All About Non-Convertible Debentures

Non-convertible debentures (NCDs) provide corporate entities with the opportunity to raise capital. For investors, it is an investment that can generate fixed returns. It is an important financial instrument for companies that want to look beyond stocks, corporate FDs and other conventional fund-raising instruments. NCDs play an important role in the Indian financial landscape. Let us understand this debt instrument in all its details.

Meaning of Non-convertible Debentures and its Key Features

NCDs are debt instruments that are issued by companies to raise funds from the public. Convertible debentures offer the option of getting converted into equity shares of the issuing company. However, NCDs do not have that option, hence the name “non- convertible”. Its key features include,

• A fixed interest: NCDs offer a fixed interest income. The interest rate is also known as the coupon rate. Interest on NCD is paid regularly till its maturity. The frequency can be monthly, quarterly, half-yearly, or annually.
• Maturity: NCDs have a specified tenure. It can be short-term, usually one year, or long-term NCDs of up to ten years or even more.
• Credit rating: The companies issuing NCDs are rated by credit rating agencies. The credit rating helps investors understand the creditworthiness and associated risk of the NCD.

Types of NCDs

NCDs In India can be issued across various types. Some of the popular forms of NCD are,

• Secured NCDs: These NCDs are backed by the issuer with assets or collateral. These are a more secure form of investment.
• Unsecured NCDs: These NCDs are not secured by assets. To compensate for the higher risk, issuers often offer higher returns on unsecured NCDs.
• Callable NCDs: These NCDs have a lock-in period, but the issuers can redeem the debentures before maturity and after the lock-in period.
• Fixed Rate NCDs: These are NCDs that offer a fixed coupon rate till maturity.
• Floating Rate NCDs: Here the coupon rate is flexible as it is linked to a benchmark rate which could be RBI repo rate or government bond yields.

How do NCDs Differ from Corporate Fixed Deposits?

Both NCDs and corporate fixed deposits (FDs) are fixed-income debt instruments. However, there are differences too.

• Risk and Return: NCDs are sensitive to market risks, and offer higher returns to compensate for the risks. Corporate FDs are relatively safer but offer lower returns compared to NCDs.
• Liquidity: NCDs are listed on the stock exchange, and can be traded freely. Liquidity in corporate FDs is possible through premature withdrawal or early redemption only.
• Taxability: Interest on corporate FDs is taxed as per the income tax slab. Profit made on the sale of NCD is taxed as per the long-term or short-term capital gain tax rules.
• Issuance: Corporate FDs are mostly issued by banks and financial institutions while NCDs are generally issued by companies.

Why Invest in NCDs?

Here are some of the reasons that might tempt you to invest in NCDs.

Fixed income:NCDs offer a fixed and regular source of income through the interest accumulated.

Portfolio diversification:You can balance your risk exposure by investing in NCDs, thus diversifying your investment portfolio.

Decent return:NCDs offer a higher rate of return in comparison to traditional debt instruments like bank deposits.

Capital appreciation:Unlike most other debt instruments, NCDs can generate capital appreciation as well. They are listed on the stock exchanges and can appreciate market movements.

How to Buy NCDs?

Purchasing an NCD is similar to buying a stock. You can subscribe to it when it is issued by the company. Once the NCD gets listed on the stock exchange, investors can buy it through their demat and trading accounts. NCDs traded in the stock market have a T+1 settlement cycle.

Things to Check Before Investing in Non-Convertible Debentures:

If you plan to invest in NCDs, here are a few things you must keep in consideration.

Credit rating:Check the credit rating of the issuing company before investing in its NCD. Credit rating indicates the default risk associated with the company.

Interest rate and duration:Compare the coupon rates offered by different issuing companies, along with their respective credit ratings. Also, check if the tenure of the NCD aligns with your investment objectives.

The secured vs. unsecured decision:Based on your risk tolerance, decide whether to choose a secured NCD or an unsecured one.

Redemption:Check the call and put options in NCD to understand your, and the company’s right to redeem the instrument before maturity. Also, check its tradability in the stock exchange.

Market conditions:Always monitor the market conditions, the prevailing interest rate, and general economic conditions before investing in NCDs.

Issuer's financials:Check the financial robustness of the issuing company and its business model, revenue patterns, liabilities and recent financial performances.

Summing it up

Non-convertible debentures are an ideal way of generating high returns through debt investment. By evaluating the risks associated with the NCD, you can get a steady and regular income on your investment. These evaluations include an assessment of the credit rating, interest rate, maturity period, market scenario, etc. Depending on market conditions, you can also earn a profit on the capital appreciation in your NCD investment. NCDs can be a rewarding addition to your existing portfolio.

Reference

https://www.angelone.in/knowledge-center/share-market/how-to-buy-ncd https://support.zerodha.com/category/trading-and-markets/trading-faqs/trading- categories-and-groups/articles/debentures-bonds-on-kite
https://www.iifl.com/blogs/other/how-to-buy- ncds#:~:text=Later%2C%20the%20company%20issues%20the,order%20to%20buy%2 0NCD%20online. https://cleartax.in/s/non-convertible-debentures-ncd#diff
https://www.godigit.com/business-insurance/debentures/what-is-non-convertible- debenture https://www.bajajfinserv.in/non-convertible- debentures#:~:text=Non%2Dconvertible%20debentures%20(NCDs)%20are%20fixed% 2Dincome%20instruments%20that,cannot%20be%20converted%20into%20equity%20o r%20stocks.