In the field of finance, there’s a constant search for instruments that offer a good balance between risk and return. Non-convertible debentures (NCDs) emerge as a compelling option for investors seeking a steady stream of income with a predictable level of risk. This article will explore what is NCD, what is NCD in finance, what is NCD bond, What is NCD investment, How to buy NCD online and How to invest in NCD.
What is NCD?
An NCD or Non-Convertible Debentures refers to long-term funds that are raised through debt instruments by various companies. To know what is NCD, While other forms of debt securities can be converted into equity, NCDs cannot be converted into equity shares of the issuing company. It sets them apart from Convertible Debentures (CDs) which give the investor the right to convert this debenture into company shares at a predetermined price and at a particular time. It implies that NCD holders are debenture holders and are legally entitled to interest and capital on the debenture at the due date.
In simple terms, when investing in an NCD, you are actually depositing money with the company for a certain number of years. Consequently, you will receive a fixed rate of interest throughout the expiry of the NCD, and the company will redeem the face value upon its expiration.
Types of Non Convertible Debentures
Non-Convertible Debentures (NCDs) are classified into two primary types based on the security offered to investors: Secured NCDs and Unsecured NCDs:
Secured NCD
Secured NCDs are backed by specific assets of the issuing company, which serve as collateral. This means that in the event of default by the issuer, investors have a claim on the pledged assets. The presence of collateral significantly reduces the risk for investors, making secured NCDs a safer investment option. These debentures typically offer lower interest rates compared to unsecured NCDs due to the reduced risk associated with them.
Unsecured NCDs
In contrast, unsecured NCDs do not have any collateral backing them. Investors in unsecured NCDs rely solely on the creditworthiness and financial stability of the issuing company. As a result, these types of NCDs carry a higher risk, and consequently, they tend to offer higher interest rates to compensate for that risk. If the issuer defaults, investors may face difficulties in recovering their principal investment.
NCD Investment: How Does it Work?
When a company issues an NCD, it simply means that it is seeking financial assistance from investors like you. In return, the company agrees to pay a fixed rate of interest periodically, usually monthly, quarterly, or annually and the face value at the end of the NCDs’ maturity period. This maturity date could take as little as a few months and up to several years based on the specific NCD issuance.
Non Convertible Debentures Example
Let’s say Company XYZ, a well-established infrastructure company, decides to raise funds for expanding its highway project.
To achieve this, Company XYZ issues Non-Convertible Debentures (NCDs) worth Rs. 100 crores with a tenure of 5 years. The interest rate offered on these NCDs is 8% per annum, payable annually.
Here’s a breakdown:
- Investor Perspective: An investor who purchases a Rs. 10,000 NCD of Company XYZ will receive an annual interest payment of Rs. 800 (8% of Rs. 10,000) for five years. After five years, the investor will receive the principal amount of Rs. 10,000 back.
- Company Perspective: Company XYZ borrows Rs. 100 crores from investors through these NCDs and agrees to pay a fixed interest rate of 8% annually for five years. At the end of five years, the company will repay the principal amount of Rs. 100 crores to the investors.
Important to note:
- Unlike Convertible Debentures, these NCDs cannot be converted into shares of Company XYZ.
- The interest rate of 8% is just an example and actual interest rates may vary depending on market conditions,issuer’s creditworthiness, and other factors.
This non convertible debentures example illustrates the basic concept of an NCD where a company borrows money from investors and promises to pay interest and principal back at maturity.
Non Convertible Debentures Meaning in Finance?
The question of what is NCD in finance, to understand, in relation to finance, NCDs fall under the category of fixed-income securities. This implies that an NCD comes with a coupon, a rate that is determined at the time of issue and which remains unalterable up to the time of the bond’s maturity. This feature makes the cash flows very attractive to investors and gives them some level of certainty about their returns on investment.
Such securities are usually floated by well- established firms with good credit status in the market. This is because NCDs are unsecured instruments and do not have any security attached to them, as is the case with secured debentures. Hence, the ability of the issuer to pay its debts on time is an important factor in defining the interest rate on the NCD.
What is NCD Bond?
Sometimes the terms NCD and bond are used interchangeably with each other without much difference in the general meaning. To know better what is NCD bond, though there are some similarities, it is important to understand the difference.
- NCDs: Particularly relate to securities in the nature of loans advanced to companies in an effort to finance their activities.
- Bonds: A general term which actually refers to debt securities which could be issued by the government, corporations or any other legal entity.
Therefore, it could be stated that all NCDs are bonds, but not all the bonds are classified as NCDs.
What is NCD Investment?
Purchasing an NCD is similar to providing a loan to a company and therefore, it is important to consider the borrowing company as well. In exchange, you get short-term cash flow in the form of interest and the principal repayment at the termination of the bond. As compared to other fixed income generators such as bank fixed deposits, NCDs attract a relatively higher rate of interest. Nonetheless, it is crucial to know what is NCD investment and to highlight that NCDs fall under credit risk since the ability to pay the interest and the principal is based on the ability of the issuers of the securities.
