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Suresh Krishnamurthy

FOR US-64 unit-holders, the deadline for opting for cash has been extended to April 10. However, it looks like unit-holders may not need the extension. It is now clear that for all classes of unit-holders, irrespective of their tax status, not opting for cash is now the preferable option.

It has been argued that for investors who do not pay taxes, the 6.75 per cent tax-free bond does not make sense. That is because they can buy higher yielding instruments, such as post-office monthly income scheme, by opting for cash. It had therefore been suggested earlier in this column that non-tax paying investors should opt for cash and not bonds.

However, opting for cash is now not a suitable option for these investors too. By not opting for cash, they can now get a higher amount that they can still deploy in higher yielding assets. This is because US-64 units are now traded at a price that is higher than their redemption amount.

Non-tax paying investors, therefore, will be better off either selling in the market now or selling later when the trading of US-64 bonds commences.

What price?: The Central Government guarantees the payments required to be made on US-64 bonds. Therefore, the yield on these bonds will approximate the after-tax yield on five-year government securities.

The pre-tax yield on government securities is now around 6 per cent. For banks, the post-tax yield will be 3.9 per cent. This suggests that there is a lot of potential for appreciation in value of US-64 units now and for US-64 bonds when trading commences.

At a price of Rs 11.25 for the Rs 10 unit and Rs 13.50 for the Rs 12 unit, the yield on US-64 bonds would be around 4 per cent. That will perhaps be the maximum value to which the units will appreciate given the present interest rate scene. Banks and other corporates may not be willing to buy the units at a price higher than that.

So, any price above say Rs 11 or Rs 13.25, as the case may be, would be an attractive price for non-tax paying investors to sell before April 10. The cash can then be utilised to buy into post-office monthly income scheme or even into LIC's new pension scheme.

However, despite high volumes, prices are refusing to move higher. On Friday, the Rs 10 units closed at Rs 10.15 while the Rs 12 units closed at Rs 12.30. Importantly, at close, sell-side orders were much higher than that of buy-side orders. So, whether the prices of US-64 units will move higher is the moot point.

Risks exist: Non-tax paying investors may be in a predicament if prices do not move up to those levels before April 10. That is because beyond that date investors may be exposed to two risks.

First, volumes may dip. If the UTI allows another record date to determine unit-holders eligible to receive US-64 bonds, volumes may not dip. Otherwise, there is the likelihood that they will. With declining volumes, prices may not be attractive for unit-holders to sell.

A decline in volumes will mean that investors will have to wait for trading in US-64 bonds to commence before off-loading their holdings. That implies a wait of nearly another two months. During this period, interest rate movements could prove adverse. If interest rates do rise, the price commanded by the bonds will decline.

So, investors who wait for trading in US-64 bonds to commence will run that risk. The best outcome for non-tax paying investors would be if the anticipated appreciation in the price of US-64 units happens before April 10. However, the risk-averse investor would look to sell at whatever high price is available before April 10.

The tax-paying individual investors, especially in the 30 per cent tax bracket, are in an enviable position, though. The 6.75 per cent tax-free US-64 bonds already offer above market yields. In addition, they now have the chance of selling these units for a higher price and re-investing them in the 6.5 per cent tax-free Government bonds. They can afford to wait a little longer.

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