Reserve Bank of India (RBI) has recently launched the Floating Rate Savings Bond 2020. According to Ministry of Finance, it is a replacement of 7.75 per cent bond that was launched in the year 2018. So, in this article, we will discuss how investing in this is a good option.
However, before that, let’s know more about the Floating Rate Savings Bond 2020. Unlike a fixed-rate bond, a floating rate bond has a variable interest rate. This means that in the rising interest rate scenario, the interest paid out would increase and vice-versa. In case of a fixed rate bond, though the coupon rate is constant, the value of the bond would depend upon the interest rate scenario. However, in the case of a floating rate bond, the spot price of the bond would be quite close to its face value but the interest payments will change with the movement in interest rates. Usually, such bonds are used by debt mutual funds (MFs) to lower interest rate sensitivity.
The initial coupon rate of Floating Rate Savings Bond 2020 is 7.15 per cent. The interest rate would reset every six months. The first reset will be on January 01, 2021. There is no cumulative option available with these bonds. The interest rate is benchmarked against the prevailing rate of National Saving Certificate (NSC) with a spread of 35 basis points over the NSC rate. Further, these bonds are not tradable and its tenure is of seven years. However, premature redemption is allowed only for senior citizens of specified categories. The interest earned is taxable as per individual tax slab rates.
So, who can invest in them? All resident Indians, legal guardians on behalf of a minor and members of Hindu undivided family (HUF) can invest in this bond. Unfortunately, non-resident Indians (NRIs) cannot invest in it.
Should you invest in them?
It is important to understand that if the interest rate falls, the issuer benefits from it and if the interest rate rises, the investor benefits. Also, the effective yield due to the possibility of a higher coupon rate, would be lower in a floating rate bond.
Having said that, who should consider investing in these bonds? The one who needs regular income can consider investing in them. This is because there is no cumulative option available with these bonds. The interest rates are nearing a trough and are expected to increase when economic activity revives. However, more rate drops can be witnessed seven years down the road. Therefore, these cannot be termed as a good source of regular income.