Non-convertible debentures (NCD) are fixed-income instruments, usually issued by high-rated companies in the form of a public issue to accumulate long-term capital appreciation. They offer relatively higher interest rates when compared to convertible debentures.
Advantages of Non-convertible debentures
There are mainly 4 advantages that investors see during investing in NCD.
- Every company that seeks to raise money through an NCD is rated by agencies such as Fitch Ratings, CRISIL, ICRA and CARE so the information provided is verified and the chances of fraud are zero.
- NCDs issued by NBFC’s normally pay an interest rate of 150-175 basis points higher than what banks pay on their FDs. Since most of the NBFCs issuing these NCDs are reputed and well-capitalized, investors do not see much risk in investing in them.
- The other advantage of NBFCs is if the rates start falling by 25 to 50 basis points from current levels, then the investor enjoys capital appreciation on these NCDs.
- Debentures have a first or second charge on the assets of the issuer so are much safer as compared to other unsecured forms of investment.
Disadvantages of Non Convertible Debentures
- Taxwise these NCDs are not very efficient. For example, even though NCD pays around 9%-10% coupon rate, the actual returns are less than 7% on a post-tax basis.
- Inflation is another major risk. Inflation eats into your profit. Most of the NCDs mention returns in nominal terms which may not give the right idea about the soundness of return. The real return will always be less than the nominal return. Real return, simply defined, is nothing but the nominal return minus the inflation. Hence if inflation goes up, the real return will go down.
- There are no guaranteed returns beyond the Government bonds and bank fixed deposits (even bank FD has risk but it is very low). Hence the moment investors see promises of returns larger than the returns offered by Government bonds; they should intuitively understand that this will expose them to risk. This is the cardinal rule of investing.
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