What are Non Convertible Debentures?
NCDs are debt instruments that companies issue to raise capital. They cannot be converted into equity shares of the issuing company. They get issued for a fixed tenure with fixed interest rates, and hence the returns are regular. Typically, firms with high credit ratings issue NCDs, and they are considered safer investments.
Let us understand NCD investments better with an example. Suppose a well-established company, XYZ Ltd., wants to raise funds for expansion. Instead of issuing equity shares, which would dilute ownership, XYZ Ltd. decides to issue NCDs. The company offers NCDs with a tenure of five years and an annual interest rate of 8%. Investors who purchase these NCDs lend money to XYZ Ltd. and, in return, receive an 8% interest annually. At the end of the five-year period, investors will get back their principal amount along with the accrued interest.
XYZ Ltd. has a high credit rating, which assures investors of the company’s capability to repay the debt. The NCDs are listed on a stock exchange, allowing investors to sell them in the secondary market if they need liquidity before the five-year term ends.
Types of Non Convertible Debentures
Secured NCDs<: These are backed by the company’s assets, providing an added layer of security to investors. In case of default, investors have a claim on the company’s assets.
Unsecured NCDs<: These are not backed by any collateral and hence are riskier compared to secured NCDs. But unsecured NCDs tend to come with higher interest rates.
Features of Non Convertible Debentures
Fixed Interest Rates<: The interest rates that Non Convertible Debentures offer are fixed and higher than most conventional savings schemes, like bank fixed deposits.
Tenure<: Tenure varies from a few months to several years, offering flexibility to the investor.
Liquidity<: Since the NCDs are listed on stock exchanges, they can be bought or sold before their maturity, providing liquidity.
Advantages of Investments in Non Convertible Debentures
Higher Returns<: The interest rates for Non Convertible Debentures are mostly higher when compared with other fixed-income instruments like bank fixed deposits.
Regular Income<: Investors receive periodic interest payments, providing a steady income stream.
Diversification<: NCDs bring diversification to an investment portfolio and reduce overall risk.
Risks Associated with NCDs
Credit Risk<: One major risk is the issuer’s chance of default. Before investing in an NCD, the investor should examine its credit rating.
Interest Rate Risk<: Change in market interest rates affects the price of NCDs. With the rise in interest rates, the market price of outstanding NCDs may decline.
Liquidity Risk<: While listed NCDs are quite liquid, unlisted NCDs are not readily saleable before maturity.
Regulatory Framework
The issue of NCDs and their listing is governed by the Securities and Exchange Board of India. The SEBI, under the (Issue and Listing of NonConvertible Securities) Regulations, 2021, has laid down the requirements for the issue of NCDs with stipulations for transparency and investor protection.
Key provisions
Disclosure Requirements
It is mandatory for the issuer to give detailed disclosures about the financial statement, risk factors, and purpose of the issue in the offer document so that the same is available to the investors for making relevant investment decisions.
Credit Rating
An NCD has to be compulsorily rated by a credit rating agency of some repute. This credit rating considers the creditworthiness of the issuer and hence, it helps the investors estimate the amount of risk involved.
Frequently Asked Questions
What are the key takeaways from this article?
NCDs are debt instruments that companies issue to raise capital. They cannot be converted into equity shares of the issuing company. They get issued for a fixed tenure with fixed interest rates, and hence the returns are regular. Typically, firms with high credit ratings issue NCDs, and they are considered safer investments.
Who should read this article?
This article is designed for retail investors, first-time bond buyers, and anyone looking to understand fixed income investments in India.
How does this relate to my investment portfolio?
Understanding these concepts helps you make informed decisions about asset allocation and build a diversified investment portfolio.
