What are Non-convertible Debentures (NCDs): Meaning, types, and how they work?

The Indian stock market offers a robust platform for wealth creation through strategic investments. Equity investments provide growth potential through stock ownership, while Debt instruments like non-convertible debentures offer stable, low risk returns with fixed income.

By balancing high-potential equities and predictable debt securities, investors can craft a diversified portfolio tailored to their financial goals and risk tolerance. This approach enables systematic wealth accumulation and financial security.

What are Debentures & Non-convertible Debentures (NCDs)?

Debentures are unsecured / secured bonds. Secured bonds are those that have collateral or security tied to them. So, if the company whose debentures you have bought defaults on the interest or principal that is due to you, the secured asset or collateral will be sold to pay that interest or principal. The security is usually some asset of the issuer company.

Unsecured bonds have no specific collateral or security tied to them. Debentures are usually issued for a long term, say for more than 12 months. Debentures can be issued by companies as well as governments and their agencies.

Non-convertible debentures (NCDs) cannot be converted into the equity of the issuing company. Debentures can be convertible too. Convertible debentures can be converted into the equity or shares of the company, after some time, usually at the option of the bondholder. The conversion ratio is specified at the time of selling of convertible debentures. The conversion ratio is the number of shares of the company that will be issued to the bondholder for every unit of the bond or NCD that the bondholder owns.

Types of Non-convertible Debentures

Non-convertible debentures can be registered NCDs or bearer NCDs. In registered NCDs, only the person in whose name, the debenture is registered will have the right to receive the interest and principal payments. In the case of a bearer NCD, anybody who owns the NCD will have the right to receive the interest and principal payments on the NCD.

NCDs can also be classified as redeemable or irredeemable. Redeemable debentures have a specific date of maturity. On maturity, all the principal is paid back to the debenture holders. Irredeemable NCDs are perpetual meaning that interest on them is paid forever but there is no maturity date, on which the principal amount will be paid back.

Types of Non-convertible Debentures

• They are non-convertible. They cannot be converted into the equity or shares of the company at a later date.
• They are usually issued for a long term.
• NCDs are unsecured and are not secured by any specific collateral or security.
• NCDs are debts that the issuing entity owes to those who have bought the NCDs. The issuer therefore has the legal obligation to pay back the interest and principal to the NCD holders, when they become due. If the issuer fails to do so, then it will be rendered bankrupt. Its assets can then be sold to pay the amount due to NCD holders.

Key Benefits of NCDs

• Interest income can be earned through investment in NCDs.
• NCDs issued by companies that have investment-grade credit ratings are quite secure. They have low or negligible credit risk. Credit risk is the risk of the issuer company not being able to pay back the interests or principal on the NCDs when they become due.
• Credit risk is high in the case of NCDs issued by companies with low credit ratings. To compensate for this higher credit risk, these NCDs pay a higher interest rate.
• Some types of NCDs, like those issued by governments, may have some tax benefits too.

How does investment in NCDs work?

Most NCDs are now issued in demat form. A Demat account holds securities in dematerialized or electronic form. So, you need to have a demat account with a broker to buy NCDs when they are first issued by the issuing company or entity. The application process is like that for stocks and other securities. Your application is supported by the blocked amount (ASBA). This amount is released from your account and paid to the issuer company when the NCDs are allotted to you.

Each NCD has a face value. The face value is the principal amount that the issuer owes to you. An NCD can be issued by the issuer at a price more than the face value, equal to the face value, or less than the face value. Usually, the price at which an NCD is issued by the issuer company is equal to the face value. Each NCD typically has a face value of ₹1,000. There is also the coupon rate that will be paid on the NCD. This coupon rate is the periodic interest rate that the issuer entity will pay to those who invest in the NCD.

You can also trade in NCDs that are listed in secondary markets, such as the various stock exchanges.

Conclusion

NCDs are secured / unsecured debt securities. They offer good diversification for equity investors. NCDs of investment grade issuers are also a secure form of investment.