INVESTORS looking for various options for investment in debt should be considering the various long-term alternatives that are available to them.
This is necessary because these long-term investments represent a route through which they will be able to lock in the interest rates for an extended period of time. Financial institutions including banks have been issuing bonds of this nature at regular time intervals.
While looking at these options there are a few things that need to be considered in determining the suitability of the investment.
Income flow: The flow of the income from the instrument is important because the rate of returns is just one part of the equation. There might be a higher rate of return but this might not be available in cash on a regular basis so this will have to be considered.
For example several of these bond issues are in the nature of deep discount bonds, which pay the interest only at the time of maturity. This means money after 10 or 15 or 20 years at the time of maturity.
Others have an option for payment of interest on a regular basis or on a cumulative basis. The available option has to be matched with the requirement of the individual investor.
Taxation: Another aspect impacting the final return for the investor, is the taxation of the income earned on the bonds. In most cases these are not tax-free bonds so that amount that is earned will be taxed in the hands of the investor.
This puts those in the highest tax bracket in a situation where 30 per cent of the earned amount will be lost to taxation. In such a case the investor has to make the calculation before the investment to en sure that the actual rate of return after taxation is known and this is used for a like to like comparison with other alternatives.
Redemption options: There are also two types of options that are available on long-term bonds and use of either of these can throw the entire planning out of gear.
The put option refers to the option available for the investor to return the bonds to the issuing entity after a certain period of time. This option is important for the individual because they can then ensure that they can redeem the bonds earlier but only on specified days in case they want the funds back.
On the other hand the call option refers to the right of the institution to call back the bonds for redemption before the due date. The time periods when any of the options is available is mentioned in the investment information so this has to be considered while planning for the investment.
Coupon rate change: There are also bond investments where the rate of interest or the coupon rate can change after a specified period of time. This can happen when specified conditions are met and can be something like a situation where there is no redemption at a certain time point which will lead to a higher interest rate for the remaining tenure.
A rate rise like this is also known as a step up rate because the rate is rising for continuing investment.
This kind of rate change has to be factored in right at the time of the investment so that when the actual change occurs this does not come as a surprise.
Liquidity: Another factor that has to be considered is the liquidity of the instrument. There are some bonds where there might not be any liquidity and an investor who is looking to invest for the long term and needs some liquidity might have to reconsider the available options.
In other situations there is a listing that is made on the stock exchanges and while in theory this might provide the liquidity, the actual volumes and the ability to transact has to be seen for the real situation to emerge.
