Non Convertible Debentures (NCDs) offer fixed income to investors for a specified tenure. Companies issue NCDs as a means to raise capital for diverse needs such as expanding their operations or initiating new projects. Essentially, an NCD is a commitment made by the issuing company to repay the principal amount with a promised interest rate, as documented.
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What are Non Convertible Debentures?
Non-Convertible Debentures (NCDs) are essentially closed-ended debt instruments available for subscription only within a specific timeframe. The attraction towards NCDs has largely been due to the comparatively higher returns they offer in comparison to traditional fixed income options such as bank deposits, recurring deposits, or post office schemes. The interest rates offered by NCDs, ranging from 11 to 12 percent, often entice investors, especially during periods when equities aren’t performing well.
Distinguishing between debentures and bonds, in India, usually involves the tenure and purpose of borrowing. Bonds typically serve as long-term borrowing instruments, while debentures cater to relatively shorter-term financial requirements.
Types of NCDs and Taxation
Non Convertible Debentures are broadly categorized into two types: Secured and Unsecured. Secured NCDs are backed by collateral or assets offered by the issuing company, providing a safety net for investors in case of a default. On the other hand, unsecured NCDs pose higher risk as they lack such collateral and usually offer higher interest rates as compensation.
Moreover, NCDs come with options such as call and put options. The call option allows the company to redeem the debenture before maturity, while the put option permits investors to surrender the debenture before maturity.
When it comes to taxation, interest income from NCDs is treated akin to bank fixed deposits. The interest accrued on NCDs is taxed based on your applicable tax slab. Additionally, gains from selling NCDs in the secondary market within a year of purchase are considered short-term capital gains and taxed accordingly. However, holding NCDs for over a year before selling them results in long-term capital gains taxed at a flat rate of 10% without indexation benefits.
Buying and Selling NCDs and Their Advantages
During a public issue, individuals can invest in NCDs either by submitting physical forms or through online platforms using their demat accounts. The liquidity aspect of NCDs provides investors with the flexibility to sell them in the secondary market as they are listed on stock exchanges like NSE or BSE.
The advantages of investing in NCDs include a constant income stream, higher interest rates compared to traditional bank deposits, and diversification of a debt portfolio. The ease of interest crediting directly to the bank account and the absence of tedious paperwork in Demat format further adds to their appeal.
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Risks and Disadvantages of Non Convertible Debentures
Despite their allure, NCDs come with their fair share of risks. Credit ratings play a crucial role in determining the reliability of the issuing company. A sudden downgrade in ratings can severely impact investors, highlighting the importance of choosing NCDs issued by well-established and high-rated companies.
Liquidity issues in thinly traded NCDs can pose challenges during the selling process. Moreover, investors need to consider post-tax returns and thoroughly examine the financial statements of companies issuing NCDs to assess their financial health and risk factors.
Example of Non Convertible Debentures
Suppose XYZ Corporation, a well-established company in the manufacturing sector, plans to expand its production facilities. To raise capital for this expansion, XYZ Corporation decides to issue NCDs worth ₹100 crore with an interest rate of 10% per annum for a tenure of 5 years.
Investors interested in this NCD offer can subscribe to it during the specified subscription period. These NCDs come with a face value of ₹1,000 each, and investors can choose the number of NCDs they wish to purchase based on their investment capacity.
Let’s assume an investor, Mr. A, decides to invest ₹1 lakh in these NCDs. At a face value of ₹1,000 per NCD and an interest rate of 10% per annum, Mr. A would be purchasing 100 NCDs (₹1,00,000 ÷ ₹1,000 = 100 NCDs).
The terms of the NCDs specify that interest will be paid annually. Therefore, Mr. A can expect to receive an interest of ₹10,000 every year (100 NCDs × ₹1,000 face value × 10% interest rate = ₹10,000).
Upon maturity after 5 years, XYZ Corporation will return the principal amount to Mr. A, which would be ₹1,00,000 (the initial investment).
Disclaimer:
This blogpost is on Non Convertible Debentures is not any kind of recommendation. All efforts have been made to correctly represent facts and figures in the post. The website or its management is not responsible for any kind of losses arising out of Investing in equities. Investors must therefore exercise due caution while investing or trading in stocks. NSE Options.in or the author are not liable for any losses caused as a result of the decision based on this article. Please consult your investment advisor before investing
