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Understand the features INFLATION-indexed bonds

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INFLATION-indexed bonds will be available soon as an investment option.

Initially, they will be available for only institutional investors. But later, they would be open to retail investors as well. These investment instruments could be slightly difficult to understand at the outset, but one would gradually get used to their features, procedures and ways.

Here is a quick look at some key features of these bonds. It's important that the investor first gets familiar with them.

Floating principal:

One of the first things to understand is how interest would be calculated on these bonds. There would be variations in the interest that is paid out to the investor over the life of the bond. But it should be important to understand the calculation and see how it works. The percentage rate of the interest will be fixed, which means there will be no variation on this front. The principal, however, will be a variable component. This would be changing over the life of the bond. For example, this could be Rs 1,000 at one point and then drop to Rs 990 or rise to Rs 1,005, depending on the rise and fall in inflation.

The other important fact is that the rate will be calculated as a percentage of this figure. So the final interest amount too will be variable.

Procedures:

There are procedures that the investor would need to know regarding the bonds, because they are what will determine his experience of the bond. For now, it has been announced that interest payments will be paid out twice a year.

This is a crucial bit of information that should let him know when the payment would come and let him plan accordingly.

Another important detail is the manner in which adjustment for the capital will be made. This will be based on the WPI with a four-month lag. The final WPI figure will be considered and, hence, this would be the manner in which the changes should actually be tracked. The rate that would be fixed for the first time would remain constant over the life of the bond. This would be decided through an auction. The time period for the bonds would be 10 years, so that investors know the time span for which they will be making the investment. At the time of maturity, the adjusted principal or the face value, whichever is higher, would be paid.

Decision:

The key job for the investor is therefore to understand the nature of the bonds so that there is no confusion over how they operate. The other thing is he must make sure that there is some logic behind the investment so that this would be undertaken only when inflation is expected to rise so that the rates go higher and there is a real rate of return earned by the investor.

If interest rates look likely to fall then a smart strategy would be to lock money into traditional fixed-income instruments like deposits so that the higher rate is fixed and this leads to a higher real rate of return over a period of time.

A rising interest-rate scenario, on the other hand, would be perfect for people to gain from investing in the bonds.

Happy Investing!!

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