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Debt Instruments

The word ‘Debt’ is synonymous with borrowing. But as an investment parse, it’s a very lucrative option. A Government /Corporate /Institution borrows money from people via debt instruments. These products are of least risk in nature and offer fixed returns which are more than traditional fixed income returns. An exposure to a debt instrument helps in diversifying your portfolio. There is a decent range of products wherein one could invest which are follows:

Bonds

Infrastructure Bonds under section 80 CCF of the Income Tax Act – IFCI, IDFC, L&T offer a coupon of around 9.15 % pa for a minimum investment horizon of 5 yrs.

What is a Bond?

By purchasing a bond, an investor loans money for a fixed period of time at a predetermined interest rate. While the interest is paid to the bond holder at regular intervals, the principal amount is repaid at a later date, known as the maturity date. While both bonds and stocks are securities, the principle difference between the two is that bond holders are lenders, while stockholders are the owners of the organization. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is perpetuity (i.e., bond with no maturity).

Types of Bonds

  • Infrastructure Bonds under section 80 CCF of the Income Tax Act – IFCI, IDFC, L&T offer a coupon of around 9.15 % pa for a minimum investment horizon of 5 yrs.
  • Tax free Bonds like NHAI, IRFCand PFC offer tax free interest above 8% pa with a minimum 10 year lock in option.
  • Corporate Bonds viz Tata Steel ltd, Dhanlaxmi bank, First Leasing company offer yields above 12% with a coupon of above 11.50%.

Corporate Fixed deposits

Corporate FDs are just like a normal Bank FD, where instead of a Bank a particular company, borrows money from the applicant of the FD over a predetermined interest for a fixed period. These FDs are unsecured in nature.

Non Convertible Debentures (NCDs)

A Non Convertible Debenture (NCD) is a low to moderate risk debt instrument issued by companies, for a fixed maturity period at a fixed rate of interest. NCDs cannot be converted into equity of the issuing company unlike convertible debentures which can be converted into equity of the issuing company at a future date.

Benefits of NCDs

    • Issuance and trading: NCDs are issued and traded in physical or demat form.
    • Returns: NCDs are ideal for conservative investors who seek higher returns but are risk averse. Returns are generally in the range of 11 to 13%,depending upon the market and the company.
    • Safety: NCDs are relatively safer than company FDs. They possess low to moderate amounts of risk depending upon the company. NCDs could be secured or unsecured. Secured NCDs are secured against the assets of the company. In other words, in case of a default, these investors will be paid back first, by selling some of the assets of the company. In case of unsecured NCDs, there is no security for repayment of principal or interest.
    • Liquidity: Investors could liquidate NCDs by either selling it on the stock exchange or by exercising the Call or Put Option
    • Tax Implication: There is no Tax Deducted at Source (TDS) on NCD investments. However for NRI investors, there is a Tds deduction. The interest income of an NCD is taxed at normal rates and is included under Income from other sources.They are also subject to capital gains tax when sold at the stock exchange.

Well Known NCDs

      • Shriram Transport Finance NCD
      • Muthoot Finance NCD
      • Manappuram Finance NCD

ICDs

An Inter-Corporate Deposit (ICD) is an unsecured borrowing by corporates and FIs from other corporate entities registered under the Companies Act 1956. The corporate having surplus funds would lend to another corporate in need of funds. This lending would be an uncollateralized basis and hence a higher rate of interest would be demanded by the lender. The short term credit rating of the corporate would determine the rate at which the corporate would be able to borrow funds. Further the credit spreads demanded even for the top rated corporates would be higher than similar rated banks and the rates on ICDs would higher than those in the Certificate of Deposit (CD) market. The tenor of ICD may range from 1 day to 1 year, but the most common tenor of borrowing is for 90 days. Primary Dealers are only permitted to borrow in the ICD market. The borrowing under ICD is restricted to 50% of the Net Owned Funds and the minimum tenor of borrowing is for 7 days. The market of inter-corporate deposits depends crucially on personal contacts. The decisions of lending in this market are largely governed by personal contacts.

Commercial Papers (CPs)

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers/ to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Some of the Highlights of a CP are as follows:

    • They are unsecured debts of corporate and are issued in the form of promissory notes, redeemable at par to the holder at maturity.
    • Only corporate who get an investment grade rating can issue CPs, as per RBI rules.
    • It is issued at a discount to face value
    • Attracts issuance stamp duty in primary issue
    • Has to be mandatorily rated by one of the credit rating agencies
    • It is issued as per RBI guidelines
    • It is held in Demat form
    • CP can be issued in denominations of Rs. 5 lakh or multiples thereof. Amount invested by a single investor should not be less than Rs.5 lakh (face value).
    • Issued at discount to face value as may be determined by the issuer.
    • Bank and FI’s are prohibited from issuance and underwriting of CP’s.
    • Can be issued for a maturity for a minimum of 15 days and a maximum upto one year from the date of issue