Non Convertible Debentures (NCDs) or Bonds are nothing but debt instruments issued by a corporation. Ordinarily, a company can raise money by either issuing shares or taking a loan. They can take a loan from a bank, financial institutions, raise money abroad, or take a loan from the public.
When they take a loan from the public - the instrument used is called a debenture or a bond. Further, there are two types of debentures - Convertible Debentures, and Non Convertible Debentures.
Convertible Debentures can be converted into shares after the lapse of a certain time period, whereas Non Convertible Debentures always remain debt instruments. Hence, the return offered by them is relatively higher than convertible debentures. The issuing company pays a fixed rate of interest for the pre-defined period.
Debentures and bonds are used inter - changeably, so keep that in mind as well, and don’t be confused with that.
For e.g. If you hold a 10% 5-year corporate bond issued by XYZ company with Face Value Rs. 100 and interest is paid annually then XYZ company will
• Pay you Rs. 10 every year for 5 years
• Redeemable face value of the bond will be Rs.100 + Rs. 10 accrued interest at the end of 5 years
Benefits of investing in NCDs If you are looking for an investment that generates fixed income periodically, NCDs may be an ideal investment for you.
• It offers higher rate of interest as compared to fixed deposits or postal savings or similar investments avenues
• If the bonds are listed, you can also sell it in the secondary market before its maturity
• A listed bond may also earn you capital appreciation i.e. you can sell your bond at a price higher than your cost price in the market
Things to be considered before investing in NCDs…
• Ratings: Rating agencies use simple alphanumeric symbols to convey credit ratings. For example, CRISIL assigns credit ratings to debt obligations on three basic scales: the long-term scale, the short-term scale, and the fixed deposit scale. AAA is the highest Credit rating by CRISIL indicating highest safety. Higher rating indicates timely servicing of debt obligations by the issuer and lower amount of credit risk.
• Secured and Non Secured NCDs: If the company in whose NCDs you have invested is wound up (closes down), it’s important for you to know where you stand when the company repays its debts. The order in which the Company repays its debts depends upon the ranking of the bonds based on the security Bonds are either secured against assets or unsecured. If the bonds are secured, in the event of winding up of the company, it would sell off the assets against which the bonds were secured and repay the investor. However, all secured assets do not have the same ranking
• Listing & Liquidity: Debentures can be listed on a stock exchange, providing opportunities to accumulate additionally or to sell them and exit earlier than the tenure of the debenture. But investors have to be careful about the price movement of the instruments, which in turn depends upon the interest rate movements and the applicable coupon interest rate payable on them. More the liquidity better it is for the investor.
• Varying Tenures: Redemption periods usually range from 2-15 years. One should choose the tenure on the basis of his/her own personal financial goals and risk appetite.
• Embedded Options: There are embedded options such as Put and Call attached to NCDs. A callable bond could be called or redeemed by the issuer before the maturity of the bond. A puttable bond works in an exactly opposite way where the investor can sell the bond to the issuer at a specified price before the maturity of the bond if the interest rates go up after the issuance and investor has higher yielding investment options available.
Comparison between FD and NCD:
|Characteristics||NCD||Fixed Deposit (FD)|
|Liquidity||More liquid due to listing on exchange||FD can’t be sold in the market. However, bank FDs are also highly liquid and can be encashed before maturity with penal charges.|
|Security||NCDs are mostly secured debt||Bank FDs are insured to the extent of Rs One lakh only by Deposit Insurance and Credit Guarantee Corporation of India (DICGC) for both principal and interest amount earned by you.|
|Taxation||No TDS is applicable on debentures held in demat form. In addition to interest income, there can be capital gains if the NCD is sold before maturity. ||TDS is applicable|