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 term
infrastructure 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

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 loan
evaluation process.
 • 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 InvestmentYogi’s Tax Calculator to help you estimate your taxes.

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

Written for InvestmentYogi by Ramya Ramachandran

Published Jul 22 2010, 04:07 AM by 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 mutual
funds 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 keep
in 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 bank’s Board of Directors is
free 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 expertise
available within the bank as per the investment policy approved by the Board of Directors
subject 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 the
Board of Directors. Such investments should be in specific schemes of UTI / Mutual Funds
and 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

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 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

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
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.

Posted about a year ago

certificate is that while the

Member (Account Deleted) former is negotiable and
[ Scorecard : 981] 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 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

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.

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 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,

Posted about a year ago

certificate is that while the

Member (Account Deleted) former is negotiable and
[ Scorecard : 981] 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 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

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.

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 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,

Posted about a year ago

Part B of the PCD will be

Member (Account Deleted) redeemed at par in three
[ Scorecard : 981] 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,
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 3
years 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.

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
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 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

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 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 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
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

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.
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 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,

Member (Account Deleted)

[ 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
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

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.

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 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,

Member (Account Deleted)

[ Scorecard : 981] Posted about a year ago

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,
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 3
years 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

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

All Commercial Banks

(excluding RRBs and LABs)

Dear Sirs,

Guidelines for Classification and Valuation of Investments by banks

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 Governor’s 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
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
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,

Guidelines for Classification and Valuation of Investments by banks

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 Governor’s 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

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

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.