Non-Convertible Debentures (NCDs)

Non-Convertible Debentures (NCDs) are fixed-interest debt instruments issued by firms, financial institutions or government bodies in order to raise capital. They can't be converted into shares of equity at a later date as opposed to the convertible debentures. Instead, they have a fixed interest rate and a specific length of maturity, during which the principal amount is refunded to the investor after this period. Usually, NCDs are either secured or unsecured, depending on whether they contain assets backing them or not. Regular interest payments allow them to provide investors with steady income streams, which makes them relatively safe for investment over stocks. However, this exposes them to interest rate risks and credit worthiness of an issuer. NCDs have played an important role in financial markets by providing other sources of funding for corporations as well as other entities while at the same time giving investors diversified alternatives away from equities and traditional bonds.

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Types of Non-Convertible Debentures

Non-convertible debentures (NCDs) are debt instruments issued by companies to raise funds from investors. There are two types of NCDs: secured and unsecured.

1. Secured NCDs: Debt securities backed by company assets are known as secured non-convertible debentures. On default, the investors can guarantee these assets. These are relatively safer than unsecured NCDs due to the security layer it provides to the investment. The investor receives fixed interest till maturity when there is repayment of principal amount. The credit rating agencies rate these NCDs and the rating reflects issuer's financial stability and investment risk.

2. Unsecured NCDs: Debt instruments which are not backed by any assets of the issuer are called unsecured non-convertible debentures. Their default risk is very high since investors can't claim any assets in case an issuer default. For this reason, they will have higher interest rates than secured NCDs. Investment safety largely depends on the tendering capacity of the debtor. These types of NCDs also come with credit ratings that allow for investment decisions based on levels of default potential.

Both types of NCDs are tradable securities and can be bought and sold in the stock market. They are often rated by credit rating agencies, which helps investors assess the risk associated with the investment. The interest rates on NCDs are usually fixed, and on maturity, the investor receives the principal amount along with the accrued interest.

Factors to Consider Before Investing in Non-Convertible Debentures

Mostly, non-convertible debentures are supported by the creditworthiness and debt-servicing capacity of a company. From this perspective, they may be said to be highly influenced by the nature of business and its capability in money management. These instruments are prone to business risks and threats. The reason for that is that if the company borrows beyond their repayment abilities, then the company's credit rating will go down. Below is a short summary of some things you should consider when purchasing NCDs.

Credit Rating of The Issuer

The credit rating indicates the ability to raise capital through internal and external sources and its viability. It is thus recommended that one chooses those firms with an AA credit rating or more since non-convertible debentures are not option-giving in nature, hence depending on the repayment capability of the issuer. 

Debt Level

Also prior to investing in any non-convertible debentures, some analysis of the issuer's financial statements must be done. Considerations such as asset quality of the company, debt-equity ratio etc. are very important. 

Capital Adequacy Ratio

Capital Adequacy Ratio (CAR) assesses a company's capital asset base while determining whether it is sufficiently funded to withstand potential losses. 

Provisions for Non-Performing Assets

Therefore, look out for the company's consistency in making provisions for its non-performing assets. This will also depend on whether the company is able to churn enough profits. 

Interest Coverage Ratio

This ratio shows how many times interest is covered by the earnings of a business firm. It tells how comfortably a company can settle its interest obligations: a higher interest coverage ratio may act as a plus point.

Benefits of Non-Convertible Debentures (NCDs)

Non-convertible debentures offer several benefits to both issuers and investors:

Fixed Interest Payments

NCDs provide a guaranteed regular income stream for the investors through payment of fixed interests at defined intervals. Investors who want a stable return prefer them.

Lower Risk

NCDs are generally considered less risky compared to equity investments. They have a predetermined interest rate and principal repayment upon maturity, which minimizes chances of capital loss.

Diversification

For risk diversification purposes, having NCDs in an investment portfolio helps. Its nature is different from that of equities as well as other debt instruments, hence leading to a greater number of assets available to spread risk over.

