When eligible corporate houses and financial institutes take a loan from the public, they issue certificates against such loan, which are called debentures. These debentures cannot be converted into equity of the company later on. Accordingly they are called “Non-Convertible Debentures” or NCDs.
Such NCDs are of two types: Secured and Unsecured. Secured NCD is relatively safe, as, in case of default, an investor can claim on the assets of the company. No such claims are allowed on unsecured NCDs. However, unsecured NCD fetches a higher interest rate for investors willing to take a higher risk.
Why NCDs are Not Convenient for Small Investors
There are many special needs and formalities like demat account, which makes procurement, maintenance, and maturity of NCD complicated for new investors.
The necessity of a Demat Account
For purchase, maintenance, and sale of an NCD, you should have a demat account. For new investors having limited use of the demat account, there is a yearly expense associated with maintenance of the account. It increases the overall cost of the investment.
On the other hand, investing in a FD is very simple. It is effortless to maintain an FD until maturity. At maturity, proceeds are automatically credited into the bank account of the deposit holder.
The necessity to Trade for Premature Withdrawal
To take the premature exit from NCD, you have to sell it to stock exchanges BSE or NSE through a demat account. On the top of this, you can only sell NCD if there is enough liquidity in the market. In a rising interest rate cycle, it is difficult to get the buyer of existing NCD due to lesser yield. The premature exit is also subjected to price discovery in the open market. There is no set rule of an assured amount in such cases.
Taking the exit from Fixed Deposit is extremely easy. You can approach the financial institution, and you will get money on demand. For premature exit, there is a small penalty. However overall experience is hassle-free and seamless.
Higher Risk if Unsecured NCD
While most NCDs are secured, some are unsecured as well. You should carefully examine the terms and conditions of the debentures to understand the risk associated with it. Unsecured NCDs also have problems of liquidity in the market. There are not enough buyers in an open market in case you want to take a premature exit from your investment.
The transactions related explicitly to premature exit are confirmed offline but settled through BSE or NSE. You have to coordinate through your broker who handles your demat account. All such formalities add efforts to transactions for new investors.
Handling Fixed Deposit is relatively easy. You can directly approach to your bank or financial institute for any transaction related to your Fixed Deposit.
Getting Loans against Investment
To avail a loan against NCD, you have to pledge it with Banks or NBFC. It is at the discretion of Bank or NBFC to grant loan application against third party NCD. However, if you approach your financial institute from where you have booked FD, they provide loan or overdraft facility against FD without any hassles.
If you take an exit from NCDs, you are subjected to capital gain tax. If the exit is before one year, it is subjected to short-term capital gain tax which is 15% at present. For exit after one year, it is subjected to long-term capital gain tax which is at 10%. In either case, it works against investors who come into lower tax brackets. If you prematurely withdraw a fixed deposit, interest is added to his total income. The tax is only 5% for such investors in case of FD.
In case of a Fixed Deposit, to calculate maturity amount and yield, FD calculators and related videos are available online. For premature exit from NCD, you are merely dependent on prevailing market rate on stock exchanges.