What Is the Difference Between Non-Convertible and Convertible Instruments?
Learn what non-convertible and convertible instruments are, their key features, and how they differ in terms of risk, income type, and potential returns.
Non-Convertible Instruments
Definition
Non-Convertible instruments are types of securities (like bonds, debentures, or preferential shares) that cannot be converted into equity shares of the issuing company at any point during their tenure.
Key Features
- Fixed Income: They generally offer a fixed interest rate (coupon rate) and return the principal amount upon maturity.
- Security: Secured non-convertible instruments are backed by certain assets of the issuing company.
- Higher Priority: In case of liquidation, non-convertible debenture holders have a higher claim on the company's assets compared to equity shareholders.
- No Ownership: Investors do not get any ownership in the company by holding non-convertible instruments.
Convertible Instruments
Definition
Convertible instruments, on the other hand, are securities that grant the holder the option to convert them into a specified number of equity shares of the issuing company after a predetermined period.
Key Features
- Potential Ownership: Upon conversion, investors gain ownership in the company, potentially allowing them to benefit from the company's growth.
- Interest/Dividend Rates: Convertible instruments might offer lower interest or dividend rates compared to their non-convertible counterparts due to the added benefit of conversion.
- Risk and Reward: These instruments inherit the risks and rewards associated with equity ownership post-conversion.
Comparative Overview
| Feature | Non-Convertible | Convertible |
|---|---|---|
| Conversion into Equity | Not possible | Possible after a specific period or under conditions |
| Income Type | Fixed income through interest payments | Variable, potentially including dividends post-conversion |
| Risk | Generally lower risk as they may be secured and have fixed returns | Higher risk due to potential future equity conversion |
| Claim in Liquidation | Higher priority over equity shareholders | Becomes equal to equity shareholders upon conversion |
| Interest/Dividend Rate | Usually higher because of the lack of conversion option | Generally lower due to the benefit of conversion |
Examples
Non-Convertible Example: A company issues an NCD (Non-Convertible Debenture) with an 8% annual interest rate, maturing in 5 years. Investors receive regular interest payments and get back their principal amount after 5 years, without any option to convert these debentures into equity shares.
Convertible Example: A company issues Convertible Debentures with a 5% annual interest rate, and after 3 years, holders have the option to convert each debenture into 10 equity shares of the company. It’s a more attractive option for investors who believe in the long-term growth potential of the company, as they stand to gain ownership.
Conclusion
Non-Convertible Debentures (NCDs) offer a fixed income stream and lower risk compared to convertible instruments. They are suitable for investors looking for stable returns without the added risk of equity ownership. On the other hand, convertible instruments provide the potential for capital appreciation and ownership in the issuing company, making them more suitable for investors seeking higher returns and willing to take on additional risk.