A convertible bond that is released with a fiat currency that is different from the country of origins national currency, is known as a foreign currency convertible bond. A product that combines debt and equity is known as a convertible bond. It performs the same functions as a bond in terms of making regular principal and coupon payments, but it also allows the bondholder the choice to convert the bond into stock.
A bond is a type of debt security that offers investors income in the form of periodic interest payments known as coupons. At bond maturity, investors are given their entire face value back. Convertible bonds, a sort of bond that is more convertible into equity, are issued by some corporate companies. Bondholders who own convertible bonds can benefit from the growth of the issuer's underlying shares. Bonds that are convertible into equity have a conversion rate that must be met. The foreign currency convertible bond is one of many different varieties of convertible bonds.
As an illustration, an American listed firm has effectively issued a foreign currency convertible bond when it issues a bond in India in rupees. The periodic coupon payments and principal repayment will both be done in the currency of another nation. When raising funds using foreign fiat currencies, multinational corporations frequently issue foreign currency convertible bonds. Investors in FCCBs are frequently foreigners and hedge fund arbitrators. These bonds may also include call or put options, the latter of which gives the bond issuer the ability to redeem the bond.
A business may choose to raise capital outside of its own nation in order to access new markets for brand-new or expansionary projects. Companies typically issue FCCBs in the currencies of nations with lower interest rates than their own or with more stable economies. The issuer is exposed to any political, economic, and legal risks present in the nation while issuing bonds in a foreign currency. Due to the fact that the principle must be returned at maturity, negative exchange rate movement where the local currency decreases can result in larger cash outflows during repayment. These bonds are available for purchase at stock exchanges by FCCB investors, who can then choose to convert the bonds at a later date into equity or a depositary receipt. By converting the bond to equity, which is an option only available to FCCB holders, investors can take part in any price increase of the issuer's stock.
Bonds that can be exchanged for foreign currencies fall under the category of quasi-debt products. They make it possible for the investor and the corporation issuing the bonds to share in the risk and benefit. By placing a bet on the company's financial performance, investors take on risk. To finance their operations, businesses can raise money in a number of different currencies. Bonds that can be converted into stocks are a unique feature of foreign currency convertible bonds (FCBs), which are comparable to standard bonds in other ways. The principal amount and coupon payments, as well as the proceeds the issuing business received from the bond offering, are all made in foreign currencies. Investors will receive the entire bond's face value when it matures. The bond can be converted into stock by the issuer at a predetermined conversion rate. The issuing business has the right to redeem the bond if it was issued with a call option.
FCCBs have interest rates that are often lower than those offered by traditional banks, which lowers the price of debt financing. By issuing FCCBs, the corporation can lower its debt and increase equity capital if the securities are converted. The corporation also earns from a positive shift in the US dollar's value relative to the euro. A guaranteed minimum fixed return. It is a special dual benefit of equity and debt that the investor receives through foreign currency convertible bonds. This benefit includes flexibility in deciding when to enter the capital market and obtaining a steady stream of income through bond payments (coupons).
With each issuer that decides to convert their bonds into stocks, ownership will be diluted and earnings per share would decline. The cost of principal and coupon payments will increase if the issuing company's currency underperforms relative to the native currency of the bondholder. Bonds with foreign currency conversion options are subject to both credit risk and exchange rate risk. Bondholders have no influence over the established conversion rates and pricing. The face value payments at maturity could not be maintainable if the issuing company files for bankruptcy.
There are both benefits and drawbacks for the parties engaged in foreign currency convertible bonds. Although a financial instrument that permits risk sharing between the issuing business and the issuer, a financial currency convertible bond, there are some instances that are exceedingly dangerous.
Foreign currency convertible bonds frequently have lower coupon rates since they give investors the possibility to gain from an increase in a company's equity. Certain factors, such as debt obligations and development expectations, make conversion unavoidable if the share price rises significantly above the conversion price.
Apex stock fell to barely 40.35 after the business distributed shares to bondholders as a result of a required bond conversion. After shares rose beyond a predetermined price of 171.08 for one tranche of bonds and 153.36 for another, the bonds were converted. The regulator has every right to claim that these bondholders are some of the most knowledgeable buyers on the market. They need to have been fully informed of the product's risk. One could legitimately argue that the bondholders did not perform enough research before making their investments. Some market participants contend that Sebi should take action to preserve the market's integrity. FCCBs are specialized goods with a troubled history. No systemic risk exists in this case.
Due to the steep decline in share prices following the financial crisis, this stock of FCCBs had problems. The Reserve Bank of India permitted businesses to purchase their FCCBs back from secondary markets at a discount in 2008. Later, the RBI liberalized the program even more and permitted these buybacks via the automatic approach. According to this line of reasoning, regulatory involvement was appropriate because the FCCB crisis was caused by outside sources.
Poor performing foreign currency bonds serve as a warning that complicated products have complex risks. Businesses now have a variety of options for raising capital, including the standard foreign currency bond market. It would generally be advisable for businesses and investors to stay with some of these simpler instruments.
Ashly Chole - Senior Finance & Technology Editor