Infra Bonds(tax)

8/7/2019 Infra Bonds(tax)

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Invest in Long Term Infrastructure Bonds to Save Tax

In the Union Budget 2010, Finance Minister, Pranab Mukherjee proposed a new section 80CCF under

the Income Tax Act of 1961. From April 1, 2010, section 80CCF would provide an additional tax

deduction, over and above the existing 80C deduction, in respect to investments made in long terminfrastructure bonds.

Background on Infrastructure Bonds

Infrastructure Bonds are not new to the country. They have been used by the government in the past years, for infrastructure

projects. These bonds were earlier offered by financial institutions such as ICICI and IDBI, and had a lock in period of 3 years.

Section 88 of the Income Tax Act offered tax deductions on investments of up to Rs 30,000, in these infrastructure bonds.

However, with the 2005-2006 union budget, section 88 was scrapped.

So What Does Section 80 CCF Offer Tax Payers?

Section 80C currently offers a maximum deduction of Rs 1 lakh, for investments in National Savings Certificate (NSC), Public

Provident Fund (PPF), Life Insurance premiums and Pension Plans.

The new section 80CCF, will offer a deduction of Rs 20,000, in addition to the deduction of Rs 1 lakh under sections 80C,

provided the investments are in notified long term infrastructure bonds. The government has proposed this section to promote

investments in infrastructure projects in the country.

Key Features of 80 CCF and Infrastructure Bonds

Section applicable from start of April 2010 and would be issued in the financial year 2010-11.

Deduction limit of Rs 20,000 in addition to the 1 lakh limit under sections 80C.

Investments to be in long term infrastructure bonds as specified by the government.

The long term infrastructure bonds will have tenure of 10 years.

Minimum lock in period of 5 years.

Exit from the infrastructure bond, after the lock in period, will be either through the secondary market or through

buyback option, as specified by issuer.

The infrastructure bonds could be pledged for loans from specified banks after the lock in period.

Investments in infrastructure bonds would require PAN to be mandatorily furnished.

Who can claim this additional deduction?

Section 80CCF is applicable to Individuals and to Hindu Undivided Family (HUF) only. Deductions could be up to a maximum

amount of Rs 20,000 from the taxable income, for any amount invested in long term infrastructure bonds from financial year

2010-11.

Specified Long Term Bonds that Qualify under this Section


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Bonds issued by the following agencies would qualify for tax benefit under section 80CCF.

Industrial Finance Corporation of India

Life Insurance Corporation of India Infrastructure Development Finance Company

Any non-banking finance company which has been classified as an infrastructure finance company by the Reserve

Bank of India.

Currently IFCI has come out with its first issue of long term infrastructure bonds. The issue opened on 9th August 2010 and

closes on 31st August 2010. The bonds with a tenor of 10 years have a buy back option after 5 years. The yield on redemption

offered by these bonds is between 7.85%-7.95% p.a., depending on the option chosen by the investor.

Infrastructure Bonds Benefit

Investment in long term infrastructure bonds would give you the following benefits:

Tax Saving - A long term infrastructure bond offers a tax benefit in the form of a deduction. The amount of tax

saved would depend on the tax bracket one would fall under. To illustrate this benefit :

For a person in the highest tax bracket, a Rs 20,000 investment in long term infrastructure bonds could save a

tax of around Rs 6,000 (Rs 20,000 X 30%)

For a person in the 20% tax bracket, an investment of Rs 20,000 in long term infrastructure bonds could give him a saving of

around Rs 4,000 (20,000 X 20%).

(Education cess ignored in illustration to keep it simple)

Assured Returns - An investment in infrastructure bond assures you a reasonable rate of return. So as an investor you are

guaranteed peace of mind over your investment!!!!

Concluding Thoughts

InvestmentYogi wants you to keep in mind the following while investing in long term infrastructure bonds.

A long term investment with a period of 10 years and a lock in feature could block your money. So take a call

after considering your financial situation.

Infrastructure bonds offer pre-determined interest rates, which may be lower than other investment options;

hence they may not offer much protection against inflation.

Borrowing money by pledging infrastructure bonds with banks would fetch you an amount, which would depend

on the market value of the bond. Banks also take into account the creditability of the underlying issuer, in their loanevaluation process.
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The yield of the bond along with its terms and conditions will be specified by its issuer. However it must be

understood that the yield of the long term infrastructure bond will not be higher than the yield of other government

securities or corresponding residual maturity schemes.

Use InvestmentYogisTax Calculator to help you estimate your taxes.

Create your FREE Financial plan before making investment decisions. Click onStart for FREE.

Written for InvestmentYogi by Ramya RamachandranPublished Jul 22 2010, 04:07 AMby Yogi

Ceiling on direct investment in shares, etc

5. Within the above overall ceiling of 5 per cent for total exposure to capital market, the total

investment in shares, convertible bonds and debentures and units of equity-oriented mutualfunds by a bank should not exceed 20 per cent of its net worth, as hitherto. While making

investment in equity shares etc., whose prices are subject to volatility, the banks should keepin view the following guidelines :

i. The ceiling for investment in shares, etc., as stated in the above paragraph (i.e., 20 per

cent of net worth), is the maximum permissible ceiling and a banks Board of Directors isfree to adopt a lower ceiling for the bank, keeping in view its overall risk profile and

corporate strategy.ii. Banks may make investment in shares directly taking into account the in-house expertiseavailable within the bank as per the investment policy approved by the Board of Directorssubject to compliance with the risk management and internal control systems indicated

below.iii. Banks may also make investment in units of UTI and SEBI - approved other diversified

mutual funds with good track records as per the investment policy approved by theBoard of Directors. Such investments should be in specific schemes of UTI / Mutual Fundsand not by way of placement of funds with UTI / Mutual Funds for investment in the

capital market on their behalf.iv. Underwriting commitments taken up by the banks in respect of primary issues through

book building route would also be within the above overall ceiling.v. Investment in equity shares and convertible bonds and debentures of corporate entities

should as hitherto, be reckoned for the purpose of arriving at the prudential norm of

single-borrower and borrower-group exposure ceilings.

