FOREIGN CURRENCY CONVERTIBLE BOND

 FOREIGN CURRENCY CONVERTIBLE BONDS

Foreign Currency Convertible Bonds are debt instruments issued in a currency different than the issuer’s domestic currency with an option to convert them in common shares of the issuer company. It’s a quasi-debt instrument to raise foreign currency funds at attractive rate. FCCB acts like a bond by making regular coupon and principal payments; and also gives the bondholder an option to convert the bond into stock. In other words we can say that, Foreign currency convertible bond (FCCB) is a convertible bond issued by a country in a currency different than its own currency. This is the powerful instrument by which the country raises the money in the form of a foreign currency. The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bond-holder the option to convert the bond into stock.

Guidelines for issuing FCCBs in India: 

(a) Any company that requires to raise the foreign funds by issuing FCCB, require prior permission of the Department of Economic Affairs, Ministry of Finance, Government of India. (b) The company issuing the FCCB should have the consistent track record for a minimum period of three years. (c) The Foreign Currency Convertible Bonds shall be denominated in any freely convertible foreign currency and the ordinary shares of an issuing company shall be denominated in Indian rupees. (d) The issuing company should deliver the ordinary shares or bonds to a Domestic Custodian Bank as per regulation. The custodian bank on the other hand instructs the Overseas Depositary Bank to issue Global Depositary Receipt or Certificate to non-resident investors against the shares or bonds held by the Domestic Custodian Bank.

Advantages of FCCBs: 

(a) It is more stable and predictable than domestic currency. (b) It gives issuers the ability to access investment capital available in foreign markets. (c) Companies can use the process to break into foreign markets. (d) The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. (e) It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component. (f) Conversion of bonds into stocks takes place at a premium price to market price. Conversion price is fixed when the bond is issued. So, lower dilution of the company stocks.

Some of the perceived disadvantages of FCCBs: 

(a) The exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs. (b) FCCBs mean creation of more debt and a forex outgo in terms of interest which is in foreign exchange. (c) In case of convertible bond the interest rate is low (around 3-4 per cent) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity. (d) If the stock price plummets, investors will not go for conversion but redemption. So, companies have to refinance to fulfill the redemption promise which can hit earnings. (e) It remains as debt in the balance sheet until conversion.