Fixed Income securities or products are the ones which pay fixed interest or coupon either till maturity or, on maturity, along with the principal. These instruments are issued by governments, corporations, municipalities, and other entities to finance their operations. Based on interest payment option, FDs are of two types viz. cumulative and non-cumulative. Cumulative FDs pay interest amount on maturity along with the principal, whereas non-cumulative FDs pays interest amount periodically as per the frequency (monthly, quarterly, semi-annual, annual) chosen and principal payment on maturity.
Corporate Fixed Deposit is a financial instrument provided by BANKS or NBFCs which provides investors a higher rate of interest than a regular savings bank account, for a given deposit period. In FDs an investor agrees not to withdraw or access their funds for a fixed period.
Non-Convertible Debentures are long-term financial instruments with a debt obligation to issuer. These instruments are mostly unsecured by collateral and they rely on the creditworthiness and reputation of the issuer. Debentures which cannot be converted into equity shares are called non-convertible debentures (NCDs).
Perpetual Bonds are debt instruments that do not have a fixed maturity and not redeemable. These bonds pay a steady stream of income forever. Perpetual bond payments are similar to stock dividend payments, as they both offer some sort of return for indefinite period. Because of its nature, there bonds are even viewed as a type of equity and not as debt.
Zero-Coupon Bonds are the ones which do not pay any periodic interest called coupon. These bonds assume positive time value of money and pay par value or face value to investors on maturity. The biggest advantage of zero-coupon bond is its predictability of maturity value without worrying about market ups and downs if one does not intend to sell prior to maturity.
Tax-free Bonds offer interest or coupon for longer duration to investors, which is tax-free. It means, one need not pay tax irrespective of the tax slab one falls under. These bonds are majorly offered by government and public sector enterprises for a period of 10 years and above. Money collected from the tax-free bonds is invested in infrastructure and housing development.
Government of India (GOI) Bonds are commonly known as RBI bonds or GOI taxable bonds as they are offered by RBI and returns are taxable. Previously, these bonds were offered fixed interest rate for the investment tenure. Now, with the changes in the product, these bonds offer interest rate on floating basis every 6 months, based on the repo rate during the investment period. So, these bonds are named as floating rate savings bonds and returns are taxable. Only resident Indians are allowed to invest in these bonds.
Postal savings systems provide depositors who do not have access to banks, a safe and convenient method to save money. Many nations have operated banking systems involving post offices to promote saving of money by the poor. Through postal savings services one has multiple savings option in fixed income category as mentioned below.
- Post Office Time Deposit
- Post Office Monthly Income Scheme
- Senior Citizens Savings Scheme
- National Savings Certificate
- Kisan Vikas Patra
The Public Provident Fund is a savings-cum-tax-saving instrument in India, introduced by the National Savings Institute of the Ministry of Finance in 1968. The aim of the scheme is to mobilize small savings by offering an investment with reasonable returns combined with income tax benefits.
Investment in PPF account will provide tax benefits under sec 80(C) of income tax Act 1961, interest receiving on investment is tax-free and also the maturity proceedings are tax-free. The maximum investment per account per year is INR 1.5 lakh.
PPF account can be opened either with a bank or a post office and will have a lock-in period of 15 year (Financial Years) with partial withdrawal option after the completion of 5 years from the end of the year in which initial subscription was made. Partial withdrawal is allowed up to 50% of balance available in PPF accounts that to only under special circumstances. Only one partial withdrawal is allowed in each financial year.
- Provides stable returns
- Capital invested is at lower risk
- Priority during liquidation
- Helps in diversifying investments
- Helps in diversifying investments
Drawbacks of Fixed Income Products:
- Lower returns compared to other investment products like equity, which are risk riskier
- Lose value of investment during high inflation periods
- Lower net returns to investor as most fixed income products returns are taxable
- Credit and Default Risk: Credit risk is that a lender will not get paid all principal and interest on time as scheduled on a loan or other borrower obligation. Default risk is the risk that a lender takes on in the chance that a borrower will be unable to make the required payments on their debt obligation. Lenders and investors are exposed to default risk in virtually all forms of credit extensions
- Interest Rate Risk: Interest rate risk is the potential for investment losses that result from a change in interest rates. How much interest rate risk a bond has depends on how sensitive its price is to interest rate changes in the market. The sensitivity depends on two things, the bond’s time to maturity, and the coupon rate of the bond. If interest rates rise, for instance, the value of a bond or other fixed-income investment will decline.
- Inflationary Risk: Inflationary risk is the risk that inflation will undermine an investment’s returns through a decline in purchasing power. Bond payments are most at inflationary risk because their payouts are generally based on fixed interest rates and an increase in inflation diminishes their purchasing power.
- Reinvestment Risk: Reinvestment is the practice of using receivables like interest, coupons, dividends etc., from existing investments to purchase additional units of the same investment rather receiving the distribution in cash. In the process of reinvestment investors may not be able to get the same rate of return as received from the existing investment. This risk associated with re-investment option is called reinvestment risk.
- Price Risk: Price risk is the risk of a decline in the value of a security or a portfolio due to a variety of factors, excluding a complete downturn in the market. Diversification is the most common and effective tool to mitigate price risk. Financial tools, such as options and short selling, can also be used to hedge price risk.
- Purchase Power Risk: Purchase power risk is that the unexpected changes in consumer prices will penalize an investor’s real return from holding an investment. Inflationary risk results in purchase power risk. Supplies, Demand, Credit, interest rate, inflation are various factors which influences purchasing power of consumers.
Income from fixed income products is treated as either income from other sources or capital gains. Some products provide tax free income as well as tax benefit while doing investment, to avail tax exemption for the particular amount subject to capping as per regulations. Taxation would be as per the marginal tax slab. It means one need to pay tax as per the tax slab one falls under, for the income received in a financial year
Gains received from fixed income products are classified as short term and long term. If the gains are received within 3 years from the date of investment, it would be treated as short term capital gains and needs to be paid as per the marginal tax slab. If the gains are received after 3 years from the date of investment, it would be treated as long term capital gains and tax needs to be paid at the present rate of 20% on the gains, after applying indexation benefit.
Indexation Table
Financial Year | CII Number |
2020-21 | 301 |
2019-20 | 289 |
2018-19 | 280 |
2017-18 | 272 |
2016-17 | 264 |
2015-16 | 254 |
2014-15 | 240 |
2013-14 | 220 |
2012-13 | 200 |
2011-12 | 184 |
2010-11 | 167 |
2009-10 | 148 |
2008-09 | 137 |
2007-08 | 129 |
2006-07 | 122 |
2005-06 | 117 |
2004-05 | 113 |
2003-04 | 109 |
2002-03 | 105 |
2001-02 | 100 |
For better tax adjusted returns from various fixed income products, please contact us.