SOURCE OF FINANCE/FUNDS:

There is always demand for good-rated investment products which can offer attractive returns. Keeping this in mind, companies keep on coming with debenture issues to raise capital from the market. In the current scenario, when equity markets are not doing well, NCDs have become more important from the investor point of view as these offer attractive returns with the benefit of liquidity. There is also a separate set of investors for the debt category who prefer to invest in such issues irrespective of the equity market movement. Non-convertible debentures: An NCD is a fixed-income debt paper issued by a company. In other words, the issuer agrees to pay a fixed interest on your investment. As the name suggests, these debentures cannot be converted into shares of the issuing company like convertible debentures where investors have the option of getting shares in the issuing company on conversion. An NCD can be both secured as well as unsecured. For secured debentures, which are backed by assets, in case the issuer is not able to fulfill its obligation, the assets are liquidated to repay the investors holding the debentures. Secured NCDs offer lower interest rates compared with unsecured ones. If you want a regular income from NCDs, you can pick those that pay interest on a monthly, quarterly or annual basis. If you just want to grow your wealth, you can opt for cumulative option where the interest earned is reinvested and paid at maturity. Any Indian company can raise money through NCDs if it has a tangible net worth of at least Rs 4 crore and has been sanctioned loans by banks or financial institutions which is classified as 'standard asset' and not as bad debt.

Companies seeking to raise money through NCDs have to get their issue rated by agencies such as CRISIL, ICRA, CARE and Fitch Ratings. NCDs with higher ratings are safer as this means the issuer has the ability to service its debt on time and carries lower default risk. NCD Vs BANK DEPOSIT NCD is better than a bank fixed deposit because the interest differential is quite significant which comes at just a slightly higher risk. The risk-return ratio is in favor of NCDs. Currently, bank fixed deposits are offering an interest of 9-10% for a tenure of one to five years. In contrast, the recently concluded Shriram Transport NCD offered 11.6% for five years and 11.35% for three years to individuals. A bank fixed deposit or savings certificates issued by the postal department is for a maximum of five to seven years. In contrast, NCDs are available from two years to as much as 20 years. You can use long-tenure NCDs to create a retirement corpus.

ASSESSING RISKS An investment offering higher returns invariably comes with additional risk. "The biggest risk with NCDs is the possible capital loss in case of increase in interest rates. But investors willing to wait till maturity need not fear the same.
NCDs have a fixed coupon or interest which is paid to the holder of the instrument at maturity. If you sell an NCD in the secondary market when the interest rate is higher than that being offered by the debenture, your return will be less or even negative as the buyer will pay only that amount which allows him to get the return equal to the prevailing market rate. If the interest rate goes down, your effective return will be higher than that being offered on the NCD. Apart from the risk of lower return or loss of capital, there is the risk of default by the company even though the chances are low as most of the firms are under supervision of the RBI and Sebi. "As NCDs are mostly secured against assets of the issuing company, risk of default is low. In addition, debentures of blue-chip companies have less risk as these firms have robust finances. Small companies have more risk and so offer higher rate of interest. NCDs are also listed on bourses. This allows investors to liquidate the bonds even before maturity. However, there is no active market for NCDs on the wholesale debt market segment of the stock exchanges and their liquidity is low. You might not be able to find a buyer for your NCDs if their trade volumes on bourses are insignificant. Huge debt obligations of a company mean it might have trouble repaying its debt. So you should see the debt-equity multiple of the issuing company before investing. There is no fixed acceptable level for the debt-equity ratio as it depends on the business of the company. For example, an NBFC, which is in the business of borrowing and lending money, can have a debt-equity multiple of five to six times without putting any unnecessary strain on its debt-servicing power. TAX IMPLICATIONS Interest earned through NCDs, if held until maturity, is clubbed with your income and taxed at your marginal income tax rate. If you sell your NCDs on the stock exchange before a year then you will have to pay short-term capital gains at income-tax rates applicable to you. If the debenture is encashed after one year but before its maturity, you will have to pay capital gains tax on the effective return. However, NCDs do not have the advantage of the tax deduction allowed for investments upto Rs 20,000 in infrastructure bonds. The latter, though, has limitations on the interest rate they can offer.

Interest rate on infrastructure bonds cannot be greater than that of the prevailing government securities. NCDs do not have such interest rate limitations. So, NCDs are an attractive source of finance.