Foreign Currency Convertible Bond

Let us understand each of the above term individually.

A Bond is a debt security, in which the issuer is the borrower and the bond holder is a lender. Depending on the terms of the bond, issuer is obliged to pay interest (the coupon) and repay the principal at a future date called the maturity.

A convertible bond is a bond that can be converted into a predetermined amount of the company’s equity at a certain time during its life, usually at the discretion of the bondholder.
Lets us understand this with a help of an example. Suppose a company ‘A’ issues bonds with following terms –
1. Issue Price of the Bond Rs. 1000
2. Coupon rate 10%
3. Maturity – 2 yrs
4. Convertible into equity shares @ Rs. 800 per share
Now suppose an investor subscribe to 4 such bonds. Thus the total investment required is Rs. 4000. On this investment he is entitled to get an interest @ 10% for 2 years. On the maturity date, i.e. after 2 years, the investor will have an option of either claim full redemption of the amount from the company or get the bonds converted into fully paid equity shares @ Rs. 800 per share. Thus if he goes for the conversion he will be entitled to 5 (4000/800) equity shares. The choice of the investor will depend on the market price of the share on the date of conversion. In the above example if the shares of the company ‘A’ is trading at lower than Rs. 800, say Rs. 500, the investor will be better of by claiming full redemption of his bonds and buying the shares from the market. In this case he will get 8 (4000/500) equity shares as against 5 which he was getting on conversion. Similarly if the market price of the share is higher than Rs. 800, the investor will benefit by getting its shares converted.
Thus from the above we can conclude that on the day of maturity, an investor will seek full redemption if the conversion price is higher than the current market price, and will go for conversion if the conversion price is less than the current market price.
Whatever be the share price on the date of maturity, the investors in such type of bonds does not stand to loose. Their capital stays protected. Thus it’s a win-win situation for the investors.

A Foreign Currency Convertible Bond (FCCB) is a type of convertible bond issued in a currency different than the issuer's domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency.

Advantages of FCCB –
Advantage to the investors is clear from the above example. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the stock.

The issuer company also stands to benefit from the issue of FCCBs-
- Due to the equity side of the bond, which adds value, the coupon payments on the bond are lower for the company, thereby reducing its debt financing costs.
- Saves the risk of immediate equity dilution as in the case of public shares.

Present Day Situation

Indian companies that had raised money through FCCBs during Bull Run to finance their growth and acquisition plans are currently in situation of doom. With demise of Indian stock markets the conversion price of these FCCBs has gone several times higher than their current market price. Various estimates show that India Inc has issued close to $20 billion of FCCBs in the past few years. Now the investor will only exercise its option to convert his bond into fixed number of shares at predetermined price if conversion price is lower than the market price. Now in this scenario of dooming stock markets conversion price in most of the FCCB issues is several times above the market price. For ex. Some companies like JP Associates have a pretty big amount of money out there - JP has $400 million, convertible around Rs. 247. Current price is Rs. 170. Therefore, in such a scenario investors won’t be interested in converting their bonds into equity. The maturity of many FCCBs is expected to start in October 2009 and peak in 2010-2011. Most analysts say the market is unlikely to recover so significantly over the next two years that will match the conversion prices.
In some cases, the outstanding amount on account of FCCBs is higher than or around the current market capitalization of the companies concerned. For instance, Hyderabad-based Subex Auzure raised $180 million (Rs 846 crore) in 2007 to finance the acquisition of Azure. The company’s market capitalization as of September 30 was Rs 298 crore.
Thus at the maturity, the companies that issued FCCBs would be in a difficult situation as they will be burdened with huge debt obligation which will be difficult to meet given the tight liquidity condition.