Finance Ministry has notified Zero Coupon Bond (ZCB) for Power Finance Corporation. The company can raise up to ₹10,000 crore.
ZCB is an instrument that doesn’t pay interest during its term, but instead is sold at a discount to its face value. When the bond matures, the investor receives the full-face value. There will be no periodic payment of interest.
According to the notification, the bond will be issued with a discount of ₹49,546 for a face value of ₹1 lakh. In other words, the investor will pay ₹50,454 at the time of issuance, while get ₹1 lakh at maturity. These bonds will have the maturity value of 121 months or 10 years and one month. “To be issued on or before march 31, 2027,” the notification said. The notification has capped the number of bonds to be issued at 10 lakhs.
These bonds are meant for long-term investors who are not looking for periodic interest payments but are focused on substantial lumpsum payout at a future date. Since these bonds pay the full-face value at the maturity date, they are perfect for allocating funds for respective future financial obligations such as a child’s education, marriage, retirement etc.
It may be noted that these bonds offer fixed returns if held until maturity and are less risky than equities or variable-rate bonds, so conservative investors can invest in them. Also, if the investor portfolio primarily consists of growth investments, adding zero-coupon bonds can be advantageous. These bonds can help them secure a guaranteed return over a fixed time period and also help in portfolio diversification.
However, there are some disadvantages too. First, these bonds are subject to interest rate risk if sold prior to the date of maturity. The value of these bonds is inversely related to the interest rates. With the rise in interest rates of newer bonds, the demand for older bonds reduces. Also, there is duration risk which is associated with a bond’s price sensitivity to a one-per cent change in the rate of interest. The sensitivity of long-term zero-coupon bonds to interest rates exposes them to duration risk. This means that the longer a bond’s duration, the greater its sensitivity to interest rate changes.
The ZCB attracts tax on gains only. It will depend upon the duration of holding. If it is less than 12 months, then gains will attract short term capital gain tax according to bond holder’s income tax slab. However, gain after holding for more than 12 months will be subjected to long term capital gain tax which is 12.5 per cent.
