### NHAI Bonds vs Fixed Deposit

POSTED BY ON December 25, 2011 3:49 am COMMENTS (20)

After reading about the NHAI Bonds Issue I am curious to get others view on the following comparison:

a) Investing in this Bond for 10 years at 8.2% where the interest is non-taxable and paid out annually

OR

b) Making a cumulative Fixed Deposit of 10 years at 8.75% where the interest is compounded quarterly and taxable

My calculations revealed that for an investment of 50,000 (min. investment amount in the Bond):
Option (a) would earn annually approx 4100 as tax-free interest and
Option (b) would earn in 2022 a taxable interest of approx 69000.

I understand that these figures do not account for inflation over the next decade. Also that there is scope for speculation on what the taxation laws might be in 2022.

1. Dear Dominic Prakash, the FD interest is taxable at your slab rate, hence the actual return ‘ll be lower than the quoted 9.5% rate for the City Union bank FD.

Thanks

Ashal

2. Dominic Prakash says:

In City Union Bank I am getting 9.50% for 10 Years. So these bond’s returns are not that exceptional.

Thanks

Ashal

4. Dear Dominic Prakash, Please check my reply to dear Anirban Ghosh & decide yourself.

My take, if you are in the highest tax slab, these tax free bonds are good.

Thanks

Ashal

5. Dear Anirban Ghosh, Let me put the answer for rephrased query. If you opt to reinvest the bond interest anywhere @ a moderate 6% interest rate, The 41000 Rs. received over the 10Y period from bond as interest ‘ll become 54389. Out of this 54389, the 13389 Rs. is the interest earned over the period from the interest reinvestment. Which is taxable. @ 30.9% slab, the effective SB interest ‘ll be 9252 Rs. Hence cumulative return from Bond = 50252 Rs.

From the 8.75% bank FD, Pre Tax cumulative Interest 68817. Tax adjusted @ 30.9% slab cumulative return = 47552.

Nos. are there to tell the truth.

Thanks

Ashal

1. The moSt important take away is that the NHAI bonds returns must be reinvested failing which the FDs will give better returns. As long as one is aware of this they can invest in the NHAI bond!

1. Anirban Ghosh says:

This has been very informative!
To summarize again the key points that justgrowmymoney and Ashal have highlighted:

(i) NHAI Bonds are better for those who come in the highest taxation slab
(ii) But the annual Bond interest payouts need to be regularly reinvested
(iii) Those coming in the 10.3% & 20.6% slabs, reinvestment even at 9% does not match the returns from a cumulative FD at 8.75%
(iv) But for 30.9% slab people even a reinvestment at 6% turns out beneficial

And inspired by all the of complex formulæ mentioned before, here’s my own set of calculations to illustrate the above key points: http://goo.gl/Xb4DP

Thank You.

6. Dominic Prakash says:

I would like to invest in NHAI. It opens in two days. Still I am not clear how Bank FD’s are better than NHAI tax free bonds.

7. Anirban Ghosh says:

Yes that is the underlying comparison I am trying to make here. But I do not know much about calculating these effective return rates. That’s why thanks to both of you for contributing.

So to rephrase my question: How does the “cumulative” feature of the FD measure up to the “tax-free” feature of the Bond, given the above parameters?

1. Anirban – you can plug in the interest rate st which you will be able to reinvest over the long term and just modify the excel attached, you will get the solution. Can you check?

8. Dear justgrowmymoney, can you elaborate your xl sheet? @ 9.25% & Qtly compunding, the pretax maturity of bank FD is around 1.247L Rs. Then how your figure is 1.41L Rs.?

If we add the Tax liability, the actual return ‘ll go down even lower.

Thanks

Ashal

1. Ashal – I had the formula =FV(8.75%/4,48,0,-50000,1) in Excel. Agreed it must have been 40 periods instead to 48 (12 yrs instead of 10). The return would be 124k @ 9.25% (not at 8.75%). Agreed on that.

The point is unless you reinvest the annual payout the returns will dwindle. Again I had made use of 9% as the rate we can reinvest. We will be looking at the 8% range for FDs and Short term Mutual funds after next 2-3 years so avenues to re-book at higher rates for future cashflows in NHAI bonds will not be possible. [Do we have annual RDs to lock rates? I am just asking]. There are so ,any assumptions here and unless we list down the most common of them (like reinvesting, which majority of the investors wont do) the bonds will return lower than the FD.

9. Dear Justgrowmymoney, Please recalculate on the basis of taxation.

Thanks

Ashal

1. Ashal – My spreadsheet considers only the 30% taxation though [The pretax income is displayed out there]. If you spot something that appears to have been missed let me know.

10. Dear Anirban Ghosh, Please understand that the major difference lies in the tax treatment. The NHAI Bond Interest is tax free where as bank FD interest is taxable @ individual’s Tax slab.

Sample this – The 8.75% interest of bank FD ‘ll become actual interest –

@ 10.3% slab = 7.84%
@ 20.6% slab = 6.95%
@ 30.9% slab = 6.04%

Where as the 8.2% rate of return from these NHAI Bonds is tax free irrespective of from which tax slab, the investor is.

So the bottom line is – these Tax free bonds are better than Bank FDs.

Thanks

Ashal

1. Just comparing the returns is not the right way to go. In the case of FDs the interest is compounded (every 3 MONTHS in this case) while for NHAI bonds there is an annual payout. It is imperative that the annual returns are reinvested to achieve the return like the FD.

If my spreadsheet is right, which I believe is, then the FD returns beat the Bonds.

11. I think the FD beats the NHAI Bonds even assuming the annual NHAI returns are reinvested at upto 9%.

The important point here is the reinvestment can be done in either FDs or Long term Debt funds. Currently Debt funds dividends are taxed at 15% but I am assuming in 10 years time, when DTC will be implemented and tax slabs are raised, the tax code will further be changed in a way such that all income will be taxed at the individual’s assessment rate. This is the primary assumption here in which case FD beats NHAI. If the Debt fund dividend is taxed at a lower rate then NHAI will be netter

All – Check this spreadsheet and comment.

1. Here it is finally!

1. Dear Justgrowmymoney. Your calculation is totally wrong. FYI – as on date banks are also offering to receive the interest from the FDs on intervals say mly, qtly, 1/2yly or yly. So no need to make complex & imaginary calculations for reinvestment of NHAI bond interest money.

At the end of year –

The return from NHAI bond = 8.2% Tax free

The Tax adjusted return from Bank FD of 8.75% qtly compounding =
@ 10.3% slab – 8.11%
@ 20.6% slab – 7.17%
@ 30.9% slab – 6.24%

Now do tell me how these bank FDs are better than these NHAI Bonds?

Thanks

Ashal

1. I agree the calc was done for 48 quarters instead of 40 to begin with but the approach is absolutely correct. I think Anirban’s query is about CUMULATIVE returns in FD which you probably missed. This means unlike NHAI bonds where there is an annual payout the FD just grows. In this case without reinvestment there is absolutely no way for the bond to beat the FD. If it was a simple 8.3% tax free return it automatically becomes a 11+% notional return taxed at the 30% level and just takes a moment to say the bond is better ONLY if the FD returns are paid out as well. But since we are looking at cumulative returns, investors must know they must reinvest the bond payout annually and that inherently all debt instruments have something called as reinvestment risk – the risk that one may not get similar return avenues all the time and the decision to invest in bonds must be made after taking cognisance of this fact. That’s really what I am trying to push.

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