Default risk: Corporate FDs carry a risk called default risk, which means that on maturity the investor may not get the promised amount and the firm may default in repaying the funds. This difficulty could arise due to reasons such as the company not having enough funds to repay the investor or if the business is in a financial turmoil at the time.
Unsecured investments: These deposits are unsecured because they are not backed by any credible authority like RBI or the government. Bank fixed deposits are insured up to Rs. 100, 000 by deposit insurance and credit guarantee corporation (DICGC).
Premature Withdrawal: Unlike, bank fixed deposits where an investor can withdraw funds before its maturity by simply breaking the fixed deposit; premature withdrawal of funds from corporate FDs is not encouraged by companies. The processing for premature withdrawal is long and a lot of paperwork is involved in it. At times, investors are even asked to provide reasons for premature exit.
Malpractices adopted by sales agents: In order to encourage the sales agents to push for their FDs, corporates pay the salespersons high commission. But, the high commission also gives the sales agents an impetus to adopt selling malpractices such as not revealing critical details of the investment scheme and so on.
Tips to the investor:
An investor should always look for credit rating of the company, where he wishes to park his funds, by certified rating agencies like CRISIL or ICRA. The rating provides a guarantee of credit worthiness of the company.
Companies which offer abnormally high interest rates (say more than 15%) should be avoided as there are chances of defaults in paying interests or even frauds.
Companies whose balance sheets are showing losses and which are not paying regular dividends to its shareholders should be avoided.
Investments should be avoided in unlisted companies as it is difficult to judge their performance.