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All about Equity Linked Debentures

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An equity-linked debenture is a hybrid structured product. It is a zero-coupon bond and the returns are linked to an index such as Nifty or Sensex or a basket of stocks. There is no fixed rate payout like other debentures which are usually linked to debt instruments. The zero-coupon bond matures to the principal by the end of the tenor of the product. The rest is used to effectively create the payoff of the structure (the variable market linked coupon).


Higher the interest rate, the better is the payoff to the customer. Although these have become an all-season product, the combination of high interest rates and bullish equity market indices has been the best time to invest in such debentures. Even if the stock market slips into a bearish phase, these debentures, just like most other structure products, protect the downside even as they allow the customer to participate in the upside of the market, say wealth managers.

Who Issues Them

These debentures are issued by nonbanking finance companies (NBFCs) to meet their credit requirements. Industry experts say NBFCs meet 40% of their credit requirements through these debentures. NBFCs have been issuing such debentures as these are primarily zero-coupon bonds with no fixed regular interest servicing, unlike regular debt borrowings.

Pricing Of Elds

One of the major determinants of the overall payoff is the rate at which the issuing NBFC borrows. In the current high interest rate scenario, there is more money available for allocation to optionality, which can create better payoffs for investors.
Two factors play an important role in pricing an ELD — the underlying funding cost and option prices. In a high interest rate regime, structures can also be attractive as a pure hedging mechanism.

The Ideal Investor Profile

Equity-linked debentures make sense to those investors who want to participate in the upside potential of equities, yet at the same time they need to protect against the downside risks of capital erosion that accompany equity investing. These products can help bridge the gap between a pure equity exposure and pure fixed income products.


As on February 18, 2012, the total number of issuances of such debentures is 1,020, out of which 1,008 were principal protected structures. Principal protected equity linked debentures have become more popular as compared to non-principle protected debentures because it has became mandatory for the issuer to get them rated from a third-party agency. Also the volatility of the equity markets has added to the popularity of the principal-protected equity linked debentures.

Risk Factors

However,there are several risks associated with these products. The most important risk factor is the credit risk of the issuing NBFC. Also, each underlying debenture has a different payoff structure, which has to be understood by the investor.

Every investor has his or her own idea and outlook on the market. The investors have to ensure that the structure suits their requirements. If the investor is aggressive, then knock-out option should be avoided.

These products are not without strings. Such instruments usually carry a knock-out level clause, wherein if its benchmark index rises beyond a particular level, your returns will not be commensurate with the rise in the index.

The argument put forward is that it is a 'small' price that you pay in return for any structured product with capital protection.
Also this product, in itself, is not very liquid. These debentures are not easily traded. The money is usually locked in for a certain duration, usually 2-3 years, in these debentures

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