall, you lose out on interest but the RBI says your principal is protected. 
  3. In other words, you get back what you had originally invested when the bond matures.


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