Before moving to understand the concept of Non convertible debentures, lets first have an introduction of debentures. What are debenture? Debentures are financial instruments usually issued by companies and government to raise there capital to finance their business without forfeiting control of company ownership. In other words, debentures are simply loans taken by the companies to raise short to medium term loan needed for expenses or for expansions and do not provide the ownership in the company. A debenture is a debt instrument, just like a fixed deposit (FD), usually issued by a company. You invest a sum, and the company pays you a fixed rate of interest for the pre-defined period. After the period gets over, you get back your principal amount. However, these types of bonds are not secured by physical asset or collateral. These are unsecured loans as company is not bound to return the principal amount on the maturity and are backed only by the general creditworthiness and reputation of the issuer.
Although there are several types of debentures exists, which includes Registered debentures, Bearer debentures, Secured debentures, Unsecured or Naked debentures, Redeemable debentures, Irredeemable or Perpetual debentures, Convertible debentures and Non Convertible debentures. Here we are focusing on one type of debentures i.e. Non Convertible Debentures (NCD)
Non Convertible Debentures (NCDs) are debt instruments: Ordinarily, a company can issue shares or take a loan to raise there capital for financing there business. Issuing shares forfeits the company’s ownership, so companies issue shares and take loan in proportion to maintain a balance. There are different ways of taking a loan – they can take a loan from a bank, financial institutions, raise money abroad, or take a loan from the public. When they take a loan from the public – the instrument used is called a debenture or a bond.
Convertible Debentures can be converted into shares after the lapse of a certain time period, whereas Non Convertible Debentures always remain debt instruments.
Secured / Unsecured NCDs
A company can either issue secured or unsecured NCDs. Secured NCD is one which is secured with some assets of the company, which means in case of default the company will sell some company assets to pay the bond holders. And in case of bankruptcy, secured debt holders will be paid first by selling off the company’s assets. Whereas unsecured NCDs are not unsecured loans, in case of default unsecured bond holders used to pay off with the leftover money after making all payment to secured bond holders. That’s why it’s said that secured debt is relatively safer than unsecured debt for bond holders.
No Guarantee To Get Back Principal Amount Even In Secured NCDs
Although secured NCDs are secured with companies assets but it does not offer you any guarantee to pay back even your principal amount. Lets assume a bond issued to you is secured with 120% assets, which means that the company has designated assets worth as much as 120% of the debt issue. However, the price of the asset may fluctuate anytime and at the time of selling the asset the company may be able to recover only 60% of the price of the asset, and hence may not be able to repay your principal amount in full. This is an important point to keep in mind while investing in debt instruments.
Non Convertible Debentures (NCDs) And Fixed Deposits (FDs) – Compare
- Debentures are debt instruments like FDs where you invest a sum, and the company pays you a fixed rate of interest for the pre-defined period. After the period gets over, you get back your principal amount. But in case of fixed deposits, RBI being the head of the banks pays upto a limit of Rs 1 lakh in case of bank go break. And in case of co-operative banks, RBI try to takeover weak bank, and generally try to avoid a bank going under. However, you wont get this kind of coverage in case of companies, especially the smaller ones. That’s the reason, generally bank deposits are safer than company deposits.
- Investor should have a demat account to transact in NCDs whereas for fixed deposit investor just need to have a saving bank account.
- Only a company with good credit rating can issue NCDs to investors whereas all banks offer fixed deposit service to account holders (investors).
- Company do not deduct TDS on NCDs return where banks deduct TDS on fixed deposit return.
- Company NCDs offers higher rate of return as compare to bank fixed deposits.
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