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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Comparison of Products Across Categories

When an investment adviser compares a 5-year bank fixed deposit with a 5-year tax-free bond for a client in the highest tax bracket, which feature of the tax-free bond is the main reason it may deliver a higher post-tax yield than its coupon rate suggests relative to the deposit?

The tax-free bond's interest is exempt from income tax for the investor, while FD interest is taxed at the slab rate. For a client in the highest bracket, this makes the bond's post-tax yield compare favourably with the deposit even at a lower stated coupon.

  1. AInterest on the bond is exempt from income tax in the investor's hands, while deposit interest is taxed at the slab rateCorrect
  2. BThe bond's principal is guaranteed by the RBI
  3. CThe bond has no interest rate risk if sold before maturity
  4. DThe bond's interest is taxed at a flat 10% irrespective of slab

Explanation

Interest on eligible tax-free bonds is exempt in the investor's hands, whereas bank FD interest is added to income and taxed at the slab rate. For a high-bracket client this widens the post-tax gap. The other options state features that tax-free bonds do not have: no RBI guarantee, price risk exists on sale, and no flat 10% tax.

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