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Thursday, March 8, 2012

Corporate Fixed Deposits

With the Interest Rate situation in the Indian Debt Markets at an all time high, options for good fixed income investments like Bank Fixed Deposits & Company/Corporate Fixed Deposits are ripe for the picking. All of us know what a Bank Fixed Deposit is. But, many of us do not know what a Corporate or Company Fixed Deposit is. The purpose of this article is to explain on what they are and how they can be a useful investment option for investors.

What is a Corporate Fixed Deposit?

A deposit made by investors with corporations for a fixed time period, for a predetermined/agreed upon rate of interest is called a "Corporate Fixed Deposits".

How are they different from Bank Fixed Deposits?

By the way they work, they are extremely similar to fixed deposit schemes offered by banks. The differences are:

Bank Fixed Deposits Corporate Fixed Deposits
Money accepted as deposits is used by the bank to grant loans to other loan customers Money accepted as deposits is used by the company to expand its business and meet its cash requirements
The Reserve Bank of India governs all these deposit operations done by Banks The deposits are not governed by the Reserve Bank
Rate of Interest is governed by the RBI RBI does not govern the Rate of Interest offered by the company
Very Low to Low Risk as the RBI will intervene if they feel any unstability in the banks operations Medium to High Risk as no one will intervene if they feel the company is unstable
Rate of Interest is lower than company FD's due to the relatively lower risk Rate of Interest is higher than bank FD's due to the relatively high risk
If the Bank defaults, the deposit insurance scheme from the RBI will be invoked to recover customer money If the Company defaults, the investor stands to lose his money
How does the Corporate Fixed Deposit work?

Company's/Corporations can raise capital by means of issuing Fixed Deposits to investors using the Section 58A of the Indian Companies Act. These deposits will be used by the company to fund its expansion, meet its day to day cash requirements etc. This is just like a regular loan that we may take from any financial institution. The company will make periodic Interest Payment (Usually Once a Year) to all the investors in return for the deposit they made with them. At the end of the deposit tenure the company will re-pay the money deposited to all the investors.

A point to note here is that, these deposits are unsecured. If the company is unable to perform as expected or starts making losses, the interest payments may be skipped and in the worst case, if the company declares bankruptcy, the whole deposited money may be lost.

This is exactly the reason why company fixed deposits offer a higher rate of interest (Usually 2-3% more than Bank FD's) to attract high risk investors who want better returns that what is offered by Banks.

How are Interest Payments made to the Investors?

The Interest payment is usually made depending upon the Investors choice. They can opt for Monthly or Quarterly or Half-Yearly or Annual Interest Payments. The company will declare upfront the mode of interest payment. It will either be through cheques mailed out the investors address or through ECS into the investors bank account.

Am I Saying that Investing in Corporate FDs is a Bad Idea?

In this article, you might have seen multiple references to these deposits being unsecured and that chances of losing the money are high if the company goes broke. If this had made you think that Investing in them is a bad idea, then you are wrong.

The point here is that, not all company's are mismanaged or go broke. There are numerous well-performing company's that raise capital by using this FD option. They do it because, it is usually cheaper than borrowing from banks. Banks usually charge a much higher interest rate than what these company's would pay on their corporate FD schemes. So, if the company is a well managed one, with a reputation of stable business and profit earning, then there is a very good probability that you will receive your interest payouts on time and that the company will meet its commitment to repay your deposit at the end of the deposit tenure.

Verdict:

Investing in Corporate FD's is a good idea if the company is good and has a history of good performance. In the subsequent posts, we will take a look at the good Corporate FD schemes that you can invest now and how to identify a good Corporate FD scheme from one that is an impending disaster

Happy Investing!!!

2 comments:

  1. Basically, the bank provides you with a fixed amount of interest o­n your money. These are a reliable method of saving and investing money. But the money accepted by company as deposits is used by the company to expand its business and meet its cash requirements and there is no such guarantee or security in case of company fixed deposits.

    ReplyDelete
    Replies
    1. Yes. That is why they are considered riskier investments and in return the company's offer better rate of interest than banks to customers who are willing to take the risk.

      No risk = No Reward

      Delete

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