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Convertible Vs. Non-Convertible Debentures: A Comparison
Debentures are a sort of long-term debt instrument that does not have any collateral backing them up. In other words, debentures are not secured or have no security. Debentures, along with bonds, are one of the most common types of debt securities. Debentures are often issued by corporations and, in certain cases, the government to collect cash from the general public. They are like non-convertible bonds, which are a common type of financial instrument.
Convertible debentures can be defined as a form of long-term debt issued by a corporation that may be converted into a stock market after a set time. Convertible debentures are often unsecured bonds or loans with no underlying security to back them up.
These long-term debt securities, like any other bond, pay interest to bondholders. Convertible debentures are distinguished by the fact that they can be exchanged for shares at predetermined intervals. Ensuring a sense of security for the bondholder, this mitigates the risk associated with investing in unsecured debt.
If you are wondering what is NCD then you can define non-convertible debentures as the fixed-income instruments that are often issued as a public offering by high-rated firms in order to accrue long-term capital appreciation. When compared to convertible debentures, they provide somewhat higher interest rates.
They are NCD into the stock market or equity. NCDs have a set maturity date, and the interest can be paid monthly, quarterly, or yearly, depending on the fixed term chosen. When compared to convertible debentures, they provide superior yields, liquidity, minimal risk, and tax advantages to investors.
Difference between Convertible Debentures and Non-Convertible Debentures
Following are the difference between convertible and non-convertible debentures on various parameters:
|On the basis of||Convertible Debentures||Non-Convertible Debentures|
|Value at Maturity||The maturity value of convertible debentures is decided by the company's current stock price, implying that a high stock price will result in higher returns, while a low||Non-convertible debentures have a fixed value and hence earn fixed returns when they mature.|
|Interest Rate||Convertible debentures have a lower rate of interest than non-convertible debentures since holders can convert them into equity shares.||The interest rate on NCDs is greater. These debentures, however, are regarded as less hazardous than convertible debentures and bonds.|
|Status||This is one of the key distinctions between convertible and non-convertible debentures. Holders of convertible debentures have dual status since they can be both creditors and owners of the firm.||Holders of non-convertible debentures on the other hand are the company's only creditors.|
The Types of NCDs
Following are the two types of NCDs:
- Secured NCDs
Secured NCDs are regarded as the safest of the two types because their issuance is backed by the company's assets. If the firm fails to pay on time, the investors can recoup their losses by liquidating the company's assets. The interest rate on NCDs, on the other hand, is modest.
- Unsecured NCDs
Unsecured NCDs are considerably riskier than secured NCDs since the company's assets do not back them up. As a result, if the firm fails to make a payment, the investors have little alternative but to wait until they are paid because the company has no assets to recover their losses. Unsecured NCDs, on the other hand, have a higher interest rate than secured NCDs.
Features of NCDs
Following are the key features of NCDs:
- Rate of Interest
The majority of interest rates are fixed. The interest rate is inversely related to the company's credibility. When compared to FDs, the returns are larger, and NCDs give greater flexibility in terms of duration. Because some of the debentures are unsecured, the interest rates are extremely high.
This is an essential feature since highly liquid assets are in great demand. In the event of an emergency, the asset should be easily encashable. In this regard, NCDs perform well since they are listed on exchanges and have a high level of liquidity. Anyone can buy or sell on the marketplace at any time.
- Return Rates
Every non-convertible debenture has two ways to earn returns: growth and interest, or cumulative opportunities. The rate of interest on unsecured NCDs may be lower than those on secured NCDs as they are secured by the company's assets.
Things to Consider when Investing in NCDs
Few tips that you should consider before investing in NCDs:
- Credit Rating
Credit ratings indicate a company's capacity to generate cash from internal or external sources, as well as its long-term viability.
Because non-convertible debentures do not provide any options, it is entirely dependent on the issuer's ability to repay. As a result, it is advised to select firms with a good credit rating.
- Interest Coverage Ratio
This ratio indicates how many times the company's earnings pay the interest. It influences how easily a company's interest obligations may be met. As a result, a greater interest coverage ratio may be advantageous.
- Non-performing Assets
Keep track of whether the firm is able to allocate provisions for non-performing assets on a regular basis. This will also be determined by the company's ability to generate sufficient earnings.
The real return an investor may receive from an investment in non-convertible debentures is not determined solely by interest rates. It is also necessary to conduct a health assessment on the firm in order to determine whether or not the company will be able to honour the NCD payments to investors upon maturity.
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