All you need to know about Non-Convertible Debentures
Debentures are long-term loans raised by governments or corporations from the public to fulfil their capital requirements. There are two types of debentures, convertible and non-convertible. The former can be converted into equity after their maturity at the discretion of the owner.
Non-convertible debentures (NCD) are fixed-income debt instruments that cannot be converted into equity. They have a fixed tenure and a maturity date upon which the issuing corporation or government has to repay the lenders. The interest rate on debentures is also called the coupon rate and it can be paid either monthly, quarterly, semi-annually or annually. The entity raising the funds benefits by fulfilling its capital requirements without losing ownership and the investors benefit by receiving returns that are higher than other fixed-income financial instruments, tax benefits, low risk and liquidity.
Features of NCDs
NCDs are listed on the stock market and issued by companies through open market public issues which makes buying and purchasing of this instrument very easy and accessible. While they are not as liquid as stocks, they are more liquid than bank FDs.
NCDs and the companies issuing them are rated by professional and certified credit rating agencies. Only companies with good credit ratings can issue debentures and are rated regularly by the agencies.
The interest rates are fixed, and the investor has different payout options to pick from ranging from monthly to annually. The interest rates are often higher than other fixed-income investment options. But the rates are inversely related to the creditworthiness of the issuing company. If the creditworthiness is low, the interest rate will be high.
There is no TDS (tax deduction at source) on NCDs offered in DEMAT mode and are listed on stock exchanges. The income from NCDs; however, carries tax liability based on the normal rate of taxation similar to that of fixed income securities under ‘income from other sources. If the NCDs are sold in less than a year, then they will be taxed as per the STCG (short-term capital gains) norms, and if they are sold after a year, then LTCG (long-term capital gains) norms will be applicable.
Difference Between Corporate FDs and NCDs
Corporate Fixed Deposits are term deposits offered by banks and non-banking financial companies for a fixed period of time and with a fixed interest rate. FDs are similar to NCDs in terms of high returns, fixed time period, and fixed rate of interest, but there are a few important differences that one must know.
Types of NCDs
NCDs are of two types of non-convertible debentures - secured and unsecured.
Secured NCDs are backed by some collateral of the issuing company to protect the investors from losses in case the company fails to repay. If the borrower defaults on repayment, investors can recover their dues by liquidating the collateral assets. The interest rates are lower in secured NCDs compared to unsecured NCDs since they carry a lower risk.
Unsecured NCDs are not backed by any assets as collateral and thus carry a higher risk. In the case of default of repayment, the investors have no choice but to wait till the issuer repays them. Hence, the interest rates tend to be higher.
Non-convertible debentures are a financial instrument for companies to raise funds when in need. NCDs are standardised instruments and can be traded on exchanges, giving them superior liquidity than many other fixed-income assets. They also tend to bring higher returns. But before making an NCD investment, it is important that the investor checks the company’s health by means of their credit rating and understands the risk exposure they are taking.
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