What is NCD (Non Convertible Debentures)?
Non Convertible Debentures
Non-convertible debentures are a type of debt instrument that provides a fixed return to the investor. They have no built-in conversion option into equity. The only way for an investor to get liquidity from NCDs is by selling them in the secondary market or redeeming them at face value before maturity.
Features of an NCD
Interest: An NCD has a coupon rate determined when it's issued. The coupon rate will remain unchanged throughout its life except in case of restructuring or redemption. For example, if an NCD has a coupon rate of 10% per annum and matures after five years, its annual interest would be 10% for every outstanding year until maturity.
Credit rating: An NCD's credit rating indicates the issuer's ability to repay its obligations. Credit ratings are generally assigned by credit agencies, such as CRISIL. This rating is based on various factors such as the issuer's financial strength, track record of repayment of loans, etc. The higher the rating, the lower the risk of default; hence, better returns on investment.
No TDS: In accordance with section 193 of the IT Act, NCDs provided in DEMAT form and listed on a stock market are not subject to Tax Deduction at Source (TDS).
Individual investors will have to pay taxes at the same rate per the income tax slab if they sell their NCDs before a year has passed. The earnings will be added to the income. Tax on any gain realised by selling NCDs after one year will be charged at a rate of 10% if indexation is not applied or 20% in case of indexation.
Advantages of NCDs
Non-convertible debentures are a form of debt instrument issued by companies to raise money from investors. The main advantage of NCDs for companies is that they are not convertible into shares, which means the investor can't earn any equity in return for their investment. However, there are many advantages to investing in an NCD.
NCDs offer several advantages over traditional bonds:
They carry higher interest rates than other bonds because they are riskier to hold. NCDs are unsecured instruments, so issuers need to compensate investors for taking on this increased risk.
A company may choose to issue an NCD instead of a bond if it wants more flexibility regarding when it has access to the money raised through these instruments.
NCDs are not as restrictive as corporate bonds, which means issuers can use them to raise money and use the proceeds to make acquisitions or repurchase shares. However, investors should be aware that NCDs don't offer any protection against the dilution of their investment.
Types of NCDs
The two main categories of NCDs are secured and unsecured.
Secured NCDs are backed by real estate or other assets considered collateral for the loan made to the company (called its "issuer"). The issuer must repay these loans before repaying any other debts or interest owed to bondholders.
Unsecured NCDs, meanwhile, are not backed by assets or collateral. Instead, it depends on the issuer's creditworthiness and ability to repay investors if something goes wrong with business operations. For example, a drop in profits would affect their ability to make interest payments on time without defaulting on obligations.
Things to consider before investing in NCDs
Before you invest in non-convertible debentures (NCDs), you must understand the risks associated with this type of instrument. Here are some of these risks:
- Credit risk: If the company does not repay the amount due on the maturity date or declares bankruptcy before maturity, investors will lose their investment.
- Price volatility: The price at which NCDs are sold to investors is fixed at the time of issue, unlike equity shares, where prices vary daily depending on market conditions and investor sentiment. This means that if there is significant negative news about a company, its ratings might go down compared to when it was issued. This will impact the price of the bond.
- Liquidity risk: Although NCDs are listed on exchanges, NCDs are not as liquid as other types of instruments and can be difficult to sell when you want to do so because the market for them is relatively small.
Tips for investing in non-convertible debentures
While NCDs are not a bad investment by any means, it's important to keep in mind that they're still high-risk instruments, and you should only invest in them if you have a solid understanding of the risks involved. Here's what you need to know before doing so:
Invest only in non-convertible debentures of familiar companies. You'll want to ensure that the company has been around for at least five years and has an established track record of paying interest on time (if applicable). Look into their financial statements regularly, especially when the stock market is volatile or if there is news regarding the issuer. This will help ensure your money is safe.
Avoid investing in NCDs issued by companies facing financial problems or experiencing poor earnings growth. This is because it could negatively impact their ability to pay back their debts and make good use of any funds raised through debt issuance efforts like issuing NCDs.
Seek out long-term capital appreciation rather than short-term gains from investing in non-convertible debentures. This means buying them when prices are low, so they can appreciate over time rather than purchasing them when they are high with hopes of selling them later at even higher prices. The former strategy allows investors more flexibility since price fluctuations don't affect returns much. However, some investors prefer investing via this method because it requires less work to monitor daily price movements, which can get monotonous after a while.
If you're interested in investing in bonds, NCDs may be worth a look. They offer some of the same benefits as other types of bonds. They're backed by the company that issues them and can be traded on the secondary market. However, know that, unlike convertible bonds, there is no option to convert your NCDs into equity shares at some point during their life cycle.
Frequently Asked Questions (FAQs)
What is the difference between bonds and NCDs?
There is a big difference between non-convertible debentures and bonds. Bonds are a form of fixed-income securities that companies or governments issue to raise capital. While NCDs are issued by private companies. However, bonds might have the option to be converted into equity, while NCDs can't be converted into equities.
Are NCDs similar to Fixed Deposits(FD)?
One can compare NCDs to FDs as the return is fixed at the time of investment.
Are there any tax advantages to buying NCDs?
The NCDs will be subject to LTCG at a rate of 20% with indexation if sold after a year or before maturity.
You must check with your tax advisor before investing in any NCD.
How do non-convertible debentures work?
A non-convertible debenture is a type of debt security. It is issued by a company to raise money and can be sold to investors in the form of bonds. In most cases, these types of NCDs are issued with a set maturity date, although this may vary depending on the issuer. The holder of an NCD receives interest payments over time until it reaches maturity when all principal becomes due.
Can I sell an NCD before maturity?
Yes, you can sell an NCD before maturity. However, if you decide to sell your NCD before maturity, you should be aware that there are different ways of doing this, and some may involve paying a premium or discount on the stated price. Selling an NCD at a premium means selling it at a price higher than its face value. Conversely, selling an NCD at a discount means selling it at a price lower than its face value.