Security Forms of Financial Investment
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4/28

We know that the recipient of money in a financial investment issues a document or a piece of paper to

the investor (supplier of money), evidencing the liability of the former to the latter to provide returns. This

document also outlines the rights of the investor to certain prospects and/or property and sets the

conditions under which the investor can exercise his/her rights. This document is variously called

'Security Certificate', 'Note' and so on.

The term 'security' is a generic term used generally for those documents evidencing liabilities that are

negotiable - that can be bought and sold in the stock market. The security form of investment has received

great impetus since 1980 following the Central Government's liberal policy towards foreign investments-

direct and portfolio, streamlining of licensing, capital issues, and other procedural formalities to facilitate

faster capital formation; providing incentives for exports; and encouraging private sector to tap the

primary market for meeting their long-term capital requirements.

There are different types of securities conferring different sets of rights on the investors and different sets

of conditions under which these rights can be exercised. They are gilt-edged securities, corporate

debentures, preference shares and equity shares. The important characteristic features of these securities

are described below.

Gilt-Edged Securities

The debt securities issued by the government and semi-government bodies are called gilt-edged securities.

They comprise the treasury bills and the dated securities (also called bonds or dated loans) of the central

government, state government, and semi-government bodies like Port Trusts and State Electricity Boards.

They are the acknowledgments of debt incurred by the issuing government or semi-government body.

Gilt-edged securities thus represent the public borrowings of the issuing government or semi-government

bodies. Over the years, the central and state governments and the semi-government bodies have made an

extensive use of these securities for meeting their short and long-term resource requirements.

Treasury Bills: These short-term securities are issued by the RBI on behalf of the Central Government.

Currently, the T-Bills having a maturity of 91 and 364 days only are being traded. No interest is paid on

these bills. Instead they are sold at a discount. In other words, the buyer pays a price less than the face

value of the bill and receives the full face value on the last day of maturity. The difference between the

discount price and face value represents the interest income to the investor.

Example: Suppose the 91-day treasury bills ofRs. 100 each are sold forRs. 99 per bill. The buyer

pays Rs. 99 and will receive Rs. 100 after 91-days from the Government of India for every bill he buys

today. These bills are said to have been sold at

X 100 = 4.01% discount per annum. The rupee income, the buyer makes for 91-days investment is Re.1

per bill and the return on his investment works out to be

X 100 = 4.05% per annum. Rs. 99

Since April 1st, 1996 the sale of treasury bills by Public Debt Office of the RBI had been stopped. Now it

is carried out by the RBI by conducting auctions: weekly for 91 days T-bills and fortnightly for 364 days

T-bills.

The discount rate on treasury bills being very low, the return to the investor is meager. However, they are

the safest and the most liquid securities you can find in the market. They are a safe investment because the

central government will never default on making payment when the bills mature. They are liquid because


5/28

the commercial banks are ready to buy them at any time due to the facility of rediscounting with the RBI.

There is however little public interest in treasury bills because of the availability of equally safe

investment opportunities providing a better return and also because they are sold in large denominations.

Frequent buyers of treasury bills are the commercial banks, state governments, and semi-government

bodies. Due to rediscounting facility, the RBI generally ends up holding nearly 80 percent of the

outstanding treasury bills at any given time.

Member (Account Deleted)

[ Scorecard : 981]

Posted about a year ago

certificate is that while the

former is negotiable and

transferable by a simpleendorsement, a stock

certificate can As against

the periodic issue of the ad

hoc treasury bills to the

RBI in the past, the

government is now raising

funds through the Ways

and Means financing.

Since the RBI has started

selling treasury bills

auction, through, thediscount rate is now

determined by market

forces and on a competitive

basis. The discount rates on

treasury bills increase as

the number of days to

maturity increase.

However, the discount rates

on T-Bills are lower than

the rates on the dated

government securities.

Central Government

Dated Securities: These

securities of the central

government have a

maturity period longer than

one year and carry a fixed

rate of interest. The interest

is payable semi-annually

and the payment is usually

made by issuing coupons

which can be encashed at

any bank. Though thesesecurities are redeemed at
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6/28

par, their issue price can be

higher or lower than the

face value depending upon

the prevailing market

conditions.

These securities are held

either in the form of

promissory notes or stock

certificates. The difference

between a promissory note

and a stock be transferred

only by executing a transfer

deed and submitting a copy

of the deed to the RBI. The

RBI issues a new certificate

to the transferee. A

promissory note has to bepresented to RBI every

time the payment of interest

is due, but no such

presentation of the stock

certificate is required

because the RBI knows

who the present owner is

and mails the interest

coupon to him on the due

date. The public/recognized

provident funds are

required to hold thesesecurities only in the form

of stock certificates.

