Fixed Income
Inflation Index Bonds: Five things you must know

Inflation indexed bond is not a plain vanilla financial instrument. The real working of these bonds will be out only post 4 June 2013.  Investors need to understand these bonds thoroughly before taking a call of investments

No financial instrument has made the news in India in recent times like Inflation Indexed Bonds (IIBs). There is a lot of curiosity and excitement about these bonds. For some it looks like a panacea for all woes related to inflation, while for others it is still a Pandora’s Box. While the complete picture of these bonds will be out after the first issuance of these bonds, here are five important things that retail investors must know about these bonds before investing in these bonds:
 

A retail investor cannot quote the price/yield of his choice during issuance: Inflation index bonds will be issued through a process of auction. Retail investors will be able to buy Inflation Indexed Bond (IIB) through a process of non-competitive bidding. Non-competitive bidding means that a person would be able to participate in the auctions of dated government securities without having to quote the yield or price in the bid. As per the RBI (Reserve Bank of India) website in a non-competitive bidding, “Eligible investors cannot participate directly. They have to necessarily come through a bank or a primary dealer (PD) for auction. Each bank or PD will, on the basis of firm orders, submit a single bid for the aggregate amount of non-competitive bids on the day of the auction.”So retail investors become price takers in inflation index bond issuance process.
 

Face value of inflation indexed bond will be adjusted to inflation: In the inflation index bond face value of the issued security will be adjusted to the cash flow. The coupon will be paid on the adjusted face value; however the coupon decided at the time of issuance remains same till maturity. Effectively the coupon payment received by the investor changes but the coupon fixed at the time of issuance is not altered. Let us look at the example below of an inflation indexed bond at the time of issue:
 

  • Face Value: 100
  • Maturity: 10 years
  • Coupon: 6% per annum, payable semi-annually
     

Now assume the inflation changes by the inflation number given below in the period one. As a result of the change in inflation a new face value is arrived at which is 103 and coupon payment of 3% is made on the inflation adjusted face value which translates into 3.09%. In the 5th year, inspite of negative inflation of 8%, the face value does not fall below 100. As per the RBI circular the face value of inflation index bond will never go below par value.
 

Period

Principal

Inflation, Semiannual

CashFlow

0

100

 

 

1

103

3%

3.09

2

107.12

4%

3.21

3

109.798

2.50%

3.29

4

107.602

-2%

3.23

5

100

-8.00%

3.00

6

104.5

4.50%

3.14

7

109.725

5%

3.29

8

115.8696

5.6%

3.48

9

122.8218

6%

3.68

10

126.5064

3%

130.30

Note: This is only an example for understanding the working of IIB and not actual
working.

 

Real yield of inflation index bond may become negative:  Real yield here means that the inflation exceeds the yield offered by inflation index bonds. This has happened in both UK and US markets.  In order to buy inflation indexed bonds, the investors quote a very high price which results into a very low yield for these bonds. If the inflation exceeds quoted yield, real return becomes negative. In March 2013, the UK Treasury 2.5% 2024 index-linked bond had a current real yield to maturity (the return you get, after inflation, if you buy now and hold until the bond is paid back in 2024) of minus 1.06%. The US Treasury 0.625% 2021 bond had a real yield of minus 1%. The primary market issuance of these bonds in the US were also done at negative yield. (Refer: Treasury Sells TIPS at Negative Yields as Buyers Doubt Bernanke).

 


In India, whether this happens or not needs to be seen. However, the possibility of this cannot be ruled out. On a long-term basis this may be the case, but it can happen for a series of years or randomly till the time of maturity of bonds.
 

Price of the bond will be derived through an auction at the time of issuance: Price of inflation indexed bonds will be derived through a method of auction. This means that the price at which an investor purchases these bonds will be different from the face value. This will be a new experience for most of the retail investors as they are not used to buying security in an auction format.
 

Inflation indexed bonds will be taxable: These bonds will be taxable which means that the effective return post taxation will be less for an investor. The taxation may blunt the inflation beating capacity of these bonds. The investor will need to calculate post tax return of these bonds to see, if they have been able to beat inflation or not.
 

Inflation indexed bond is not a plain vanilla financial instrument. The real working of these bonds will be out only post 4 June 2013.  Investors need to understand these bonds thoroughly before taking a call of investments.
 

(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)

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COMMENTS

Vinay Joshi

4 years ago

Only to the uninitiated writing the above article it may be IIB’s panacea or Pandora’s Box.

June 4,2013, the said bonds will be issued, by May, 24, RBI guidelines follow.

Further PLEASE BE APPRAISED THAT FOR THE RETAIL INVESTORS THE SCHEME WILL BE ANNOUNCED BY SEPTEMBER 2013. Decipher aspects & ML introspect.

ARE YOU AWARE THAT L&T, last week issued 100CR inflation linked, capital indexed, non convertible debentures, 1.65% yield p.a,‘AAA’ CRISIL RATING!

Glaring deficiencies in your write up; TEN PONTS as under, comment if you must!

1] Comparison with overseas bond issues – just no relevance.

2] Not knowing L&T issue.

3] The bonds will not be auctioned. Not MEANT for retail at the moment. Will be sold in tranches, 1K/2kCR to mop up 12/15KCR as announced, four months indexation lag.

4] NO WORD IN THE SAID ARTICLE AS IIB’s LINKED TO WPI! [Do you know April WPI/CPI? Comment. MISSED THE POINT OF & CPI v. IIB’s FOR RETAIL NVESTORS!!

5] IRRESPECTIVE, if WPI linked, retail investors will have other options including SIP’s .

6] NO QUESTION RAISED AS TO WHY NO LINK TO CPI & WHEN? [only after CPI stabilization FYI! When can it stabilize?]

