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Foreign Currency Convertible Bond (FCCB)

Definition

A Foreign Currency Convertible Bond (FCCB) is a unique type of bond issued by a company in a currency other than its domestic one. These bonds are convertible, meaning they can be converted into equity shares of the issuing company at a predetermined rate. They provide a dual advantage of not only getting a fixed return on the bond but also the potential for enjoying any appreciation in the equity value.

Phonetic

“Fohr-in Cur-en-cy Con-vert-a-bull Bond (Ehf-See-See-Bee)”

Key Takeaways

  1. Foreign Currency Convertible Bond (FCCB) is a type of convertible bond issued in a currency other than the issuer’s domestic currency. Essentially, it’s a mix of a debt instrument and a convertible instrument. It allows borrowers to raise money in a currency of their choice, providing greater flexibility and access to international markets.
  2. FCCBs are attractive to both investors and issuers. Investors benefit from the safety of a bond, with the added potential for capital appreciation if they choose to convert the bond into equity. For issuers, FCCBs are a cheap debt instrument since they carry lower interest rates because of their convertibility into equity shares.
  3. Despite the advantages, FCCBs come with certain risks. If the issuer’s share price doesn’t perform well, investors may not opt to convert the bonds into shares. Instead, they may seek repayment of the principal amount which could create a large sudden, financial outflow for the issuer. Moreover, FCCB issuance also involves an implicit cost in terms of share dilution once the bonds are converted into equity.

Importance

The term Foreign Currency Convertible Bond (FCCB) is significant in the finance/banking sector because it combines debt and equity advantages. FCCBs are considered a cheaper source of funding due to lower interest rates and are generally issued when lending rates in a foreign country are less than in a domestic market. Furthermore, they provide an option for conversion into equity, which is attractive to investors as it offers the potential for capital appreciation. In addition, it helps in diversifying a company’s investor base geographically. Therefore, understanding of FCCBs becomes crucial for both investors and businesses for strategic financial planning and investment.

Explanation

A Foreign Currency Convertible Bond (FCCB) primarily serves as a financial instrument used by companies to raise capital in a foreign currency. Its dual essence enables it to function as a bond and an equity instrument. The primary purpose of issuing an FCCB is to take advantage of lower interest rates in foreign countries while also minimizing the risk of exchange rate fluctuations. Simultaneously, it could serve as a strategic tool for a company wishing to establish a presence in a foreign country or increase its attractiveness to foreign investors, given that FCCBs are seen as less risky than standard equity.Moreover, FCCBs can provide a variety of potential benefits to investors. They offer a fixed income like a traditional bond yet carry the added advantage of potential capital appreciation if the issuer’s share price goes up. The conversion feature of the FCCB allows investors to convert their bonds into equity shares of the issuing company at a pre-determined price or rate during a specified period. This flexibility makes FCCB a lucrative proposition from an investor’s perspective. In essence, FCCBs are used to bridge the gap between debt and equity financing, offering the advantages of both worlds.

Examples

1. Tata Steel FCCB Issue: In 2007, Tata Steel Limited, an Indian multinational steel-making company, issued FCCBs worth $875 million to finance its acquisition of Corus Group, a UK-based steel company. FCCBs allowed Tata Steel to raise the necessary funding, offering debt security convertible into a certain number of equity shares of the company at a later date. However, due to market volatility, Tata Steel had to buy back some of these FCCBs in 2011 to prevent dilution of stake.2. Reliance Communications FCCB Issue: Reliance Communications, one of India’s major telecommunication companies, issued FCCBs worth $1 billion in 2006. The company intended to use the funds for its expansion plans. But later, due to market conditions and the company’s financial health, it had trouble in FCCB redemptions, proving that FCCBs can sometimes pose risks for the issuer.3. Vedanta Resources FCCB Issue: Vedanta Resources Ltd., a global diversified metals and mining company, issued FCCBs worth $1.25 billion in 2016. The company intended to use the funds to reduce its existing debt. As part of the offer, the bonds were convertible into American depositary shares, representing the company’s equity shares, demonstrating how FCCBs can be tailored to different regulatory environments.

Frequently Asked Questions(FAQ)

What is a Foreign Currency Convertible Bond (FCCB)?

A Foreign Currency Convertible Bond (FCCB) is a type of convertible bond issued in a currency different than the issuer’s domestic currency. Essentially, it is a type of corporate bond that the holder can convert into equity or cash at a specific rate and time.

Who issues FCCBs and why?

FCCBs are typically issued by companies looking to raise capital in foreign currencies. These bonds are attractive as they potentially allow the issuer to raise capital at a lower cost due to the convertibility feature which is appealing to investors.

What are the benefits of investing in an FCCB?

The benefits of investing in an FCCB include the potential for capital appreciation if the issuing company performs well, combined with the relative safety of a bond. Investors also benefit from any increases in the value of the issuer’s currency against their domestic currency.

What are the risks associated with FCCBs?

Like any investment, FCCBs come with risks. Since they are issued in a foreign currency, they carry currency risk. If the value of the issuer’s currency falls against the investor’s domestic currency, the value of the bond could decline. Additionally, there’s a risk that the issuing company could perform poorly, making conversion into equity less attractive.

Can FCCBs be converted into equity at any time?

Typically, FCCBs have specific periods during which they can be converted. The exact terms of conversion, such as the conversion rate and the conversion period, will be laid out in the bond’s prospectus.

What happens if an FCCB isn’t converted by the end of its tenure?

If an FCCB is not converted into equity by the end of its tenure, the issuing company is obligated to repay the bond’s face value in the foreign currency in which the bond was issued.

Related Finance Terms

  • Conversion Price: This is the pre-determined price at which the bonds can be converted into equity shares of the issuing company.
  • Equity Dilution: When a FCCB is converted into equity, it leads to increase in the number of shares outstanding which may result in diminution of earnings per share.
  • Currency Risk: As FCCBs are denominated in foreign currencies, the issuing company is exposed to currency fluctuation risks.
  • Callable Bonds: Bonds that can be redeemed by the issuer before its maturity. Some FCCBs come with this feature, allowing issuers an advantage if the market conditions are favourable.
  • Zero Coupon Bonds: FCCBs are sometimes issued as zero coupon bonds, where the bond is sold at a significant discount, but does not pay periodic interest, instead providing a return at maturity that includes both the principal and accrued interest.

Sources for More Information

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