The coupon rate on the

central government dated

securities is higher than the

discount rate on treasury

bills, due to the fact that the

maturity of dated securities

is longer. Hence there is a

need for providing

liquidity premium to theinvestor. These securities

are the next best alternative

from the stand point of

safety. There is no default

risk, but the real value of

income and capital returned

on maturity could be lower

due to possible inflation.

The market for central

government securities is

captive in the sense that

certain institutions such ascommercial banks, Life


7/28

Insurance Corporation

(LIC), General Insurance

Corporation (GIC),

development financial

institutions like the

Industrial DevelopmentBank of India (IDBI),

recognized/public provident

funds, registered trusts,

government and semi-

government bodies are

required by law to invest at

least a certain percentage of

their investible funds in the

central government

securities. Besides the

central government, and the

state governments also issuedated securities.

Semi-Government Dated

Securities: These are the

promissory notes issued by

the institutions and

corporations set up by the

central/state governments.

They also include the

securities of municipal

corporations. The semi-

government bodies such aselectricity boards, housing

boards, port trusts, central

and state financial

institutions issue securities

to meet the financial needs

of their developmental

activities. Semi-

government securities are

guaranteed by their

respective governments and

carry a higher coupon rate

or lower issue price thanfor their counterpart state

government dated

securities.

The price quotations for

gilt-edged dated securities

are reported to stock

exchange for inclusion in

the official quotations list

by the licensed dealers.

While the issue of

securities, payment ofinterest, and transfer of the


8/28

central and state


handled by the RBI, the

issue, interest payment and

transfer of semi-

government securities arehandled by the commercial

banks for a fee. As

mentioned earlier, the gilt-

edged securities market is

dominated by the

institutional investors like

the LIC, GIC, banks, and

provident funds. There are

a few members of the stock

exchanges who specialize

in gilt-edged securities. But

they operate primarily asbrokers and not as dealers.

Corporate Debentures

Corporate debentures are

the promissory notes issued

by the joint stock

companies in the private

sector. They are thus the

debt obligations of the

issuing corporation. Likegovernment securities, they

have an issue price at

which they are originally

issued, a coupon interest

rate, and a specified

maturity date.

Debenture Trust Deed

When a debenture issue is

sold to the investing public,the debenture trust deed

calls for appointing a

trustee. Banks, insurance

companies and firms of

attorneys usually act as

trustees to corporate

debenture issues. The main

job of the trustee is to look

after the interest of

debenture holders by

ensuring that the company

adheres to the provisions ofthe indenture - the


9/28

agreement entered into

between the issuing

company and the debenture

holders. To perform their

role effectively, the trustees

are vested with adequatepowers which include the

right to appoint a nominee

director on the board of the

company in consultation

with the institutional

debenture holders.

The indenture is a legal

document describing in

considerable detail the

contractual relationship

between the issuingcompany and the debenture

holders. This agreement

specifies, among other

things, the periodicity of

interest payment; mode of

redemption of debentures;

collateral securities, if any;

rights of the debenture

holders in the event of

default; rights, duties, and

responsibilities of the

trustee to the issue; andrestrictive covenants such

as limit on dividend

payment,


[ Scorecard : 981]


certificate is that while theformer is negotiable and

transferable by a simple

endorsement, a stock

certificate can As against

the periodic issue of the ad

hoc treasury bills to the

RBI in the past, the

government is now raising

funds through the Ways

and Means financing.

Since the RBI has startedselling treasury bills
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10/28

auction, through, the

discount rate is now

determined by market

forces and on a competitive

basis. The discount rates on

treasury bills increase asthe number of days to

maturity increase.

However, the discount rates

on T-Bills are lower than

the rates on the dated

government securities.

Central Government

Dated Securities: These

securities of the central

government have a

maturity period longer thanone year and carry a fixed

rate of interest. The interest

is payable semi-annually

and the payment is usually

made by issuing coupons

which can be encashed at

any bank. Though these

securities are redeemed at

par, their issue price can be

higher or lower than the

face value depending upon

the prevailing marketconditions.

These securities are held

either in the form of

promissory notes or stock

certificates. The difference

between a promissory note

and a stock be transferred

only by executing a transfer

deed and submitting a copy

of the deed to the RBI. The

RBI issues a new certificateto the transferee. A

promissory note has to be

presented to RBI every

time the payment of interest

is due, but no such

presentation of the stock

certificate is required

because the RBI knows

who the present owner is

and mails the interest

coupon to him on the due

date. The public/recognizedprovident funds are


11/28

required to hold these

securities only in the form

of stock certificates.

The coupon rate on the

central government datedsecurities is higher than the

discount rate on treasury

bills, due to the fact that the

maturity of dated securities

is longer. Hence there is a

need for providing

liquidity premium to the

investor. These securities

are the next best alternative

from the stand point of

safety. There is no default

risk, but the real value ofincome and capital returned

on maturity could be lower

due to possible inflation.

The market for central

government securities is

captive in the sense that

certain institutions such as

commercial banks, Life

Insurance Corporation

(LIC), General Insurance

Corporation (GIC),

development financialinstitutions like the

Industrial Development

Bank of India (IDBI),

recognized/public provident

funds, registered trusts,

government and semi-

government bodies are

required by law to invest at

least a certain percentage of

their investible funds in the

central government

securities. Besides thecentral government, and the

state governments also issue

dated securities.

