What Are NCDs Non-Convertible Debentures? How Investment In NCD Works? IIFL Finance

NCDs are backed by specific assets of the issuing company, providing an additional layer of security for investors. In case of default, the assets can be liquidated to repay the NCD holders. Organizations tend to raise funds through non-convertible debentures mostly to fulfil a specific business purpose.

So, you get both a steady income and a chance for more money if the company does well. If you belong to low income-tax brackets, you can surely consider investing in highly rated (like AAA, AA, AA+ etc.,) NCD public issues. Since Bank Fixed Deposits may offer 6 to 7% returns, so it is normal to get lured looking at 8-9% returns provided by NCDs. But, we need to compute post-tax returns on debentures, as the interest payouts are taxable.

One can invest in Non-convertible debentures through NCD Public Issues or purchase through the secondary market. Investors want investment options that manage liquidity and risks while offering substantial returns. Debentures are long-term financial instruments issued by a company https://1investing.in/ for specified tenure with a promise to pay fixed interest to the investor. Debentures are long-term debt instruments that a business offers to entice investors’ funds. A company may issue both convertible and non-convertible debentures, among several other categories.

1. Where security is provided for loan stocks or bonds in the US, they are termed «mortgage bonds».
2. The issuing company lists the non-convertible debentures on the stock exchanges, which are allotted based on a first come, first serve.
3. Because of this, irredeemable debentures are also known as perpetual debentures.
4. Companies are ranked by credit rating agencies such as CRISIL, CARE etc.
5. Interest payouts are either monthly, quarterly, half-yearly or annually.

Bondholders have the option of holding the bond until maturity—at which point they receive the return of their principal—but, holders may also convert the debentures into stock. The debenture can typically only be converted into stock after a predetermined time, as specified in the bond’s offering. Both a bond and a debenture are types of fixed income securities wherein entities borrow money, but they differ in how they are structured.

When a depositor places money in a fixed deposit, the amount of profit or interest paid on the investment is fixed. The rate will not increase or decrease at any time regardless of fluctuations in interest rates. The interest rate offered by fixed deposits is usually set by prevailing low-risk market standards like the London Inter-bank Offered Rate (LIBOR) or Treasury rate.

Tax implication in NCDs

Although they are riskier than convertible bonds in terms of market volatility, non-convertible bonds offer a higher interest rate or yield to bondholders. Since these cannot be converted to equity shares, the only option is to wait until the maturity period. A debenture is a long-term debt instrument issued by corporations and governments to secure fresh funds or capital. There is no collateral or physical assets required to back up the debt, as the overall creditworthiness and reputation of the issuer suffice.

Notably, the investment threshold for this product starts at just Rs. 10 lakhs. Non-convertible debentures are mostly backed by the creditworthiness and debt-servicing capability of a company. Hence it can be said that they are highly affected by the nature of business and its money management capability.

What is a zero-interest convertible debenture?

First, a trust indenture is drafted, which is an agreement between the issuing entity and the entity that manages the interests of the bondholders. Next, the coupon rate is decided, which is the rate of interest that the company will pay the debenture holder or investor. This rate can be either fixed or floating and depends on the company’s credit rating or the bond’s credit rating.

The debentures which can’t be converted into shares or equities are called Non-convertible debentures (or NCDs). A higher rate implies higher risk debt instruments, and a lower rate means lower risk debt instruments. Coupon payouts can be made monthly, quarterly, semi-annually, or annually. 1)  Secured debentures  – The secured NCD is the safer option because it is backed by the company’s assets or any available collateral. Investors may be able to recover their money by selling the company’s assets if it doesn’t make the agreed payment on time. Some debentures, like other bonds, are convertible, meaning they can be converted into company stock, while others are non-convertible.

The number of equity shares you receive after debenture conversion is the debenture’s conversion rate. When you have this loan, the company pays you regular interest, like a monthly allowance. But if the company’s stock becomes more valuable over time, you can switch your loan into owning some of that stock.

Debentures vs. Fixed Deposits: An Overview

Therefore, all debentures can be bonds, but not all bonds are debentures. In business or corporate financing, unsecured debentures are typically riskier requiring the payment of higher coupons. Companies often favor issuing secured bonds because they can pay a lower coupon rate. The percentage of debenture holdings converted into equity shares is known as the quantum of conversion. The issuer specifies the quantum at the time of debenture issuance.

The contract specifies features of a debt offering, such as the maturity date, the timing of interest or coupon payments, the method of interest calculation, and other features. The fixed interest rate paid to investors on the convertible debenture is 2%, which is lower than the typical bond rate. However, non convertible debentures the lower rate is the trade-off for the right to convert the debentures into stock. Partly-convertible debentures are also a version of this type of debt. These loans have a predetermined portion that can be converted to stock. The conversion ratio is determined at the onset of the debt issuance.

What is the difference between convertible and non-convertible debentures?

Since NCDs are more risk-averse and liquid, they are an excellent alternative to stocks if reputable companies issue them. However, to compensate for this drawback of non-convertibility, lenders are usually given a higher rate of return compared to convertible debentures. By issuing bonds the company is able to maintain the trust of both the forms of investor to the company as in equity and debenture holders.

Therefore, these may carry relatively higher interest rates than otherwise similar bonds from the same issuer that are backed by collateral. Efiling Income Tax Returns(ITR) is made easy with Clear platform. Just upload your form 16, claim your deductions and get your acknowledgment number online.

The interest rates offered on NCD debentures are more or less fixed. On maturity, the investor will get back the principal amount along with interest. Since NCDs are not backed by collateral, but just the creditworthiness of the issuer, ratings given by credit rating agencies become important. Such ratings help investors to understand the history of the issuer’s creditworthiness and what it may look like in the future. All debentures follow a standard structuring process and have common features.