Understanding NCDs

Understanding NCDs

NCDs or non convertible debentures in the recent past has taken a significant bandwidth in the Retail and HNI debt market, with the option to liquidate the instrument in the secondary market it has an advantage on other debt instruments in the retail arena. So let’s first understand what NCDs are and how an investor can invest and fit this instrument in his financial plan.

Share trader should know about non convertible debentures

Understanding NCDs

Some of the debentures are termed as convertible debentures since they can be converted into equity share on maturity. A Non – Convertible debenture or NCD do not have the option of conversion into shares and on maturity the principal amount along with accumulated interest is paid to the holder of the instrument.

Types of NCDs

There are two types of NCDs-secured and unsecured. A secured NCD is backed by the assets of the company if it fails to pay the obligation, Contrary to this there is no backing in unsecured NCDs if company defaults. However, any company seeking to raise money through NCD has to get its issue rated by agencies such as CRISIL, ICRA, CARE and Fitch Ratings. A higher ratings (e.g. CRISIL AAA or AA-Stable) means the issuer has the ability to service its debt on time and carries lower default risk. A lower rating signifies a higher credit risk.

Also Read :Compulsory Convertible Debentures: Are they the Preferred Investment Instrument? 

Interest Rates in NCDs

Average rates in last few years have been 11-12%. Most of these were secured NCDs. Also, companies which carry higher risk give more than others to lure investors for investment. There can be various options for interest payout such as monthly, quarterly, half yearly or annually. However, most NCDs offer annual and cumulative payout. Investors who wish to earn higher returns opt for cumulative option where the interest is reinvested and paid at maturity.

Capital Gains

Any gain earned through selling in secondary market is termed as capital gains. What gains an investor will make depends on the interest rate scenario.

Taxability

The interest earned on NCD is clubbed with income of the bond holder and is taxed at individual marginal income tax rate. Short term capital gains which arises by selling NCD before one year is taxed as per the income slab of individual holding the instrument. Any gains which arises by selling NCD after one year and before maturity is taxable as long term capital gains.

Risk Involved

NCDs have some inherent risk associated which an investor has to take into consideration before making any investment decision. The company can default on the future payment if it is an unsecured NCD. Most companies get rating through agencies like CRISIL or CARE based on various parameters which investors can check for credibility. A rating of AAA by CRISIL is considered to be highest on safety. Even if NCD get listed, low volumes (case of low rated NCDs) can deprive investors of any opportunity in exiting prematurely.

How to Trade

NCDs can be either bought in the public issue or directly from the Stock Exchanges as most of the NCDs are listed on NSE. NCDs are normally traded at a 1-2% discount to their fair value on exchanges, which really makes it an attractive investment option via the Secondary markets.

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Also Read : Stock market bubble- Friend or Enemy?

Liquidity

Currently as the Debt Markets in India are still in very early stage, the liquidity and spread in some NCDs is too thin. However some selected NCDs have good liquidity, but still intraday trading is not purely advisable in NCDs as of now and the investors should take these instruments according to their financial goals.

NCDs in Financial Planning

NCDs are good instruments specially to serve in the Debt side of the asset allocation in the financial planning of an individual, specially the individuals who are in the retirement or near to retirement age can use this instrument as a pension investment to earn monthly interest income and take the taxability advantage of this instrument.

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