Semi-Government Dated

Securities: These are the

promissory notes issued by

the institutions and

corporations set up by the

central/state governments.

They also include the

securities of municipalcorporations. The semi-


12/28

government bodies such as

electricity boards, housing

boards, port trusts, central

and state financial

institutions issue securities

to meet the financial needs

of their developmental

activities. Semi-


guaranteed by their

respective governments and

carry a higher coupon rate

or lower issue price than

for their counterpart state

government dated

securities.

The price quotations forgilt-edged dated securities

are reported to stock

exchange for inclusion in

the official quotations list

by the licensed dealers.

While the issue of

securities, payment of

interest, and transfer of the

central and state


handled by the RBI, the

issue, interest payment andtransfer of semi-


handled by the commercial

banks for a fee. As

mentioned earlier, the gilt-

edged securities market is

dominated by the

institutional investors like

the LIC, GIC, banks, and

provident funds. There are

a few members of the stock

exchanges who specializein gilt-edged securities. But

they operate primarily as

brokers and not as dealers.


Corporate debentures are

the promissory notes issued

by the joint stock

companies in the private

sector. They are thus thedebt obligations of the


13/28

issuing corporation. Like

government securities, they

have an issue price at

which they are originally

issued, a coupon interest

rate, and a specified

maturity date.


When a debenture issue is

sold to the investing public,

the debenture trust deed

calls for appointing a

trustee. Banks, insurance

companies and firms of

attorneys usually act astrustees to corporate

debenture issues. The main

job of the trustee is to look

after the interest of

debenture holders by

ensuring that the company

adheres to the provisions of

the indenture - the

agreement entered into

between the issuing


holders. To perform theirrole effectively, the trustees

are vested with adequate

powers which include the

right to appoint a nominee

director on the board of the

company in consultation

with the institutional

debenture holders.

The indenture is a legal

document describing in

considerable detail thecontractual relationship

between the issuing


holders. This agreement

specifies, among other

things, the periodicity of

interest payment; mode of

redemption of debentures;

collateral securities, if any;

rights of the debenture

holders in the event of

default; rights, duties, andresponsibilities of the


14/28

trustee to the issue; and

restrictive covenants such

as limit on dividend

payment,


[ Scorecard : 981]


Part B of the PCD will be

redeemed at par in three

installments

ofRs. 28, Rs. 28and Rs.29 at the end of7th,8th and 9th years

respectively from the date

of allotment.'Convertible' Zero Coupon

Bond: A zero coupon bond

is a loan instrument slightly

different from a debenture.

A debenture is usually

offered at a face value

(say Rs. 100), earns astream of interest (say, 14

percent p.a.) till redemption

and is redeemed with or

without premium. Unlikethe above, a zero coupon

bond, say a five-year bond,

may be offered at a

discount (say, at Rs. 50),fetches no periodic interest

and is redeemed at the face

value (say, Rs. 100). Thereturn on such a bond when

subscribed to at Rs. 50, isalso about 14 percent. It is

just that in this case the

interest is reinvested in thecompany for a period of

five years. A zero coupon

bond may also be redeemed

by allocation of ordinary

share(s). For want of better

terminology, such a bond

has been referred to as a

'Convertible' zero coupon

bond.

Redemption: Irredeemable

corporate debentures are
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15/28

perhaps non-existent.In

fact, all corporate

debentures are redeemable

and the redemption takes

place in a pre-specified

manner. Typically,

debentures have a term-to-

maturity of 7 to 10 years

and are redeemed in

installments over a period

of time. Recently,

companies have been

permitted to issue

debentures of shorter

maturities like debentures

with a maturity period of

one year. Corporate

debentures can be

redeemed by creating a

sinking fund. A sinking

fund provision in the

indenture requires the

issuing company to make

periodic payments to the

trustees. The trustee can

retire the debentures by

purchasing them in the

market or calling them in a

manner acceptable to the

debenture holders. In some

cases, however, the

company itself can handle

the retirement with the

sinking fund amount.

Debenture Redemption

Reserve

The guidelines for

protecting the interests of

debenture holders requires,

among other things, theissuing company to create a

Debenture Redemption

Reserve (DRR) out of its

profits to the extent of 50%

of the amount of debentures

to be redeemed before the

date of redemption. The

company can utilize the

DRR for redeeming

debentures only after 10%

of the debenture liability

has been actually redeemedby the company.


16/28

Call Option

Some debenture issues

have a call feature attached

to them, which provides anoption to the issuing

company to redeem

debentures at a specified

price before the maturity

date. In this case, there is,

what is known as an

effective call option period

during which the option can

be exercised. The call

option period usually

commences after 1 to 3

years from the date ofallotment. When the

debentures are redeemed by

call, they are done so at the

call price which can be 5%

above the par value. The

call price is maximum at

the start of the effective call

option period and declines

step-wise towards the face

value as the call date

approaches the maturity

date. The effective calloption period and the time-

series schedule of call price

are announced at the time

of issue.

Security Forms of Financial Investment

We know that the recipient of money in a financial investment issues a document or a piece of paper to the investor

(supplier of money), evidencing the liability of the former to the latter to provide returns. This document also

outlines the rights of the investor to certain prospects and/or property and sets the conditions under which the

investor can exercise his/her rights. This document is variously called 'Security Certificate', 'Note' and so on.

