Answer Writing Practice for UPSC IAS & UPPSC Mains Exam: Paper - IV (General Studies – III) - 31 July 2020

Answer Writing Practice for UPSC IAS Mains Exam


Answer Writing Practice for UPSC IAS & UPPSC Mains Exam


UPSC Syllabus:

  • Paper-IV: General Studies -III (Technology, Economic Development, Bio-diversity, Environment, Security and Disaster Management)

Q. Critically examine the Bharat Bond Exchange Traded Fund (ETF). (250 words)

Model Answer:

  • Why in News?
  • Introduction
  • Bharat Bond Exchange Traded Fund (ETF)
  • Arguments in favour of Bharat Bond ETF
  • Arguments against Bharat Bond ETF
  • Conclusion

Introduction:

An Exchange Traded Fund (ETF) is a type of security that involves a collection of securities—such as stocks—that often tracks an underlying index. ETF shares trade throughout the day just like an ordinary stock. Bharat Bond Exchange Traded Fund (ETF) is the first corporate bond ETF of India.

Bharat Bond Exchange Traded Fund (ETF)?

  • Bharat Bond Exchange Traded Fund (ETF) is a corporate debt fund that will invest in Central Public Sector Enterprises, tracking the Nifty Bharat Bond Index. Being an ETF, after the NFO (New Fund Offer), its units can be purchased and sold on a stock exchange. The ETF will have two target maturities of three years and 10 years each:
  • The three-year Bharat Bond ETF will hold the debt of 13 public sector companies like the National Highways Authority of India (NHAI), Indian Railway Finance Corporation (IRFC) and Power Grid Corporation of India.
  • The 10-year Bharat Bond ETF will hold the debt of 12 public sector companies such as Rural Electrification Corporation (REC), National Bank for Agriculture and Rural Development (NABARD) and Power Finance Corporation (PFC).
  • This structure avoids interest rate risk, which characterizes open-ended debt funds.

Arguments in favour of Bharat Bond ETF:

  • The biggest benefit of the Bharat Bond ETF is a tax benefit. Debt funds are taxed at slab rate for holding periods of less than three years and at 20% with indexation for longer holding periods. This confers a major advantage on the ETF compared to fixed deposits in banks.
  • The maturity structure is another advantage of the Bharat Bond ETF. It allows lock-in yields if the ETF holds to maturity.
  • The ETF, unlike the Ordinary debt funds, does not lack the ‘target maturity’ structure. In a target maturity structure, the maturity of the holdings of the ETF keeps reducing over time in line with the reducing tenor of the scheme.
  • There will be virtually no credit risk as to the debt in the ETF is issued by public sector companies.
  • The open-ended structure of ETF allows investors to purchase and sell units in the stock markets to benefit from gains in the value of bonds from a decline in interest rates.
  • Liquidity is another big advantage of Bharat Bond ETF. In Fixed Maturity Plans, the customer enjoys both the tax and target maturity advantage. But they are not liquid. With Bharat Bond ETF, can be entered and exited on any trading day but also at different points during a trading day.

Arguments against Bharat Bond ETF:

  • In case the ETF holds to maturity the Net Asset Value (NAV) of the ETF will fluctuate on a daily basis due to interest rate movements as debt paper is marked-to-market.
  • The market price of ETF can also fluctuate on account of liquidity or the lack of it.
  • The ETF may not be liquid enough to actually execute transactions. you will have to buy and sell from the stock exchange.

Conclusion:

Bharat Bond Exchange Traded Fund (ETF) has been welcomed by the investors seeking low risk, predictable return and a reasonable level of liquidity. However, few properties like liquidity need to be taken care of and addressed in a more efficient manner.