How to Buy NCD Online?
Like most bonds, purchasing NCDs has become more convenient with the enhancement of the internet-based trading systems. Currently, most brokerage firms and financial institutions allow their customers to invest in NCDs online.
Here’s a guide on how to invest in NCD and how to buy NCD online. To buy an NCD online, you typically need to follow these steps:
- Open a Demat and Trading Account: It’s recommended that you open a Demat and trading account with a brokerage firm if you do not have one.
- Complete the KYC Process: Ensure that you present all the documents that are required for Know Your Customer (KYC) process.
- Select an NCD: Study various NCDs based on interest rate, duration, credit rating of the issuer, minimum investment amount.
- Place the Order: Complete the online submission of the application for the NCD that you are interested in.
- Allotment: If your application is successful, the NCDs will be credited in your Demat Account.
Non Convertible Debentures Interest Rates
The interest rate on a Non-Convertible Debenture (NCD) is a crucial factor for investors. It directly impacts the return on investment. Several factors influence the NCD interest rate offered on an NCD:
- Issuer’s Credit Rating: Companies with higher credit ratings (like AAA or AA) are perceived as less risky.Consequently, they can offer lower interest rates. Conversely, companies with lower credit ratings may need to provide higher interest rates to appeal to investors.
- Market Interest Rates: NCD interest rates are greatly influenced by the current interest rates in the economy. NCD interest rates typically rise in order to be competitive when interest rates rise.
- NCD Tenure: Higher interest rates are often offered by longer-term NCDs to make up for the longer lock-in period for investors.
- NCD type: As there is less perceived risk, secured NCDs—which are backed by assets—generally have lower interest rates than unsecured NCDs.
- Coupon Payment Frequency: NCDs with more frequent coupon payments (monthly, quarterly) might offer slightly lower interest rates compared to those with annual payments.
- Remember: Despite the seemingly promising returns NCDs come with its risks. As in any secondary market, the values of NCDs can change and the issuer may default. You should never invest with your hard earned money and avoid putting everything that you cannot afford to lose.
Why Consider NCDs?
Here are some key benefits that make NCDs an attractive investment option:
- Fixed Income: NCDs provide a fixed rate of interest that is paid for the entire period of investment. This predictability makes it possible for you to forecast your finances and create a stable source of income.
- Higher Returns Compared to Fixed Deposits: In general terms, NCDs provide better returns as compared to fixed deposits that are made available by banks. This means that there is a possibility of getting higher returns on the amount of money invested.
- Diversification: Investing in NCDs aids in diversifying your portfolio, which can aid in the reduction of risk. Compared to stocks and mutual funds, NCDs are less risky and more profitable, which makes them an excellent addition to the investor’s portfolio.
- Tax Benefits: In some countries, NCDs have relatively favourable tax treatment compared to other investment instruments. It is important that you review the tax laws that are specific to NCDs in your area of operation. (Note: The tax advantages may also depend on where you are located and it is therefore advisable to seek advice from a tax consultant.
Conclusion
Non Convertible Debentures (NCDs) are debt instruments that represent a debt obligation of a company. They also form part of fixed income securities and are widely preferred by investors in the low-risk investment category. The advantages of NCDs include a predetermined rate of interest, a definite period of redemption, and tax exemptions. Holders can opt for secured NCDs that are issued with an underlying security or unsecured NCDs, which attract higher rates.
FAQs on What is NCD
1. What are Non-Convertible Debentures (NCDs)?
Non-convertible debentures are debt instruments issued by companies to raise funds. Unlike equity, NCDs represent a loan given to the company by the investor. Investors receive regular interest payments and the principal amount back at maturity.
2. What are the different types of Non Convertible Debentures?
Non-convertible debentures can be classified based on two types. The two types of non Convertible debentures are:
- Secured NCDs: These NCDs are backed by the company’s assets. In case of default, the debenture holders have a claim on these assets.
- Unsecured NCDs: These NCDs are not backed by any specific assets. The repayment of principal and interest depends solely on the company’s financial health.
3. Is interest on Types of non-convertible debentures taxable?
The interest earned on non-convertible debentures is generally taxable under the head “Income from Other Sources.” The applicable tax rate depends on the investor’s income tax slab.
4. Are Non-Convertible Debentures risk-free?
No, non-convertible debentures are not risk-free. While they are generally considered less risky than equity, there is still a risk of default by the issuer. The creditworthiness of the issuer is a crucial factor to consider.
5. Can Non-Convertible Debentures be traded?
Yes, some non-convertible debentures are listed on stock exchanges and can be traded in the secondary market. However,liquidity may vary depending on the issuer and market conditions.
Reference :
https://www.sebi.gov.in/legal/regulations/apr-2022/securities-and-exchange-board-of-india-issue-and-listing-of-non-convertible-securities-regulations-2021-last-amended-on-april-11-2022-_58126.html