Tailored Investment Options

There are various types of NCDs like secured or unsecured with different tenures and rates. It allows investors to go for choices they feel comfortable with depending on their risk tolerance, objectives (either current or future) and time frame.

Regular Income

Retirees or people looking for additional incomes may be preferable to invest in this instrument since it provides a consistent stream of payments made regularly at agreed time intervals.

Capital Preservation

 They offer some level of capital preservation because they repay the principal at maturity, which makes them suitable for individuals who intend to protect their initial investments.

Access to Corporate Debt Market

 By investing into NCDS, one can enter into the corporate debt market and thus take part in funding firm's growth and expansion while receiving fixed returns.

What Do We Offer?

Facilitates participation in NCD public issues.
Offers a platform for NCD trading on exchanges.
Provides creditworthiness details of issuers.
Shares insights on NCD interest rates.
Presents various NCD return mechanisms.
Presents various NCD return mechanisms.
Assists in assessing risks associated with NCDs.

Who Should Consider Investing in Non-Convertible Debentures (NCDs)?

NCDs are suitable for investors who look for reliable income and are willing to undertake medium levels of risk. NCDs attract cautious investors who desire fixed returns without the fluctuations associated with share markets. Those aged close to retirement or those in search of a mix in their portfolios may like NCDs because they yield predictable interest payments and have relatively lower risks compared to shares. Apart from that, shorter-term investors or people looking to hold onto funds over a specific period might find NCDs interesting as they usually have predetermined maturity dates. Again, NCDs can be ideal for investors who wish to gain exposure to industries or companies they believe in since these are issued by different corporations across various sectors. Nonetheless, it is important for investors to carry out extensive due diligence on the credibility of the issuer since the default risk might differ depending on the health status of the issuer's balance sheet and economic conditions at different times. All in all, NCDs present a balanced risk-return profile for those seeking steady incomes coupled with preservation of capital, thus making them viable options for conservative long-term investors.

Disadvantages of Non-Convertible Debentures (NCDs)

Non-convertible debts have some benefits as investment tools, but there are also several drawbacks.

Limited Capital Appreciation:  NCDs unlike stocks or convertible debentures do not offer the potential for capital appreciation. The investors receive fixed interest payments throughout the tenure of the NCD, but they do not get to participate in any upside potential if the issuer's financial performance improves.
Interest Rate Risk: Any change in interest rates will affect the value of NCDs. Once a person has bought NCDs and there is an increase in interest rates, then their market value may fall against new debt instruments, which earn higher interests.
Dependence on Issuer's Creditworthiness: The creditworthiness of an issuer is important for determining if NCDs are safe and dependable or not. If an issuer encounters financial difficulties or fails to meet its obligations, then there is a risk that investors can lose their principal amount or fail to get timely interest payments.
Low Liquidity:  NCDs are not generally liquid like shares or other exchange-traded securities. After purchase, it may become difficult to sell NCDs in secondary markets prior to their maturity date, especially when demand is low or when market volatility is high.
Callable NCDs:  Some of these may be callable in nature and thus the issuer can redeem them before their maturity dates. The flexibility to the issuer is desirable but this could be a problem for investors if they miss out on interest payments through early calls of the NCDs and reinvestment at lower interest rates.
Taxation Policy: The tax treatment of NCDs is different depending on factors such as holding period, interest income, and capital gains. Investors should be aware of tax implications which relate to NCD's that may affect returns generally.

Features of Non-Convertible Debentures (NCDs)

Non-convertible debentures possess several distinctive features that distinguish them from other financial instruments. Some of the key features of NCDs include:

