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Cholamandalam Investment And Finance Company Limited
Non-Convertible Debentures
What are NCDs
Whenever a company wants to raise money from the public it issues a debt paper for a specified tenure where it pays a fixed interest on the investment. This paper is known as a debenture. Some of the debentures are termed convertible debentures since they can be converted into equity shares on maturity. A Non - Convertible debenture or NCD does 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.
There are two types of NCDs-secured and unsecured. A secured NCD is backed by the assets of the company and if it fails to pay the obligation, the investor holding the debenture can claim it through liquidation of these assets. Contrary to this there is no backing in unsecured NCDs if the company defaults. However, any company seeking to raise money through NCD must get its issue rated by agencies such as CRISIL, ICRA, CARE, and Fitch Ratings. A higher rating (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.
Interest Rates in NCDs
In a high-interest rate scenario, NCDs offer high rates to investors. The average rates in the last few years have been 8-9%. Most of these were secured NCDs. Also, companies that 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 payouts. Investors who wish to earn higher returns opt for the cumulative option where the interest is reinvested and paid at maturity.
Capital Gains
NCDs get listed on stock exchanges where investors can sell them before maturity. Any gain earned through selling in the secondary market is termed as capital gains. What gains an investor will make depends on the interest rate scenario. If interest rates are higher than offered by NCD then the returns will be lower if sold through secondary markets and there might be negative return for investors in some cases. However, if there is a fall in interest rates after buying NCD then selling on the stock market may prove beneficial as the NCD will demand a premium.
Taxability
The interest earned on NCD is clubbed with the income of the bondholder and is taxed at the individual marginal income tax rate. The capital gains have different taxability. Short-term capital gains which arise by selling NCD before one year is taxed as per the income slab of the individual holding the instrument. Any gains which arise by selling NCD after one year and before maturity is taxable as long-term capital gains. The applicable tax rate is 20% with indexation.
Risk Involved
NCDs have some inherent risk associated which an investor must take into consideration before making any investment decision. The biggest risk is the credit risk. The company can default on the future payment and if it is unsecured NCD, an investor does not have any recourse. 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 highest on safety. The second risk is the liquidity risk. Even if NCD get listed, low volumes (case of low rated NCDs) can deprive investors of any opportunity in exiting prematurely.