The term 'security' is a generic term used generally for those documents evidencing liabilities that are negotiable -

that can be bought and sold in the stock market. The security form of investment has received great impetus since

1980 following the Central Government's liberal policy towards foreign investments-direct and portfolio, streamlining

of licensing, capital issues, and other procedural formalities to facilitate faster capital formation; providing incentives


17/28

for exports; and encouraging private sector to tap the primary market for meeting their long-term capital

requirements.

There are different types of securities conferring different sets of rights on the investors and different sets ofconditions under which these rights can be exercised. They are gilt-edged securities, corporate debentures,

preference shares and equity shares. The important characteristic features of these securities are described below.

Gilt-Edged Securities

The debt securities issued by the government and semi-government bodies are called gilt-edged securities. They

comprise the treasury bills and the dated securities (also called bonds or dated loans) of the central government,state government, and semi-government bodies like Port Trusts and State Electricity Boards. They are the

acknowledgments of debt incurred by the issuing government or semi-government body. Gilt-edged securities thus

represent the public borrowings of the issuing government or semi-government bodies. Over the years, the central

and state governments and the semi-government bodies have made an extensive use of these securities for

meeting their short and long-term resource requirements.

Treasury Bills: These short-term securities are issued by the RBI on behalf of the Central Government. Currently, the

T-Bills having a maturity of 91 and 364 days only are being traded. No interest is paid on these bills. Instead theyare sold at a discount. In other words, the buyer pays a price less than the face value of the bill and receives the full

face value on the last day of maturity. The difference between the discount price and face value represents the

interest income to the investor.

Example: Suppose the 91-day treasury bills of Rs. 100 each are sold for Rs. 99 per bill. The buyer pays Rs. 99 and

will receive Rs. 100 after 91-days from the Government of India for every bill he buys today. These bills are said to

have been sold at

X 100 = 4.01% discount per annum. The rupee income, the buyer makes for 91-days investment is Re.1 per bill and

the return on his investment works out to be

X 100 = 4.05% per annum. Rs. 99


18/28

Since April 1st, 1996 the sale of treasury bills by Public Debt Office of the RBI had been stopped. Now it is carried

out by the RBI by conducting auctions: weekly for 91 days T-bills and fortnightly for 364 days T-bills.

The discount rate on treasury bills being very low, the return to the investor is meager. However, they are the safestand the most liquid securities you can find in the market. They are a safe investment because the central

government will never default on making payment when the bills mature. They are liquid because the commercial

banks are ready to buy them at any time due to the facility of rediscounting with the RBI. There is however little

public interest in treasury bills because of the availability of equally safe investment opportunities providing a better

return and also because they are sold in large denominations. Frequent buyers of treasury bills are the commercial

banks, state governments, and semi-government bodies. Due to rediscounting facility, the RBI generally ends up

holding nearly 80 percent of the outstanding treasury bills at any given time.


[ Scorecard : 981] Posted about a year ago

certificate is that while the former is negotiable and transferable by a simple endorsement, a stock certificate can As

against the periodic issue of the ad hoc treasury bills to the RBI in the past, the government is now raising funds

through the Ways and Means financing.

Since the RBI has started selling treasury bills auction, through, the discount rate is now determined by market

forces and on a competitive basis. The discount rates on treasury bills increase as the number of days to maturity

increase. However, the discount rates on T-Bills are lower than the rates on the dated government securities.

Central Government Dated Securities: These securities of the central government have a maturity period longer

than one year and carry a fixed rate of interest. The interest is payable semi-annually and the payment is usually

made by issuing coupons which can be encashed at any bank. Though these securities are redeemed at par, their

issue price can be higher or lower than the face value depending upon the prevailing market conditions.

These securities are held either in the form of promissory notes or stock certificates. The difference between a

promissory note and a stock be transferred only by executing a transfer deed and submitting a copy of the deed to


19/28

the RBI. The RBI issues a new certificate to the transferee. A promissory note has to be presented to RBI every time

the payment of interest is due, but no such presentation of the stock certificate is required because the RBI knows

who the present owner is and mails the interest coupon to him on the due date. The public/recognized provident

funds are required to hold these securities only in the form of stock certificates.

The coupon rate on the central government dated securities is higher than the discount rate on treasury bills, due to

the fact that the maturity of dated securities is longer. Hence there is a need for providing liquidity premium to the

investor. These securities are the next best alternative from the stand point of safety. There is no default risk, but

the real value of income and capital returned on maturity could be lower due to possible inflation. The market for

central government securities is captive in the sense that certain institutions such as commercial banks, Life

Insurance Corporation (LIC), General Insurance Corporation (GIC), development financial institutions like the

Industrial Development Bank of India (IDBI), recognized/public provident funds, registered trusts, government and

semi-government bodies are required by law to invest at least a certain percentage of their investible funds in the

central government securities. Besides the central government, and the state governments also issue dated

securities.

Semi-Government Dated Securities: These are the promissory notes issued by the institutions and corporations set

up by the central/state governments. They also include the securities of municipal corporations. The semi-

government bodies such as electricity boards, housing boards, port trusts, central and state financial institutions

issue securities to meet the financial needs of their developmental activities. Semi-government securities are

guaranteed by their respective governments and carry a higher coupon rate or lower issue price than for their

counterpart state government dated securities.