Fixed Income:   NCDs offer a predictable income stream that is obtained by issuing fixed interest rates over the investment horizon. This interest, known as the coupon rate, is determined before and does not change for the whole life of the debenture. The said payments are made periodically to investors, thus giving them much-needed money. NCDs bring stable returns, which makes them an interesting choice for people who want steadiness in their earnings rather than dependence on stock market volatility. However, the actual amount received depends on the conditions and policies of the issuer of different NCDs.
No Conversion to Equity: Also, NCDs do not provide the opportunity to convert into common stock as convertible debentures do. Consequently, during the whole period of the debenture, NCD holders would never have a chance to change their debts into company shares. Therefore, rather than taking part in a firm's equity appreciation, NCD investors rely on the interest income earned from debt instruments over the life of their investments.
Credit Rating:   The credit rating for non-convertible debts (NCDs) is very important since it shows that an issuer is creditworthy. Being unsecured and not backed by collateral, the rating measures default risk. Higher credit ratings correspond to a lower likelihood of default, making NCDs a safer bet. On the flip side, a lower credit rating signifies higher risk but could attract higher interest rates as compensation. These ratings help investors in assessing the financial strength and repayment potential of the issuer before they invest in them.
Types of NCDs:  There are two types of NCDs: Secured and Unsecured. In the case of secured NCDs, the issuers' assets are involved, thereby offering a cushion to investors. On the other hand, unsecured NCDs lack any form of back and thus depend on the creditworthiness of the issuer only. If a default occurs, secured NCD holders own assets belonging to the company, while unsecured ones do not have claims to such assets. This makes unsecured riskier than secured.
Tradability:  NCDs are liquid in the stock market. This liquidity allows investors to buy and sell NCDs in the secondary market, making it possible for one to manage their investment portfolios in a flexible manner. Being able to trade NCDs means that investors are not obliged to stay invested until maturity but could benefit from changes in prices. Nevertheless, the trading value of NCDs is influenced by issuer creditworthiness and market conditions. Most of the time, users employ this attribute so as to match personal financial goals and market trends with their investing strategies.
Interest Payment Options:  NCDs offer flexible interest payment options. Monthly, quarterly, semi-annual or annual payments can be selected depending on the investor's cash flow requirements. Alternatively, a cumulative option is also available where interest is earned and paid at maturity and may offer greater returns as interest compounds over time. This flexibility allows investors to match their NCD investments with income needs or reinvestment intentions, making NCDs versatile financial instruments for diversified investment portfolios.
Taxation:  The interest income from Non-Convertible Debentures (NCDs) is taxed under "Income from Other Sources" and is subject to the investor's tax slab rates. If NCDs are sold before one year, any profit is considered a short-term capital gain and is taxed accordingly. For listed NCDs sold after one year, gains are taxed at 10% without indexation. Unlisted NCDs held for more than 36 months attract long-term capital gains tax, with options for indexation.

Conclusion

Convertible Debentures (NCDs), which are non-convertible bonds, are a trusted investment option for investors looking for stable income and lesser risks than stocks. These come with fixed interest rates and the repayment of the initial principal balance at maturity, thus making them dependable inclusions to your portfolios. While NCDs do not provide the same potential for capital appreciation as equities, they give a sense of security and money earned through interest rates paid regularly. It is important to consider your risk tolerance and investment goals when deciding whether to invest in NCDs or not. You should also remember that diversification of your portfolio helps to spread risks and enhance returns. If you want to know more about the stock market and investment strategies, then try Bigul: it is a user-friendly online platform that offers comprehensive teaching materials following your specific requirements, assisting you in making informed decisions on investments.

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FAQs

Actually, NCDs differ from convertible debentures since they can't be converted to equity shares at a later date. They pay a fixed rate of interest and offer a regular income flow through periodic interest payments until the redemption date when the principal is repaid.

Yes, because they have fixed interest rates and are less risky than equities, NCDs are often preferred by risk-averse investors. They have got an assured income stream as well as back up by either assets or creditworthiness of the issuer.

On the one hand, trading NCDs in the secondary market is not as easy as stocks. On the other hand, they may not be liquid enough due to limited liquidity, which could make it difficult for investors to find willing buyers/sellers with respect to their price requirements.

An investor should look into the creditworthiness of the issuer, check out the interest rate offered, examine the tenure/maturity period and analyze how interest rates are currently set. Furthermore, carefully read all terms/conditions applied when issuing such an NCD.

Indeed, credit risk that refers to default risk on payment of interests or repayment of principal amount exists for NCD's. An investor must carry out proper due diligence regarding financial health and credit rating of an issuer before buying into NCD's.