What is the full form of FCCB

FCCB: Foreign Currency Convertible Bond

FCCB stands for Foreign Currency Convertible Bond. It is a special type of bond that is issued by a company in a currency different from its domestic currency, usually with a tenure of 3-7 years. It is an excellent instrument for a company to raise foreign capital. It is generally issued by listed companies overseas to raise money in foreign currency. FCCB is a mix of debt and equity instruments. Like any other bond, it makes regular coupon and principal payments till the specified date, after which it can be converted into equity at a pre-agreed price.

The companies generally issue FCCB in the currency of those countries where interest rates are usually low, or the economy is more stable than their home country. What makes FCCB an interesting investment option for investors is that it comes with a clause that allows the bondholder to convert the bonds into shares at a predetermined price on expiry of a specific duration. Thus, the FCCB holder has the option of redeeming their investment or converting it into equity after the specified duration.

Let us understand it with the following example:

A company "XYZ" issues FCCBs with the following details:

• Issue Price: Rs. 2000
• Coupon rate: 4%
• Maturity term: 3 years
• Convertible into equity shares @ Rs. 1600 per share.

An investor subscribes to 4 such bonds, so the total amount invested would be 8000. As per the features of the bond, the bondholder is entitled to receive a 4% coupon rate for three years and has the option of conversion into equity @ Rs. 1600 per share. If the bondholder chooses to convert the bond into shares, he would be entitled to 5 (8000/1600) shares. Else, he can redeem the invested amount.

Thus, on maturity, after three years, the investor will have two options: he can either claim full redemption of the amount or get the bonds converted into equity shares @ Rs. 1600. The decision made by the investor depends on the market price of the share on the date of conversion.

Suppose the share of the company "XYZ" is trading at Rs. 1000, which is lower than Rs. 1600. Then the investor would choose the full redemption of his bonds and can buy eight shares (8000/1000) with that money from the market instead of 5 which he would have received on conversion. Let us consider another scenario; the share is trading at Rs. 2000. In this case, the investor will benefit by getting the bonds converted into 5 shares whose current market value would be Rs. 10000 (2000x5).

So, on the day of maturity, the investor will decide to go for full redemption if the conversion price is higher (1600>1000) than the current market price of the share and will go for conversion if the conversion price is less than the market price of the share (1600<2000).

Why do businesses create FCCBs?

FCCBs are issued by businesses for a number of reasons, including:

• Access to global markets: FCCBs give businesses a chance to obtain financing from global markets. Generally speaking, borrowing on foreign markets is less expensive than borrowing on home markets.
• Lower interest costs: Because FCCB holders have the opportunity to convert their bonds into equity shares, the interest rate on FCCBs is lower than the interest rate on standard bonds.
• Sources of financing diversification: Businesses can diversify their sources of funding by using FCCBs to enter foreign markets.
• FCCBs can be used by businesses to hedge their currency risk. For instance, a business can issue FCCBs in US dollars to hedge their currency risk if their revenues are in US dollars, but their costs are in Indian rupees.

How do FCCBs function?

FCCBs function as follows:

1. FCCBs are issued by a firm at a fixed conversion rate in a foreign currency.
2. Bondholder: Throughout the bond's term, the bondholder will earn interest on the investment.
3. Conversion: At any moment throughout the bond's term, the bondholder has the opportunity to convert the bond into equity shares.
4. At the conclusion of the bond's life, the corporation redeems the bond if it has not been converted into equity shares.

What benefits do FCCBs offer?

The benefits of FCCBs include:

• Access to global markets: FCCBs give businesses a chance to obtain financing from global markets.
• Lower interest costs: Because FCCB holders have the opportunity to convert their bonds into equity shares, the interest rate on FCCBs is lower than the interest rate on standard bonds.
• Sources of financing diversification: Businesses can diversify their sources of funding by using FCCBs to enter foreign markets.
• FCCBs can be used by businesses to hedge their currency risk.

What drawbacks do FCCBs have?

The following are FCCB drawbacks:

Equity dilution: If the bondholder converts the bond into equity shares, the current shareholders of the firm will have less equity.

Cost of conversion risk: The conversion price is set higher than the equity shares' current market value. The bondholder is not permitted to convert the bond into equity shares if the market price of the equity shares is lower than the conversion price.

Interest rate risk: Compared to ordinary bonds, FCCBs have a lower interest rate. The cost of borrowing for the corporation increases if the interest rate on the global market rises.

Conclusion

Foreign Currency Convertible Bonds (FCCBs) are a crucial tool utilised by businesses to raise capital from global markets. Companies have the chance to obtain financing through FCCBs at a cheaper cost than by raising capital through stock. Companies also utilise FCCBs to spread out their funding sources and protect themselves against currency risk. FCCBs do, however, have several drawbacks, including equity dilution, conversion price risk, and interest rate risk. Companies should carefully weigh the benefits and drawbacks of FCCBs before determining whether to issue them.

Additionally, because of the variation in the conversion price and fluctuations in interest rates, investors should carefully assess their investment in FCCBs. Investors should assess the issuing company's creditworthiness and capacity to convert the bonds into equity shares.

For businesses wishing to expand internationally, diversify their funding sources, and manage currency risk, FCCBs can be a compelling financing choice. Before investing in or issuing FCCBs, businesses and investors must carefully weigh their benefits and drawbacks and make a choice.