What is a Foreign Currency Convertible Bond?
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. 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.
Understanding Foreign Currency Convertible Bonds (FCCB)
A bond is a debt instrument that provides income to investors in the form of regular scheduled interest payments called coupons. At the maturity date of the bond, the investors are repaid the full face value of the bond. Some corporate entities issue a type of bond known as convertible bonds.
A bondholder with a convertible bond has the option of converting the bond into a specified number of shares of the issuing company. Convertible bonds have a conversion rate at which the bonds will be converted to equity. In 2014, Twitter raised $1.8 billion in convertible bond offering. The 7-year bond has a $1,000 face value with 1% coupon rate, and a conversion rate of 12.8793 shares. This means that an investor can effectively purchase 12.8793 shares for $1,000/12.8793 = $77.64 per share. Over the life term of the bond, if the share price of TWTR rises above $77.64, bondholders will exercise their option to convert the bonds into equity. However, if the stock price stays below the conversion price, the bond will not be converted. Thus, convertible bonds allow bondholders to participate in the appreciation of the issuer’s underlying shares. There are various types of convertible bonds, one of which is the foreign currency convertible bond.
A foreign currency convertible bond (FCCB) is a convertible bond that is issued in a foreign currency, which means the principal repayment and periodic coupon payments will be made in a foreign currency. For example, an American listed company that issues a bond in India in rupees has, in effect, issued an FCCB. Foreign currency convertible bonds are typically issued by multinational companies operating in a global space and looking to raise capital in foreign currencies. FCCB investors are usually hedge fund arbitrators and foreign nationals. These bonds can be issued along with a call option (whereby the right of redemption lies with the bond issuer) or put options (whereby the right of redemption lies with bond holder).
A company may decide to raise money outside its home country to gain access into new markets for new or expansionary projects. FCCBs are generally issued by companies in the currency of those countries where interest rates are usually lower than the home country or the foreign country economy is more stable than the home country economy. Due to the equity side of the bond, which adds value, the coupon payments on the bond are lower for the issuer than a straight coupon bearing plain vanilla bond, thereby, reducing its debt-financing costs. In addition, a favorable move in the exchange rates can reduce the issuer’s cost of debt, which is the interest payment made on bonds.
Since the principal has to be repaid at maturity, an adverse movement in exchange rates in which the local currency weakens, can cause cash outflows on repayment to be higher than any savings in interest rates, resulting in losses for the issuer. In addition, issuing bonds in a foreign currency exposes the issuer to any political, economic, and legal risks prevalent in the country. Furthermore, if the issuer’s stock price declines below the conversion price, FCCB investors will not convert their bonds to equity, which means the issuer will have to make the principal repayments at maturity.
An FCCB investor can purchase these bonds at a stock exchange, and has the option to convert the bond into equity or a depositary receipt after a certain period of time. Investors can participate in any price appreciation of the issuer’s stock by converting the bond to equity. Bondholders take advantage of this appreciation by means of warrants attached to the bonds, which are activated when the price of the stock reaches a certain point.