7] IN WHICH MANNER, further scheme[s] of issuances can protect savings from inflation?

8] The said IIB’s are not TAX EXEMPT but capital indexation CAN BE claimed. No mention!

9] It can be counted towards SLR requirement of banks. [many banks may switch securities in excess of 23%.] Coupon rate of 0.45% - 0.52% attractive proposition. Fifty basis points expected.

10] When & how the instrument can be priced? Now i've told you.

Expect each & every point will be answered.

Regards,





Congressmen to Hagel: Where are the missing war records from Iraq and Afghanistan?

Unsatisfied with answers so far, leaders of the House veterans' panel ask defense Secretary Chuck Hagel to explain why Army units cannot find field records from Iraq and Afghanistan

The top Republican and Democrat on the House Committee on Veterans’ Affairs are demanding more information from defense Secretary Chuck Hagel about lost Army field records from the wars in Afghanistan and Iraq, the subject of a ProPublica investigation last year.
 

In an unusually detailed letter sent Friday to Hagel, Reps. Jeff Miller, R-Fla., and Michael Michaud, D-Maine, said the Defense Department’s response to an earlier request about why records are missing — and what the military is doing about it — didn’t go far enough.
 

“Congress must have a clear understanding of the extent of the lost records in order to safeguard the best interests of our service members and veterans,’’ the letter says.

The 12 questions posed to Hagel in the letter focus largely on the Army because it has the largest records deficit. Among other things, the congressmen want to know what happened to operational records for the 1st Armored Division and the 82nd Airborne Division and what is being done to reconstruct them.
 

In November, ProPublica and the Seattle Times reported that they were among numerous Army units that had lost or failed to keep battlefield records as required, making it harder for some veterans to obtain benefits and for historians to recount what actually happened.
 

“Operational records can be used to track the history of our nation’s military, plan for future operations and support innovative medical research,’’ Miller and Michaud wrote to Hagel.
 

In addition to chairing the veterans’ panel, Miller sits on the House Armed Services Committee, which has direct oversight responsibility for the Defense Department and service branches.
 

The department did not return a phone call seeking comment.

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RTI Judgement Series: MCD's parking lot agreement has no dates, no signatures

MCD's agreement, which was supposedly for five years, allotting the parking lot in Kailash Colony market to Ashiana Security (P) Ltd had neither dates nor proper signature of any recognizable person from the Municipal Corporation. This is the 96th in a series of important judgements given by former Central Information Commissioner Shailesh Gandhi that can be used or quoted in an RTI application

The Central Information Commission (CIC) while allowing an appeal directed the Public Information Officer (PIO) of the Municipal Corporation of Delhi (MCD) to provide a complete list of authorised parking licensees as well a list of unauthorised parking licensees in the central zone of the city.

 

While giving this judgement on 12 February 2009, Shailesh Gandhi, the then Central Information Commissioner said, “What is surprising is that a purported agreement allotting the parking lot in Kailash Colony market to Ashiana Security (P) Ltd has no dates on the agreement which is supposedly for five years. There does not even appear to be a proper signature of any recognizable person from MCD.”

 

New Delhi resident S Gopal, on 28 April 2008 sought information about parking lots allotted and details of agreement with contractors in Greater Kailash-I and Kailash Colony. Here is the information he sought under the Right to Information (RTI) Act and the reply given by the PIO...

 

1. Which are the areas earmarked in Greater Kailash -I and Kailash Colony for public car parking where one has to pay?

PIO's reply: The sketch of the parking allotted by MCD in GK-I and Kailash Colony are enclosed for perusal.

 

2. What are the terms and conditions under which the parking lot has been contracted out to individuals? A copy of the same may be provided.

PIO's reply: Copy of the terms of condition for parking are also enclosed for kind perusal.

 

3. Who should be approached for complaints against the contractors of the parking lots? 

PIO's reply” Addl. Deputy Commissioner (PPCell) and Deputy Commissioner/ Central Zone.

 

The PIO replied on 24 June 2008, after about 56 days from filing the RTI application. There was no mention of any reply given by the First Appellate Authority (FAA). Gopal then filed his second appeal before the Commission.

 

During the hearing, Mr Gandhi noted the delay in furnishing the information by the PIO. “The PIO has given this information also very late which raises a reasonable doubt about the intentions,” he said.

 

He also noted that the five-year agreement for allotting parking space to a contractor does not have any dates as well as any recognisable signatures from MCD.

 

He then directed the PIO to provide complete list of authorised parking licences as well a list of unauthorised parking licensees in Central Zone to Gopal.

 

Since the PIO did not reply within the mandated 30 days period, the Commission found him guilty under sub-section (1) of Section 7 of the RTI (Right to Information) Act. The CIC then issued a show-cause notice to the PIO asking him to give his reason as to why penalty should not be levied on him.

 

CENTRAL INFORMATION COMMISSION

 

Decision No. CIC /SG/A/2008/00300/1606

http://rti.india.gov.in/cic_decisions/SG-12022009-44.pdf

Appeal No. CIC/SG/A/2008/00300

                                                                  

Appellant                                            : S Gopal,

                                                                New Delhi-110048

 

Respondent 1                                     : Asst. Commissioner & PIO,

                                                                Municipal Corporation of Delhi

                                                                Central Zone,

                                                                Office of the Asst Commissioner      

                                                                Lajpat Nagar, New Delhi - 110024

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COMMENTS

Anand Gadiyar

4 years ago

In a lot of such cases, we see that the CIC issues show cause notices to the PIOs asking why penalties should not be levied against them. Is there a way to find out if the penalty was actually levied?

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