The Unconventional Guide to Non-Convertible Debentures
- Oct 12, 2023
- 3:46 pm
Introduction:
Non-Convertible Debentures (NCDs) are a unique and fascinating option in the financial world. Let's unwrap the world of NCDs through this blog that aims to shed light on this financial segment and its unconventional perspective.
What are the Non-Convertible Debentures?
The very question, "What are Non-Convertible Debentures?"
A debenture is a type of debt instrument a company uses to raise capital.
However, not all debentures are created equal. The term "Non-Convertible" in Non-Convertible Debentures signifies that this debenture will not get converted into the equity shares of the issuing company. It differentiates them from the convertible debentures that are convertible into equity shares at a later date.
NCDs vs. Other Debt
While NCDs offer several advantages, comparing them with other debt segments like bonds, fixed deposits, and corporate deposits.
Each segment has its risk and return profile, and the better choice depends on individual investment goals. For instance, while fixed deposits offer more liquidity, they might not provide the same returns as NCDs.
On the other hand, corporate deposits might offer higher returns but come with higher risks.
The Historical Context of NCDs
The concept of debentures isn't new. For centuries, companies have been borrowing money from the public in exchange for a promise to repay with interest.
Over time, as financial markets evolved, the instruments used for these borrowings became more sophisticated. Enter the world of NCDs. They emerged as a response to the needs of both companies wanting to retain ownership and investors seeking stable returns.
The evolution of NCDs is intertwined with the broader economic landscape, reflecting shifts in market dynamics and investor preferences.
Why Choose NCDs?
Fixed Returns
One of the primary attractions of NCDs is the promise of fixed returns.
Unlike equity, where returns depend on market fluctuation, NCDs offer a predetermined interest rate. It is appealing in a volatile market where stability is a rare commodity.
Priority during Liquidation
In the unfortunate event of a company's liquidation, NCD holders get priority over the equity shareholders at the time of repayment. It provides an added layer of security to NCD investors.
Diverse Tenure Options
NCDs offer a range of tenure options, from short-term to long-term. This flexibility allows investors to choose a period that aligns with their financial goals and risk tolerance.
Tax Efficiency
The interest earned on NCDs is taxable as certain tax benefits are associated with long-term capital gains for NCDs held for a specific period.
Types of NCDs
NCDs come in two distinct categories: Secured and Unsecured.
Secured NCDs
These debentures have an asset or collateral from the issuing company as a safety net for investors.
The incapability of issuing companies to repay debt allows investors to sell off their collateral to recoup their investment. Due to the reduced risk, the interest rates for secured NCDs are typically lower than their unsecured counterparts.
Unsecured NCDs
Lacking any form of collateral backing, unsecured NCDs present a greater risk to investors. If the company doesn't meet its repayment obligations, investors must patiently wait for the issuer's repayment. As a result, these debentures usually offer higher interest rates.
The Mechanics of NCDs
When a company wishes to raise capital but doesn't want to dilute its ownership, it can issue NCDs.
Investors who purchase these NCDs are significant, lending money to the company. In return, the company promises to pay a fixed interest rate at regular intervals and return the principal amount at the end of the tenure.
Listing Non-Convertible Debentures (NCDs) on stock exchanges offers several advantages:
Capital Acquisition
By listing NCDs, companies can tap into a broader investor base, facilitating smoother capital generation.
Enhanced Exposure
Being listed can amplify the issuer company's presence, drawing in more potential investors.
Improved Liquidity
NCDs on stock exchange lists provide higher liquidity that gives an advantage to investors who may need to sell their interest before the maturity date.
Factors to Consider Before Investing in NCDs
Credit Rating
The company's ability to honour its interest payments and return the principal amount is crucial. Before investing, one should check the credit rating of the NCD. A higher rating indicates lower credit risk.
Liquidity
Unlike shares, NCDs might not be as liquid. It means that selling them before their maturity could be challenging or can make a loss.
Interest Rate
When the market interest rate rises above the rate offered by NCDs,
NCDs might appear less favourable when compared with other segments as it could lead to a decrease in the market value of the NCD.
Reinvestment Risk
There's also the risk that when the NCD matures, there might not be a similar investment available offering the same returns.
NCDs in the Indian Landscape
In India, the oversight and regulation of non-convertible debentures fall under the purview of the Securities and Exchange Board of India (SEBI).
SEBI has set forth specific criteria for the issuance and listing of NCDs. Furthermore, governmental entities and various companies, whether public or private, have the authority to issue NCDs.
Advantages of Investing in NCDs in India
Here are some of the notable benefits of NCDs in the Indian context
Tax Incentives
NCDs from Indian enterprises come with tax advantages, as they qualify for deductions under Section 80CCF of the Income Tax Act.
Enhanced Returns
While comparing to other fixed-income segments like bank deposits, NCDs from Indian firms often yield superior returns.
Portfolio Diversification
Investing in NCDs across various sectors helps investors to achieve a more balanced and diverse investment portfolio.
How to Invest in NCDs?
Investing in NCDs is a straightforward process. They are listed on stock exchanges, allowing investors to buy and sell them like any other publicly traded security.
In Conclusion
Non-Convertible Debentures offer a unique blend of fixed returns and capital appreciation potential. They provide a middle ground between the high risk of equities and the lower returns of traditional debt instruments. With the right mix of knowledge and approach, NCDs can be a valuable addition to an investor's toolkit.
Reference Sources:
Khatabook, myespresso, equiruswealth, thefixedincome
"Content shared is for information and education purposes only and should not be treated as investment or trading advice. Please do your own analysis or take independent professional financial advice before making any investments based on your own personal circumstances."
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