Should you invest in RBI Floating Savings Bond?

Padmaja Choudhury   /   February 1, 2023

With the rising interest rates, investors’ appetite for fixed-income instruments has increased. And one of the fixed income instruments is the floating rate bond.

On December 30, RBI increased the coupon rate of the Floating Rate Savings Bond, 2020 (Taxable) to 7.35% from 7.15% after the increase in interest rate of the National Savings Certificate (NSC) from 6.80% to 7.00%. This came into effect on January 1, 2023.

Floating rate bonds can be a good investment option in a rising interest-rate environment. While many experts believe that the interest rate hike cycle is almost over, you might look into it as the interest rate goes up and down over time.

In this article, we will try to understand the different features of a floating rate bond and whether it will be the right investment option.

But first, let us see the difference between a floating rate bond and a fixed rate bond.

Bonds typically have a set interest rate or coupon. You may purchase a ₹ 10,000 bond, for instance, with a 5% coupon rate. You will receive ₹500 yearly interest payment from the bond issuer in the case of such a bond. This interest never changes and is independent of the market’s current interest rate.

A floating rate bond, on the other hand, is a type of debt instrument without a set coupon rate and instead has an interest rate that changes according to the benchmark. In this case, the benchmark can be the repo rate, reverse repo rate, T-Bills or small savings scheme.

Currently, the coupon rate of the floating rate bonds is set at a spread of (+) 35 bps over the prevailing NSC interest rate.

Features of RBI Floating Rate

Eligibility: Resident individuals and Hindu Undivided Family (HUF) can invest in these bonds. However, it is important to note that Non-Resident Indians (NRIs) are not eligible to invest in these bonds.

Investment limit: The bonds are issued at face value of ₹1000. Hence, the minimum investment is ₹1000 and multiples of ₹1000. There is no cap on maximum investment.

Maturity: The bonds come with a maturity period of seven years. The principal amount is repaid after seven years. However, premature withdrawal is applicable for citizens above 60 years.

Interest Rate: The current coupon rate is 7.35%. However, the coupon interest rate is revised every six months. The applicable interest rate is paid half yearly on January 1 and July 1. Unlike Fixed Deposits, there is no option for cumulative interest pay-out. The proceeds are credited to the registered bank account at the end of seven years.

Transfer/Trading: These bonds are not transferable and can’t be traded in the secondary market. However, the bonds are transferred to the nominee/heir on death.

Taxation: The interest received on these bonds is added to your income and taxed as per your income slab.

Collateral: Investors can’t take loans against floating-rate bonds.

Invest in RBI Floating Rate Bond?

The main concern with floating-rate bonds is that investors can wind up with lower interest rates than fixed-rate bonds since they are connected to a benchmark. Investors can earn lower returns from floating-rate bonds if the short-term benchmark rate decreases.

Additionally, there is no assurance that the interest rate on a floating rate bond will rise in a rising economy at the same rate as the market rate. As a bondholder, you might experience interest rate risk due to the bond’s underperformance compared to market interest rates.

Therefore, there is no guarantee of a consistent revenue stream in the future when buying floating-rate bonds.

These bonds can be a good investment option if you believe that market interest rates will rise in the future. However, as it comes with limitations, it would be best to consult a financial professional before investing in floating-rate bonds.

Download Wealthzi app: Invest in mutual funds, automated portfolio review and tracking