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How you can make short term gains in tax-free bonds
December, 08th 2015

Though tax-free bonds are long duration products, there is no need for 'short and medium term' investors to shy away from them, for there are several trading opportunities here.

First, they can flip these tax-free bonds also on the listing date for short-term capital gains, just like they do in any other equity IPO. For example, the previous issues by NTPC, PFC and REC got listed at a premium of around 5%. However, experts say that the listing gain from the tax-free bonds from IRFC, which is hitting the market on December 8, may be small because the issue size is significantly higher. Compared to previous issue of Rs 700 crore, IRFC is hitting the market with Rs 4,532 crore.

Though the issue may get over subscribed on the first day, it won't be oversubscribed by 6-8 times like the previous issues. So the investors who apply on first day may get around 70% of the applied amount", says Nikhil Kothari, Director and Chief Financial Planner, Etica Wealth Management. That means large part of the demand will be satisfied during the public issue itself and therefore, expect only a moderate listing gain.

Second, short- to medium-term investors can also generate fabulous returns by riding the expected fall in the interest rate structure. For most of the tax-free bonds that hit the market during 2013-14 are quoting at significant premium to their issue prices. Compared to the issue price of Rs 1,000, the 9.01% 20-year tax free bonds from Hudco is now quoting at Rs 1,290. The investors in this bond have already received 9.01% tax-free interest once, and this capital gain is over and above that. That means a cumulative gain of 38% in less than a two-year holding period.

The tax-free interest rate has fallen from 9% to around 7.5% in the last two years and most of the capital gains came from that. With the interest rate expected to go down further in the coming years, the current tax-free bond investors should also be able to generate capital gains, though the quantum may be smaller this time.

Instead of going for three-year FDs, investors should subscribe to the 15-year tax saving bonds from IRFC. In addition to getting tax free interest, they will also be able to sell the bonds at a slight premium later", says Kothari.

Now, why the 15-year paper? That is because IRFC is offering 7.53% for the 15-year bond, while the rate offered for the 20-year bond is only 7.50%. Third, the tax-free bonds are listed securities and therefore, the gains from there become long term capital gains if you sell it after a year. Since these are interest bearing instruments, indexation benefit is not allowed. That means, the long-term capital gains is taxed at 10%.

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