FCCBs with a maturity term of 3-7 years provide an option to the bondholders to either redeem their investments or convert FCCBs into equities at or before maturity term at pre-determined price. Consequently, FCCBs entitle an investor for coupon rate payments with an additional option of conversion of bonds into equities.
Illustration for clear understanding of FCCBs:
If a Company 'X' issues FCCBs with :
Issue Price : Rs. 500
Coupon rate: 2%
Maturity term : 2 years
Convertible into equity shares @ Rs.400 per share.
In this case, if an investor subscribes to 4 such bonds, total invested amount would be Rs. 2000. As per the term of the bond, bondholder becomes entitled to receive 2% coupon rate for 2 years. Also, as the bond comes with an inherent option of conversion into equity @ Rs. 400, bondholder would exercise the option at his discretion depending on the market price of the stock at the time of conversion. In case of opting for conversion into equity, the investor would be entitled to 5 (2000/400) shares. Else, he could go for redemption of the invested amount.
Considering that scrip of the company 'X' is trading at Rs.500, more than the conversion price, investor would be better off by exercising the conversion as then he would be entitled to 2000/400 = 5 shares instead of the otherwise 2000/500 = 4 shares. However, if the market price of the scrip is lower in comparison to the conversion price, say for instance, Rs 200, an investor can claim for 2000/200= 10 shares as against 5 shares that he would get on conversion. So a better option in this stance is to redeem the total investment amount.
Hence, the decision of the bondholder to either redeem the invested amount or opt for conversion of equity is dependent on market price of the company's stock. In case, the conversion price is less than the market price at the time of maturity, bondholder would opt for conversion into equity, else go for full redemption of the invested amount.
Salient features of FCCBs
1. FCCBs carry comparably lower interest rates in comparison to regular bonds. Low interest is partly on account of the inherent option available to investors for conversion of FCCBs into equities.
2. Issuance of FCCBs does not require any collateral or security.
3. FCCBs are a low-cost source of borrowing for corporates.
4. Funds raised through issuance of FCCBs meet various expansion plans and capital expenditure requirement of corporates