What are tax free Bonds ? Is the principal tax free or the interest tax free?
These are not like the 80CCF infrastructure bonds that are open right now so don't confuse these bonds with them. This is truly tax free in the sense that the interest you receive from these bonds will not be taxed.
The infrastructure bonds are called tax saving bonds but are not tax free. They save tax because when you invest in them then you can reduce the amount of investment (up to a maximum of Rs. 20,000) from your income and lower your tax incidence. But the interest income on them is taxable, so they are not tax free.
As far as the principal being tax free is concerned – the principal is always tax free. That's your money anyway and tax is charged only on the income by the way of interest or capital gains.
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