The price quotations for gilt-edged dated securities are reported to stock exchange for inclusion in the official

quotations list by the licensed dealers. While the issue of securities, payment of interest, and transfer of the central

and state government securities are handled by the RBI, the issue, interest payment and transfer of semi-

government securities are handled by the commercial banks for a fee. As mentioned earlier, the gilt-edged

securities market is dominated by the institutional investors like the LIC, GIC, banks, and provident funds. There are

a few members of the stock exchanges who specialize in gilt-edged securities. But they operate primarily as brokers

and not as dealers.


Corporate debentures are the promissory notes issued by the joint stock companies in the private sector. They are

thus the debt obligations of the issuing corporation. Like government securities, they have an issue price at which

they are originally issued, a coupon interest rate, and a specified maturity date.


20/28


When a debenture issue is sold to the investing public, the debenture trust deed calls for appointing a trustee.

Banks, insurance companies and firms of attorneys usually act as trustees to corporate debenture issues. The main

job of the trustee is to look after the interest of debenture holders by ensuring that the company adheres to the

provisions of the indenture - the agreement entered into between the issuing company and the debenture holders.

To perform their role effectively, the trustees are vested with adequate powers which include the right to appoint a

nominee director on the board of the company in consultation with the institutional debenture holders.

The indenture is a legal document describing in considerable detail the contractual relationship between the issuing

company and the debenture holders. This agreement specifies, among other things, the periodicity of interest

payment; mode of redemption of debentures; collateral securities, if any; rights of the debenture holders in the

event of default; rights, duties, and responsibilities of the trustee to the issue; and restrictive covenants such as limit

on dividend payment,



certificate is that while the former is negotiable and transferable by a simple endorsement, a stock certificate can As

against the periodic issue of the ad hoc treasury bills to the RBI in the past, the government is now raising funds

through the Ways and Means financing.

Since the RBI has started selling treasury bills auction, through, the discount rate is now determined by market

forces and on a competitive basis. The discount rates on treasury bills increase as the number of days to maturity

increase. However, the discount rates on T-Bills are lower than the rates on the dated government securities.


21/28

Central Government Dated Securities: These securities of the central government have a maturity period longer

than one year and carry a fixed rate of interest. The interest is payable semi-annually and the payment is usually

made by issuing coupons which can be encashed at any bank. Though these securities are redeemed at par, their

issue price can be higher or lower than the face value depending upon the prevailing market conditions.

These securities are held either in the form of promissory notes or stock certificates. The difference between a

promissory note and a stock be transferred only by executing a transfer deed and submitting a copy of the deed to

the RBI. The RBI issues a new certificate to the transferee. A promissory note has to be presented to RBI every time

the payment of interest is due, but no such presentation of the stock certificate is required because the RBI knows

who the present owner is and mails the interest coupon to him on the due date. The public/recognized provident

funds are required to hold these securities only in the form of stock certificates.

The coupon rate on the central government dated securities is higher than the discount rate on treasury bills, due to

the fact that the maturity of dated securities is longer. Hence there is a need for providing liquidity premium to the

investor. These securities are the next best alternative from the stand point of safety. There is no default risk, but

the real value of income and capital returned on maturity could be lower due to possible inflation. The market for

central government securities is captive in the sense that certain institutions such as commercial banks, Life

Insurance Corporation (LIC), General Insurance Corporation (GIC), development financial institutions like the

Industrial Development Bank of India (IDBI), recognized/public provident funds, registered trusts, government and

semi-government bodies are required by law to invest at least a certain percentage of their investible funds in the

central government securities. Besides the central government, and the state governments also issue dated

securities.

Semi-Government Dated Securities: These are the promissory notes issued by the institutions and corporations set

up by the central/state governments. They also include the securities of municipal corporations. The semi-

government bodies such as electricity boards, housing boards, port trusts, central and state financial institutions

issue securities to meet the financial needs of their developmental activities. Semi-government securities are

guaranteed by their respective governments and carry a higher coupon rate or lower issue price than for their

counterpart state government dated securities.

The price quotations for gilt-edged dated securities are reported to stock exchange for inclusion in the official

quotations list by the licensed dealers. While the issue of securities, payment of interest, and transfer of the central

and state government securities are handled by the RBI, the issue, interest payment and transfer of semi-

government securities are handled by the commercial banks for a fee. As mentioned earlier, the gilt-edged

securities market is dominated by the institutional investors like the LIC, GIC, banks, and provident funds. There are

a few members of the stock exchanges who specialize in gilt-edged securities. But they operate primarily as brokers

and not as dealers.


22/28


Corporate debentures are the promissory notes issued by the joint stock companies in the private sector. They are

thus the debt obligations of the issuing corporation. Like government securities, they have an issue price at whichthey are originally issued, a coupon interest rate, and a specified maturity date.


When a debenture issue is sold to the investing public, the debenture trust deed calls for appointing a trustee.

Banks, insurance companies and firms of attorneys usually act as trustees to corporate debenture issues. The main

job of the trustee is to look after the interest of debenture holders by ensuring that the company adheres to theprovisions of the indenture - the agreement entered into between the issuing company and the debenture holders.

To perform their role effectively, the trustees are vested with adequate powers which include the right to appoint a

nominee director on the board of the company in consultation with the institutional debenture holders.

