Most investors route their fixed income investments through mutual funds. However, they can also directly invest in bonds/debentures in the primary or secondary markets. One of the issues in direct exposure through bonds/debentures is credit quality: better rated papers would have a relatively low yield; and for a better yield, credit rating would be relatively low. Now there is an opportunity available for taking exposure directly in bonds: the tax-free bonds issued by five PSUs — NHAI, IRFC, HUDCO, REC and PFC. These PSUs are all rated 'AAA' except HUDCO, which is rated one notch lower at AA+'.
The returns available on these good credit quality bonds are attractive, and there is liquidity in the secondary market in lot sizes affordable to regular investors.

To understand the return from these bonds (the reason it is being called an attractive investment opportunity), let us say the investor is in the highest tax bracket of 30%. Let us assume, for simplicity, the purchase price of the bond in the secondary market is same as the face value of . 1,000 per bond. The coupon (interest) rate is say 8%. The equivalent rate for a taxable coupon (which would be the other comparable option for the investor) is 8% / (1-30.9%) = 8%/0.691 = 11.58%. It is lucrative to get a rate of return of 11.58% (pre-tax equivalent) for a credit quality that is as safe as 'AAA' rated PSU. As of now, the range of yields available in the secondary market is in a range of 20 to 30 basis points around 8% (post tax).

Operationally, the way the investors can transact in these bonds is that these are listed on the stock exchanges (NSE and/or BSE) in the equity segment. Please do not get confused with the listing in the equity segment; these are bonds, not equities, the listing in the equity segment is to offer the operational flexibility of the equity segment.
The process for transaction is the same as that of dealing in an equity stock: you have to place an order with your stock broker and you have to have a demat account.

The other segment of the exchanges is the WDM segment that is essentially wholesale in nature where deals are negotiated in lot sizes of . 5 crore. Trades take place in lot sizes of less that . 5 crore as well in the WDM segment, but a size of say . 2 crore would be out of reach for the regular investor — a fact that underscores the relevance of listing of these bonds in the equity segment.

A concept that investors should be aware of in this context is "clean price" and "dirty price". A price that includes the accrued or accumulated interest from the last interest payment date to the date of the transaction is called "dirty price" (which may also be called cum-interest) and a price that does not include the accumulated interest is called "clean price".

In the equity segment, the price quoted for these bonds is dirty price or cum interest i.e. the buyer need not pay anything over and above the quoted price. In the WDM segment, the price may be clean i.e. an investor has to pay the accrued interest separately over the quoted price.

However, remember that while the coupon (interest) on these bonds is tax free, the gains on selling the bonds in the secondary market is taxable as capital gains – short-term for a holding period of less than one year and long-term for a holding period of more than one year.

While there is no debate on the attractiveness of investment in these tax-free bonds mentioned above, one small counter-argument could be that there would be further issuances of similar tax-free bonds in this financial year.

The amount sanctioned through the Union Budget is . 60,000 crore for this financial year (2012-13), against . 30,000 crore in 2011-12. In case the coupon rates on the issuances that would come this year are marginally higher than last year, the price of the ones that are currently available in the secondary market may drop marginally.

Since we are not sure of the coupon rates that are about to come, it is better to stagger the purchases over a period of time; in case the coupons of the forthcoming issues are lower, the current ones would be better.