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).

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