The indenture is a legal document describing in considerable detail the contractual relationship between the issuing

company and the debenture holders. This agreement specifies, among other things, the periodicity of interest

payment; mode of redemption of debentures; collateral securities, if any; rights of the debenture holders in the

event of default; rights, duties, and responsibilities of the trustee to the issue; and restrictive covenants such as limiton dividend payment,



c. Part B of the PCD will be redeemed at par in three installments of Rs. 28, Rs. 28 and Rs. 29 at the end of

7th,8th and 9th years respectively from the date of allotment.

'Convertible' Zero Coupon Bond: A zero coupon bond is a loan instrument slightly different from a debenture. A

debenture is usually offered at a face value (say Rs. 100), earns a stream of interest (say, 14 percent p.a.) till

redemption and is redeemed with or without premium. Unlike the above, a zero coupon bond, say a five-year bond,


23/28

may be offered at a discount (say, at Rs. 50), fetches no periodic interest and is redeemed at the face value (say,

Rs. 100). The return on such a bond when subscribed to at Rs. 50, is also about 14 percent. It is just that in this case

the interest is reinvested in the company for a period of five years. A zero coupon bond may also be redeemed by

allocation of ordinary share(s). For want of better terminology, such a bond has been referred to as a 'Convertible'

zero coupon bond.

Redemption: Irredeemable corporate debentures are perhaps non-existent.In fact, all corporate debentures are

redeemable and the redemption takes place in a pre-specified manner. Typically, debentures have a term-to-

maturity of 7 to 10 years and are redeemed in installments over a period of time. Recently, companies have been

permitted to issue debentures of shorter maturities like debentures with a maturity period of one year. Corporate

debentures can be redeemed by creating a sinking fund. A sinking fund provision in the indenture requires the

issuing company to make periodic payments to the trustees. The trustee can retire the debentures by purchasing

them in the market or calling them in a manner acceptable to the debenture holders. In some cases, however, the

company itself can handle the retirement with the sinking fund amount.

Debenture Redemption Reserve

The guidelines for protecting the interests of debenture holders requires, among other things, the issuing company

to create a Debenture Redemption Reserve (DRR) out of its profits to the extent of 50% of the amount of debentures

to be redeemed before the date of redemption. The company can utilize the DRR for redeeming debentures only

after 10% of the debenture liability has been actually redeemed by the company.

Call Option

Some debenture issues have a call feature attached to them, which provides an option to the issuing company to

redeem debentures at a specified price before the maturity date. In this case, there is, what is known as an effective

call option period during which the option can be exercised. The call option period usually commences after 1 to 3years from the date of allotment. When the debentures are redeemed by call, they are done so at the call price

which can be 5% above the par value. The call price is maximum at the start of the effective call option period and

declines step-wise towards the face value as the call date approaches the maturity date. The effective call option

period and the time-series schedule of call price are announced at the time of issue.

Guidelines for Classification and Valuation of Investments by banks

October 16, 2000


24/28

DBOD.No.BP.BC. 32 / 21.04.048/ 2000-2001

All Commercial Banks

(excluding RRBs and LABs)

Dear Sirs,


Please refer to paragraph 44 (b) of the Statement on Mid-term Review of Monetary and Credit

Policy for the year 2000-2001 enclosed to Governors letter MPD.No.BC.201/07010279/2000-

2001 dated October 10, 2000.

2.1 At present, investments of banks comprise SLR securities and non-SLR securities. The

classification of the investments in the balance sheet, for disclosure, is under six groups viz., i)

Government securities ii) Other approved securities iii) Shares iv) Debentures & Bonds v)

Subsidiaries/ joint ventures vi) Others (CP, Mutual Fund Units, etc.). While the first two

classifications represent the banks investments in SLR securities the other four represent the nonSLR securities.

Banks were earlier advised that for the purpose of valuation,

a) the investments of banks in SLR securities should be bifurcated into current and permanent,

with the prescription that the current investments are not less than 75% of the total SLR

securities, excluding the new banks set up after 1993 in the private sector which were required to

include their entire SLR investments under current category and

b) current category of SLR investments and the entire portfolio of non-SLR investments should

be marked to market.

2.2 RBI has also been issuing detailed guidelines to be followed for valuation of the

investments and marking them to market every year. Besides, to facilitate valuation of investments

which are not quoted, YTM rates for Government securities of different maturities, as on March 31,

are also being issued annually.

Review

3. With the introduction of prudential norms on capital adequacy, income recognition, asset

classification and provisioning requirements the financial position of banks in India has improved


25/28

in the last few years. Simultaneously, trading in the securities market has improved in terms of

turnover and the range of maturities dealt with. In view of these developments and taking into

consideration the evolving international practices, an Informal Working Group in the Bank has

reviewed the existing instructions on the classification and valuation of the investments portfolio.

The guidelines on classification and valuation of investments by banks have been revised on thebasis of the

recommendations of the Informal Group to bring them in consonance with the best

international practices.

Revised Guidelines

4.1 The highlights of the revised guidelines are given below:

The revised guidelines furnished in the Annexure will be effective from the half-year ended

September 30, 2000.

The banks are required to classify their entire investment portfolio as on September 30, 2000,

under three categories viz. Held to Maturity, Available for Sale and Held for Trading.

In the balance sheet, the investments will continue to be disclosed as per the existing six

classifications viz. i) Government securities ii)other approved securities iii) Shares iv)

Debentures & Bonds v) Subsidiaries/ joint ventures vi) Others (CP, Mutual Fund Units, etc.).

