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US 64 Bond: Good News or Bad?

Come June 1, 2003, US 64 will begin a new inning as a 5-year bond. With a tax-free coupon of 6.75 per cent, US 64 bond will be the safest and the most profitable bet versus all comparable investment avenues. We think so. Do you?

US 64 investors can finally heave a sigh of relief. For all the sufferings that they endured over the last few years, there is justice at the end. April 10, 2003, turned out to be the day their fortunes changed, hopefully for the better. For now, it has worked out as a win-win situation for both sets of investors the ones who went for redemption and the ones who opted for the US 64 bond.

On June 1, US 64 will become a tradable bond. These bonds will have a 5-year tenure with a 6.75 per cent coupon, payable half-yearly. It will have a face value of Rs 100. The interest and the principal at maturity are guaranteed by the government. The number of bonds will be issued in proportion to the value and number of US 64 units you hold, as on May 31, 2003.

For example, if an investor holds 12,000 units the first 5,000 units covered under Category A, will be converted at Rs 12 per unit. The balance 7,000 units (Category B), will be converted at Rs 10. The total repurchase value of the units will be Rs 1,30,000 (Rs 60,000+ Rs 70,000). An investor will be issued 1,300 bonds.

The Ones Who Missed Out
The erstwhile US 64 unit holders (who held over 5,000 units) must be cursing their luck today for having made a distress sale at a NAV of around Rs 6. If they had more patience, they would have either got a high yielding tax-free bond or Rs 10 on May 31. The real losers though are unit holders falling in Category C (those who bought units from the secondary market between November 15, 2002 and January 23, 2003). They bought these units in the hope that they'll get at least Rs 10 on May 31. But they have been denied both the bond and the Rs 10 option. They will have to redeem at NAV or the market price, as on May 31, since US 64 units will cease to exist.

But if you fall under Category A or B and were planning to redeem US 64 units, and missed the deadline of April 10, don't be disheartened. You still have the option of exiting the fund till May 31, by surrendering the bond. But as things have turned out, investors who bought US 64 units at Rs 13 or Rs 14 (prior to June 2001) they won't be happy. Apart from incurring a capital loss, these investors can't offset the loss against the gains made elsewhere as the capital gains tax on US 64 has been waived off.

Is the Bond Option Lucrative?
The SBI fixed deposit for 5-year tenure currently fetches you 6.81 per cent interest and the yield on the 5-year government security is hovering in the 6.1-6.3 per cent range. This income is not tax-free. However, the interest income of 6.75 per cent from the US 64 bond will be tax-free. Therefore, it is pretty evident that no other bond will fetch you such a high return. The interest on RBI tax-free bonds is 6.5 per cent. The US 64 bond will be more beneficial for high income-tax payers as the effective return for them works out to around 10 per cent. Also, you won't face any liquidity problem since it will be traded in the secondary market. Even small investors will be better off here as they will earn a tax-free, assured income for the next five years, irrespective of market conditions.

Moreover, the capital gains tax on the sale and re-sale of US 64 has been done away with. This will make US 64 bond even more attractive as you won't have to pay tax on short-term capital gains.

The Probable Risk
So far the story has read pretty good, but there are few things that US 64 bondholders will have to keep in mind. There is a chance that bondholders may face liquidity problems. If trading in US 64 bond fails to gather momentum or witnesses low volumes in the secondary market, one may be stuck with the bond for five years. Low volumes could also result in price distortion. That apart, for buying or selling US 64 bonds one will have to approach a broker. And since some bondholders may not be familiar with this it may hinder development of a mature secondary market for these bonds. Thus, after listing of the bond on the NSE and the OTCEI, UTI should make an effort to develop a proper platform for trading in US 64 bonds to ensure adequate liquidity. But as the trading lot is not high—a single bond can be bought and sold in the market—it could turn out to be one of the factors going investors' way.

In a nutshell, current market condition makes US 64 bond the safest and the most profitable bet versus all comparable investment avenues. We think so. Do you?