26-Oct-2023
2 mins read
The Basics of Debentures Debentures are an avenue for companies to acquire long-term capital from the market. Unlike shares, they’re debt instruments, meaning the company owes the investor the amount they’ve invested. Often, large corporations utilize debentures to borrow funds at specific interest rates. Notably, these instruments rely on the company’s reputation and creditworthiness as they’re generally unsecured.
Convertible vs Non-Convertible Debentures
Debentures come in various flavours, the most common being convertible and non-convertible. While convertible debentures allow the investor to convert them into shares of the issuing company after a predefined period, non-convertible debentures (NCDs) do not offer this flexibility.
Diving Deep into Non-Convertible Debentures
NCDs are fixed-income instruments where the return rate and term are defined upfront. Major firms’ issue these to source funds without diluting their equity share. Once matured, investors receive both the principal amount and the accrued interest. Given their unsecured nature, potential investors should pay heed to credit ratings to gauge the issuer’s reliability.
Types of NCDs
Secured NCDs: These are backed by company assets, adding an extra layer of security for investors.
Unsecured NCDs: Solely relying on the issuer’s creditworthiness, these NCDs don’t have asset backing.
Key Features of NCDs
- Issuance: Offered via public issues in the open market.
- Liquidity: These can be traded on stock exchanges.
- Credit Ratings: Critical for NCDs, credit ratings signal the creditworthiness of the issuing firm.
- Interest Dynamics: Generally, the interest rates on NCDs remain stable. However, companies with higher creditworthiness might offer slightly lower rates.
- Returns: NCDs offer two primary return modes – appreciation-based and interest/cumulative avenues.
Investing in NCDs
When a company decides to issue NCDs, they float a public issue for a defined duration. Once this phase concludes, these NCDs find their place on stock exchanges. Investors keen on adding NCDs to their portfolio can do so through brokerage platforms.
Vital Factors to Contemplate Before Investing in NCDs
NCD investments aren’t without risks. Factors influencing their attractiveness include:
- Issuer’s Credit Rating: A higher rating indicates better creditworthiness and reliability.
- Company’s Debt Profile: Perusing financial statements, particularly the debt-equity ratio, can provide insights into the company’s financial health.
- Capital Adequacy: This metric sheds light on the company’s resilience against unforeseen financial downturns.
- Provisioning Habits: Regular provisioning for non-performing assets suggests prudent financial management.
- Interest Coverage Ratio: A barometer for assessing how effortlessly a company can manage its interest obligations.
Choosing to invest in NCDs isn’t merely about chasing attractive interest rates. It demands a holistic view of the issuing company’s financial standing. By ensuring that the company is poised to fulfil its obligations upon NCD maturity, investors can truly harness the power of this unique debt instrument.