Foreign currency convertible bond 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. Further, a convertible bond is a mix between a debt and equity instrument. It acts like a bond by making regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock.
These type of bonds are attractive to both investors and issuers . The investors receive the safety of guaranteed payments on the bond. And also are able to take advantage of any large price appreciation by means of warrants attached to the bonds. Which are activated when the price of the stock reaches a certain point.
Moreover, due to the equity side of the bond, which add value, the coupon payments on the bond are lower for the company. Thereby reducing its debt-financing costs.
Advantages of foreign currency convertible bond
- The convertible bond gives the investor the flexibility to convert the bond into equity at a price or redeem the bond at the end of a specified period, normally 3 years if the price of a share has not met his expectations.
- Companies prefer bonds as it leads to delayed dilution of equity. And allows company to avoid any current dilution in earnings per share that a further issuance of equity would cause.
- These bonds are easily marketable as investors enjoys option of conversion into equity if resulting to capital appreciation. Further, investor is assured of a minimum fixed interest earnings.
Disadvantages of FCCBs
- Exchange risk is more in foreign currency convertible bond as interest on bonds would be payable in foreign currency. Thus, companies with low debts equity ratios, large forex earnings potential only opt for foreign currency convertible bond.
- Foreign currency convertible bond mean creation of more debt. And a forex outgo in terms of interest which is in foreign exchange.
- n the case of convertible bonds, the interest rate is low, say around 3–4% ,but there is exchange risk on the interest payment as well as re-payment. If the bonds are not converted into equity shares. The only major advantage would be that where the company has a high rate of growth in earnings. And the conversion takes place subsequently, the price at which shares can be issued can be higher than the current market price.
