Instruments with floating interest rates are issued only when there are predictions that the overall interest rate will fall and the issuer needn't pay higher interest for the entire investment period.
Instruments with floating interest rates are issued only when there are predictions that the overall interest rate will fall and the issuer needn’t pay higher interest for the entire investment period. On the other hand, instruments with a fixed interest rate will be beneficial for the issuer of the instrument when there are indications that rates will rise and the issuer will continue to pay interest at the lower rate during the investment period.
Contrary to the previous series of fixed interest bonds, the Reserve Bank of India (RBI) has issued new Bonds on behalf of the Government of India with floating rates on July 1, 2020, which indicates that the overall interest rates would fall further.
The initial coupon rate offered on the floating-rate taxable bond is 7.15 per cent, which will be reviewed every six months. The floating coupon rate will be 0.35 per cent more than the interest rate offered on the National Savings Certificate (NSC), rate of which is reviewed quarterly, but the rate – at which the instrument is issued – remains fixed during the investment period.
With floating rate, the new RBI Bonds bear significant interest rate risk during the investment period of 7 years.
Also, the current coupon rate of 7.15 per cent is lower than 7.4 per cent fixed interest rate offered on both Senior Citizens Savings Scheme (SCSS) and Pradhan Mantri Vaya Vandana Yojana (PMVVY) for the entire investment periods of 5 years and 10 years, respectively, and hence the RBI Bond is not an ideal choice for senior citizens.
Even younger investors may avoid the interest rate risk by investing in NSC (6.8 per cent) and 5-year Post Office Time Deposit (6.7 per cent) with government guarantee.
Bank Fixed Deposit (FD) may be another option to avoid the interest rate risk provided the rate of interest offered on FDs are not much below 6 per cent and financial health of the issuing bank is sound.
Debt Mutual Fund (MF) schemes may be another alternative option with decent return, higher liquidity and greater tax advantage. However, the recent debacles and freezing of six debt fund schemes by Franklin Templeton have badly hit the confidence of investors.
So, in case you prefer safety over return and are not much apprehensive about immediate rate cuts, you may invest in the floating-rate RBI Bond.