Market Linked Debentures are non-Market linked debt (MLDs) debts where the returns aren’t fixed but are linked with the markets. The returns are based on what happens to the base index. The basis index could be an equity benchmark or gold index, the yield of the government, or any other.
The types of MLDs are:
The two most common types of MLDs are
Principal protected: These MLDs include an option to preserve capital. In this case, the money, or principal amount, is protected, even in extreme market volatility. It’s a reliable security investment for the downside. If the market is moving down, you might get no returns. However, you still will receive the capital. If the market is buoyant, you’re likely to earn a similar amount.
The risk is much more significant since the principal isn’t protected. Although the risk is high, the risk of an adverse outcome is also very high.
Various variants of the MLD are listed, such as those for trading in the public market; Non-listed ones are those that do not trade on the market—secured in the sense that MLDs are supported by high-quality bonds or securities with low default risk.
What are they, and how do they work?
For instance, XYZ Company issues MLD @ 10% p.a coupon that matures within 16 months. The profit is only paid subject to no change in the Nifty Index and does not fall by more than 25 percent. When the Nifty Index falls by more than 25%, only the principal amount is returned (No profit will be paid). This is an example of an MLD that is principal-protected.
Although the above example depicts a straightforward arrangement, there are many complicated structures.
The Key Features of
- They typically come with a duration of one to five years.
- They are controlled by SEBI (The Securities and Exchange Board of India).
- Unlike bonds, which pay fixed interest, either monthly or semi-annually, quarterly, or even annually, MLDs don’t pay any regular income. The payments are only paid when the bond is due.
- MLDs can be listed/unlisted, secured, or unsecured. They are instruments that can be liquid and are purchased back by issuers at various times.
- MLDs can be highly customized since they are designed to meet the needs of an investor class.
- MLDs are evaluated independently by Credit Rating Agencies. This could attract investors.