A 12.5 per cent annual interest over three years on a fixed deposit(FD) scheme at a time your bank FD is giving 9.25 per cent seems like an offer that must be grabbed.
The offer looks more lucrative if you consider that your equity portfolio shrinked 10-15 per cent over the last one year. The FD scheme we are talking about has been launched by a company that is into construction, real estate, cement and power generation.
Companies that find it difficult to get loans from banks raise money from the public. Two ways to tap the public is through FDs and non-convertible debentures (NCDs).
The two usually offer one-two percentage point more than bank FDs. However, companies cannot offer more than 12.5 per cent. Attractive rates generate a lot of interest among retail investors scared of investing in the stock market.
COMPANY FDs AND NCDs
Before we go into the pros and cons of company FDs and NCDs, let's look at the difference between the two.
Safety: NCDs are secured debt instruments backed by assets that lenders (depositors) can claim if the company fails to repay them. Company FDs are unsecured and so more risky. Bank FDs over Rs 1 lakh are also not secured by assets.
Liquidity: NCDs are traded on exchanges. Hence, there is an exit route without payment of fine for premature exits. NCDs give investors the option to sell their units back to the issuer after a specific period.
Company FDs are not traded on exchanges but investors can withdraw the money before maturity by accepting 1 per cent less than the promised rate.
Credit rating: NCD issuers have to get the instruments rated by at least one agency. The rating and what it means have to be mentioned in the offer document. If the issue has been rated by more than one agency, all the ratings have to be disclosed even if the issuer does not approve of any rating.
Corporate FDs do not need any rating. Even if a company gets the issue rated, it is not mandatory for it to disclose the rating.
Taxation: Interest earned from NCDs is taxed according to the investor's income tax slab. No tax is deducted at source (TDS).
Proceeds from sale of NCDs before maturity are considered capital gains and taxed accordingly. Short-term capital gains are taxed according to the person's income tax slab. Long-term capital gains are taxed at 10 per cent without indexation.
In company FDs, tax is deducted if annual interest exceeds Rs 5,000. There is no capital gains tax.
Someone who is ready to take risk can explore company FDs and NCDs. Company FDs are offering up to 12.5 per cent a year. Post-tax returns are 9.2-11.9 per cent depending on the tax slab. This means a company FD offering 12.5 per cent is giving 2.7-3.1 percentage points more post-tax returns than a bank FD offering 9.5 per cent.
Interest Frequency : The interest on both company FDs and NCDs does not fluctuate and hence the two can be a regular source of income. Company FDs offer investors the option of receiving interest either at regular intervals or at the end of the maturity period. The interest is compounded monthly or quarterly.
Tenure : The tenure of company FDs can be as low as six months and as much as 10 years. NCDs have similar maturity periods. Bank FDs also have several tenures, some as short as 14 days and as high as 10 years.
PRECAUTIONS
In company FDs, the biggest risk is repayment or credit risk. Investors often ignore this because they consider these instruments as safe as bank FDs, which is a grave mistake. There have been numerous cases of little-known companies promising very high returns and failing to repay.
Conclusion : Bank FD > NCD's > Company FD
Bank Fd's are most secured hence offered lesser interest rates. It's followed by NCD's in terms of security and interest rates and at last, company FD's which offers highest interest with high risks.
INVEST WISELY : Do not put all EGGS in one basket. Make Balance and diversify your portfolio according to your risk appetite.
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