All about Non-convertible debentures

Do you want to invest but with guaranteed returns? Is your risk appetite not that high? Are you looking to invest for a specific time period? Then you might be interested in non-convertible debentures (NCDs). NCDs are debt instruments issued by companies to raise funds from the public. They offer a fixed interest rate and a predetermined maturity period. This makes non-convertible debentures a suitable option for risk-averse individuals. If you are curious to know more about NCDs, look no further...

But before we get into NCDs, let's understand what debentures are.

When companies want to raise funds, they issue debentures. These debentures are long-term instruments which are not backed by any collateral. Debentures depend on the reputation of the issuer. Convertible and non-convertible debentures are the two types of debentures issued. After a specified period, convertible debentures can be turned into equity shares of the issuing company.

What are Non-Convertible Debentures?

Unlike convertible debentures, non-convertible debentures cannot be converted into equity shares of the issuing company. NCDs offer a fixed interest rate called a coupon rate, which is payable to investors at regular intervals. For instance, if a NCD has a coupon rate of 15%, it means that 15% of the invested amount is the interest offered by the company to the purchaser. They have a specific maturity period after which the principal amount is returned to the investor.

Types of Non-Convertible Debentures

Secured NCDs: These debentures are backed by the company's assets. In case of default, the assets are sold to repay the debenture holders.

Unsecured NCDs: These debentures are not backed by any specific collateral. In case of default, the debenture holders have a lower priority in repayment compared to secured NCD holders.

Callable NCDs: The issuing company has the option to call back or redeem the NCDs before the maturity period.

Non-Callable NCDs: These debentures cannot be called back or redeemed before the maturity period.

Factors to consider before investing in NCDs

1. Credit Rating- Since non-convertible debentures are not backed by any collateral, they rely on the reputation of the issuing company. Therefore, it becomes necessary to evaluate the credit rating assigned to the non-convertible debenture by credit rating agencies. A non-convertible debenture with higher ratings indicates lower default risk.
2. Interest Rate- NCDs offer attractive interest rates. But it comes with its risks. If a non-convertible debenture is offering higher rates, there is higher risk involved with it. Based on your target amount, compare and choose a NCD that offers the desired results.
3. Maturity Period- Determine the maturity period that aligns with your investment goals. If you want quick liquidity, you can invest in short-term NCDs. Whereas, if you want higher interest rates, long-term NCDs are more suitable.
4. Company's Financial Health- Without any collateral to rely on, the company's reputation becomes an important factor to consider before investing. Make sure to assess the financial strength, track record, and reputation of the issuing company. Other factors to look at are the company's profitability, debt levels, and market standing.
5. Liquidity- Even though they are listed on stock exchanges, the trading volumes may be low. Thus, you should consider the liquidity aspect before investing in a non-convertible debenture. Early exit from NCDs may be challenging.
6. Tax Implications- Income earned from non-convertible debentures is taxed according to the income slab. Keep the tax rates in mind before investing.

What are the associated risks?

1. Default Risk: There is a possibility of the issuing company defaulting on interest or principal payments. Assess the creditworthiness of the company before investing.
2. Interest Rate Risk: Changes in market interest rates can impact the value of NCDs. If interest rate rises, the value of existing NCDs may decline.
3. Liquidity Risk: NCDs may have lower liquidity compared to other investment options. Exiting early from NCDs may be challenging.
4. Market and Business Risk: External factors like economic conditions, industry trends, and company-specific events can affect the performance of NCDs.

The bottom-line is that NCDs are likely suitable for individuals seeking fixed returns with moderate risks. However, it is necessary to conduct thorough research, understand the associated risk, and carefully evaluate the creditworthiness of the issuing companies. With proper due diligence and a well-diversified portfolio, investing in NCDs can contribute to your overall financial goals.