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Non-Convertible Debentures (NCDs) are debt instruments issued by companies to raise funds from the public. Unlike convertible debentures, NCDs cannot be converted into equity shares of the issuing company. They are essentially fixed-income investments that offer a predetermined rate of interest over a specific tenure. NCDs are a popular alternative to traditional fixed deposits or corporate bonds, appealing to investors looking for potentially higher returns and diversification.
Key Features of NCDs:
- Fixed Income: NCDs provide a pre-determined interest rate, known as the coupon rate, which is paid either annually, semi-annually, or monthly, depending on the terms of the issue. This predictability makes them attractive for investors seeking stable income.
- Tenure: NCDs have a fixed maturity date, ranging from a few months to several years. Investors can choose tenures that align with their investment horizon.
- Credit Rating: NCDs are typically rated by credit rating agencies such as CRISIL, ICRA, and CARE. The rating reflects the issuer’s ability to repay the principal and interest. Higher-rated NCDs are considered less risky.
- Liquidity: NCDs are usually listed on stock exchanges, allowing investors to buy and sell them in the secondary market. However, liquidity can vary depending on the specific NCD and market conditions.
- Taxation: Interest earned on NCDs is taxable as per the investor’s income tax slab. Furthermore, if the NCDs are sold before maturity, the gains are subject to capital gains tax. If held for more than 12 months they are treated as Long Term Capital Gains and taxed at 10% (without indexation), or 20% (with indexation). Holding them for less than 12 months means the gains are added to your income and taxed at your applicable income tax slab rate.
Benefits of Investing in NCDs:
- Higher Returns: NCDs often offer higher interest rates compared to bank fixed deposits, making them an attractive investment option for those seeking enhanced returns.
- Diversification: NCDs can help diversify an investment portfolio by adding a debt component.
- Regular Income: The fixed interest payments provide a regular income stream, which can be beneficial for retirees or those seeking passive income.
- Lower Risk Compared to Equities: NCDs are generally considered less risky than equity investments, as they offer a fixed return and are not subject to market volatility in the same way.
Risks Associated with NCDs:
- Credit Risk: The primary risk is the possibility that the issuer may default on its obligation to pay interest or principal. This is why it is crucial to evaluate the credit rating of the NCD.
- Interest Rate Risk: If interest rates rise after you purchase an NCD, its market value may decline. This is because investors will demand a higher yield, making existing NCDs with lower yields less attractive.
- Liquidity Risk: While NCDs are listed on exchanges, their liquidity can be limited, especially for issues with low trading volume. This can make it difficult to sell them quickly at a desired price.
- Inflation Risk: If the inflation rate exceeds the NCD’s interest rate, the real return on the investment will be negative.
Before investing in NCDs, investors should carefully consider their risk tolerance, investment goals, and financial situation. It is important to thoroughly research the issuer, understand the terms of the NCD, and assess its credit rating. Consulting with a financial advisor is recommended to make informed investment decisions.
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