The investments under the Available for Sale and Held for Trading categories should be

marked to market periodically as indicated in the Annexure or at more frequent intervals.

The investments under the Held to Maturity category need not be marked to market as in the

case of Permanent securities at present.

Classification of investments, shifting of investments among the three categories, valuation

of the investments, methodology for booking profit/ loss on sale of investments and

providing for depreciation should be in accordance with the guidelines in the Annexure.

The risk-weights assigned to the various securities at present, including those for market

risk, would remain unchanged.

4.2 The classification of the existing investments among the three categories may be done at the

book value of the respective securities as on September 30, 2000. Subsequent valuation of the


26/28

securities included under the Held for Trading and the Available for Sale categories may be

carried out as specified in the revised guidelines. The first such revaluation may be done as on

September 30, 2000 for the securities under the Held for Trading category. Securities under the

Available for Sale category may also be revalued as on that date if the bank proposes to revalue

this category at intervals more frequent than annual intervals.

4.3 Banks should formulate an Investment Policy with the approval of their Board of Directors to

take care of the requirements on classification, shifting and valuation of investments under the

revised guidelines. Besides, the Policy should adequately address risk-management aspects, ensure

that the procedures to be adopted by the banks under the revised guidelines are consistent,

transparent and well documented to facilitate easy verification by inspectors and statutory auditors. Guidelines for

Classification and Valuation of Investments by banks

October 16, 2000

DBOD.No.BP.BC. 32 / 21.04.048/ 2000-2001

All Commercial Banks

(excluding RRBs and LABs)

Dear Sirs,


Please refer to paragraph 44 (b) of the Statement on Mid-term Review of Monetary and Credit

Policy for the year 2000-2001 enclosed to Governors letter MPD.No.BC.201/07010279/2000-

2001 dated October 10, 2000.

2.1 At present, investments of banks comprise SLR securities and non-SLR securities. The

classification of the investments in the balance sheet, for disclosure, is under six groups viz., i)

Government securities ii) Other approved securities iii) Shares iv) Debentures & Bonds v)

Subsidiaries/ joint ventures vi) Others (CP, Mutual Fund Units, etc.). While the first two

classifications represent the banks investments in SLR securities the other four represent the nonSLR securities.

Banks were earlier advised that for the purpose of valuation,

a) the investments of banks in SLR securities should be bifurcated into current and permanent,


27/28

with the prescription that the current investments are not less than 75% of the total SLR

securities, excluding the new banks set up after 1993 in the private sector which were required to

include their entire SLR investments under current category and

b) current category of SLR investments and the entire portfolio of non-SLR investments should

be marked to market.

2.2 RBI has also been issuing detailed guidelines to be followed for valuation of the

investments and marking them to market every year. Besides, to facilitate valuation of investments

which are not quoted, YTM rates for Government securities of different maturities, as on March 31,

are also being issued annually.

Review

3. With the introduction of prudential norms on capital adequacy, income recognition, asset

classification and provisioning requirements the financial position of banks in India has improved

in the last few years. Simultaneously, trading in the securities market has improved in terms of

turnover and the range of maturities dealt with. In view of these developments and taking into

consideration the evolving international practices, an Informal Working Group in the Bank has

reviewed the existing instructions on the classification and valuation of the investments portfolio.

The guidelines on classification and valuation of investments by banks have been revised on thebasis of the

recommendations of the Informal Group to bring them in consonance with the best

international practices.

Revised Guidelines

4.1 The highlights of the revised guidelines are given below:

The revised guidelines furnished in the Annexure will be effective from the half-year ended

September 30, 2000.

The banks are required to classify their entire investment portfolio as on September 30, 2000,

under three categories viz. Held to Maturity, Available for Sale and Held for Trading.

In the balance sheet, the investments will continue to be disclosed as per the existing six

classifications viz. i) Government securities ii)other approved securities iii) Shares iv)


28/28

Debentures & Bonds v) Subsidiaries/ joint ventures vi) Others (CP, Mutual Fund Units, etc.).

The investments under the Available for Sale and Held for Trading categories should be

marked to market periodically as indicated in the Annexure or at more frequent intervals.

The investments under the Held to Maturity category need not be marked to market as in the

case of Permanent securities at present.

Classification of investments, shifting of investments among the three categories, valuation

of the investments, methodology for booking profit/ loss on sale of investments and

providing for depreciation should be in accordance with the guidelines in the Annexure.

The risk-weights assigned to the various securities at present, including those for market

risk, would remain unchanged.

4.2 The classification of the existing investments among the three categories may be done at the

book value of the respective securities as on September 30, 2000. Subsequent valuation of the

securities included under the Held for Trading and the Available for Sale categories may be

carried out as specified in the revised guidelines. The first such revaluation may be done as on

September 30, 2000 for the securities under the Held for Trading category. Securities under the

Available for Sale category may also be revalued as on that date if the bank proposes to revalue

this category at intervals more frequent than annual intervals.

4.3 Banks should formulate an Investment Policy with the approval of their Board of Directors to

take care of the requirements on classification, shifting and valuation of investments under the

revised guidelines. Besides, the Policy should adequately address risk-management aspects, ensure

that the procedures to be adopted by the banks under the revised guidelines are consistent,

transparent and well documented to facilitate easy verification by inspectors and statutory auditors.

Documents

Infra Bonds(tax)