Bonds Part III: Cumulative Vs periodic interest payment

This is a 3 part of the series of post on bonds. I have designed this post as a water fall model:
1. The most common bonds in most portfolios are the infrastructure bonds and other bonds bought as part of 80 C, 80 CCF etc. These bonds usually give lower than market rate returns and have a stringent lock in period etc. If you intend to buy such bonds then ALWAYS GO FOR THE ONE WITH COUPON RATE. This way only your capital would be locked and interest (which is about 8-9% of your capital) would be returned back to you annually for reinvestment (probably in another tax planning instrument for next year) This way one can recycle the capital to ensure maximum tax benefit with least amount of capital being locked away.
2. Default risk: Simply put most companies irrespective of how harsh the times are somehow manage to pay the interest rate. However when the time comes to pay back the principal, the company faces issues. This is primarily because companies tend to prefer to roll their debt. i.e. issue fresh bonds (from retail or via banks/FI) and if their standing in the industry falls, this could become difficult. Looking at the recently open issue (10.75% interest over 15 years) 10,000/- has a maturity amount of 46,255/- So if I were you, I would prefer to get an annual coupon rate, reinvest it in another bond and diversify so that even in case of default I am able to capture back 36,255/- of the 46,255/- maturity value. However if you are subscribing to public sector bonds/bonds with explicit/implicit sovereign guarantee then move to point 3.
3. Interest rate trend: If you believe that interest rate are going to go up in the future then go for shorter duration bonds and in that one with most frequent interest payment (monthly/quarterly/semi-annually). More frequent the coupon payment, lesser would be Macaulay Duration and hence lesser sensitivity of your portfolio to interest rate hikes.
4. Trading: As mentioned in the previous point. If you don’t intent to hold the bond till maturity and sell it once the interest rate falls then probably you would make more money by going for the cumulative bonds.
5. Liquidity requirements: Pension holders prefer monthly income bonds which allow them to cover a part of their monthly expenses by bond income. On the other hand if you are young and intend to save money in bond so that you could buy property/car etc. then go for cumulative bonds that way your savings would be inflation proof (at least partly)
6. Your job/financial security: You won’t find this in any book, but for guys like me who are expected to bring food to the table but don’t have a secure government job, I prefer periodic interest payment. My logic is that these interest payments would ease my liquidity crunch which could arise due to sudden loss of job/income source. This way I don’t have to dip into my investments (which like selling gold ornaments could be very depressing) and if I don’t need the interest money, I could always reinvest and increase the diversification in my portfolio.
7. On the other hand if you are the secondly breadwinner (usually the wife) or have a secure govt. job, then all things equal I would go for cumulative bonds. Again based on your personal preference even a mix and match would not be something I would proscribe.
I hope you found this useful. Please feel free to add to this post or highlight the fault in my logic.

education Personal Finance

How to prevent pre-payment penalty on home loans

Most home loans in India have a covenant that restricts the number of times a person can make a pre-payment (usually 4 times a year) and the minimum amount. Also some of the banks charge a prepayment penalty. However if you read the fine print, most banks are relatively more flexible when it comes to changing the EMI (Equated Monthly Installment) amount.
Using this loophole, one can minimize the pre-payment penalty/charges by calling the bank one month to increase the EMI and revert it back to the old levels next month. Chances are that you would be able to stretch a little and continue paying that higher EMI for a few extra months. Hence reducing your interest expenses.
When it comes to debt, don’t ignore any processing charges, penalties or fines. It might put you in a debt trap.
For example
A 1M (10Lakh) INR loan for 15 years period at 8.75% has an EMI of 9,800/-
If you prepay 1EMI (9,800 on the first day), it will save you from paying about 3.5 EMIs 15 years later which is a net saving on 24,500/- in interest expense alone.
Please note that this calculation assumes that you would continue to pay the same EMI even though now your loan outstanding is (10Lakhs – 9,800/-)