Benefits of Bonds | srei
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Benefits of Bonds

Bonds are an important asset class that financial advisors should include in client portfolios.

Benefits of investing in NCDs

If one is looking for an investment that generates fixed income periodically, NCDs may be an ideal investment as it offers:

  • Higher rate of interest as compared to fixed deposits, postal savings or similar investments.
  • If the bonds are listed, liquidity as one can sell it in the secondary market before its maturity.
  • Possibility of capital appreciation i.e. one can sell your bond at a price higher than your cost price in the market.

Features of Non-Convertible Debentures

Returns: Both unsecured and secured NCDs give higher returns than fixed deposits. However, unsecured NCDs give higher returns than secured NCDs. Interest is paid through Direct Credit / ECS / RTGS / NEFT mode.

Maturity: RBI has stipulated that the maturity must not be less than 90 days. Maturities range from 90 days to as long as 10 or even 30 years.

Risk: Highly rated NCDs generally exhibit lower credit risk. NCDx lose value when interest rate in the system goes up and gain when the interest rate declines. However, when the NCD is held till maturity one is likely to realize the promised return and the risk due to movement in interest rates will not be there.

Liquidity: Listed debentures can be sold anytime before maturity, in the secondary market.

Tax: Returns on NCDs are taxed as income. If you sell before one year it is taxed as short term capital gain and if sold after one year and before the maturity date, the gain is taxed as long term capital gain. Interest received in the interim is treated as income and taxed. The income is subject to Tax Deducted at Source (TDS). TDS is deducted if annual income from NCD is more than Rs. 2500/-.

Things to be considered before investing in NCDs

Ratings: Rating agencies use simple alphanumeric symbols to convey credit ratings. For example, CRISIL assigns credit ratings to debt obligations on three basic scales: the long-term scale, the short-term scale, and the fixed deposit scale. AAA is the highest Credit rating by CRISIL indicating highest safety. Higher rating indicates timely servicing of debt obligations by the issuer and lower amount of credit risk.

Payback History Of Company: Check if the company has any history of default on its payment. If so it is unwise to invest in the company. However if the company has a good consistence history of repayment to its creditors then it is better to invest in NCDs of that company.

Secured and Non Secured NCDs: If the company in whose NCDs you have invested has downed its shutters, it’s important for you to know where you stand when the company repays its debts. The order in which the Company repays its debts depends upon the ranking of the bonds based on the security. Bonds are either secured against assets or unsecured. If the bonds are secured, in the event of winding up of the company, it would sell off the assets against which the bonds were secured and repay the investor. However, all secured assets do not have the same ranking.

Listing & Liquidity: Debentures (convertible and/or non convertible) can be listed on a stock exchange, providing opportunities to accumulate additionally or to sell them and exit earlier than the tenure of the debenture. But investors have to be careful about the price movement of the instruments, which in turn depends upon the interest rate movements and the applicable coupon interest rate payable on them. More the liquidity better it is for the investor.

Varying Tenures: Redemption periods usually range from 2-15 years. One should choose the tenure on the basis of his/her own personal financial goals and risk appetite.

Embedded Options: There are embedded options such as Put and Call attached to NCDs. A call-able bond could be called or redeemed by the issuer before the maturity of the bond. A put-able bond works in an exactly opposite way where the investor can sell the bond to the issuer at a specified price before the maturity of the bond if the interest rates go up after the issuance and investor has higher yielding investment options available