What it means
A convertible bond is a loan that can be turned into shares. A foreign currency convertible bond adds a twist: it is denominated in a currency other than the issuer's home currency, usually a major one such as the US dollar or the euro.
Companies in emerging markets often issue them to reach international investors. The attraction for the issuer is cheaper funding.
Because investors receive a valuable option to convert into shares, they accept a lower coupon (the regular interest payment) than on a straight bond. If the share price rises above the conversion price, holders convert, and the issuer never has to repay the cash.
For investors, an FCCB offers a mix of protection and upside. If the company does well, they can convert and share in the gains, and if it does poorly, they still hold a bond that pays interest and returns the principal at maturity.
This balance explains why the pricing sits between a bond and a share. The main risk for the issuer is currency.
If the bond is in dollars and the issuer earns income in its local currency, a weakening of that currency makes the debt more expensive to repay. A company that raised money when the exchange rate was favourable may find repayment far costlier if the rate moves against it.
There is also dilution, which means existing shareholders own a smaller share of the company after conversion. Accounting rules require the bond to be split into a debt portion and an equity portion in many cases, so the cost shows in the accounts in several ways.
Finance teams must model the conversion terms, interest, exchange rates and redemption at maturity together. Because of these features, FCCBs need careful planning.
Companies should set a hedging policy, track the share price against the conversion price, and prepare for the possibility of a large cash repayment if conversion does not occur. Treating the bond as cheap money without these steps is a common error.
In practice
Real-world examples.
Example
A pharmaceutical company based in an emerging market issues a dollar FCCB to fund a new plant. The coupon is 2%, well below its local borrowing rate. Investors accept the lower interest because they can convert into shares if the business grows.
Example
An exporter earns most of its revenue in dollars and issues a dollar FCCB. The currency match reduces its exchange rate risk, because both the income and the debt are in the same currency. The finance team treats this as a natural hedge.
Example
A technology company sees its share price fall well below the conversion price. Bondholders do not convert, so at maturity the company must repay the full $50,000,000 in cash. It arranges new loans to cover the payment.
Formula
Calculation
Conversion value = number of shares received on conversion x current share price
Suppose an FCCB has a face value of $10,000,000 and a conversion price of $20 per share. Shares on conversion = 10,000,000 / 20 = 500,000. If the share price rises to $24, conversion value = 500,000 x 24 = $12,000,000, which is $2,000,000 above face value, so holders would convert. If instead the share price stays at $15, conversion value = 500,000 x 15 = $7,500,000, so holders would prefer to be repaid $10,000,000 in cash.Case study
Seen in the real world.
Sapphire Textiles is an illustrative, fictional manufacturer that issued a $30,000,000 FCCB with a conversion price of $12 per share and a 5-year term. Most of its revenue was in its local currency.
During the term, the local currency weakened by 25% against the dollar. The cost of repaying $30,000,000 in local currency terms rose by one third, from 3.0 billion local units to 4.0 billion, since the exchange rate moved from 100 to 133 per dollar.
In this fictional story the share price had not reached the conversion price, so Sapphire had to repay in cash and borrowed locally to do so. The lesson is that a cheap coupon can hide a large currency and repayment risk, and it must be hedged or matched to income.
Watch out
Common mistakes.
- Treating an FCCB as cheap money because of the low coupon, while ignoring currency risk on repayment.
- Assuming bondholders will convert, when conversion happens only if the share price is above the conversion price.
- Forgetting dilution, which reduces existing shareholders' percentage ownership after conversion.
Questions
People also ask.
What does FCCB stand for?
It stands for foreign currency convertible bond.
Why is the interest rate on an FCCB lower?
Investors receive an option to convert into shares, which has value, so they accept a lower coupon.
What happens at maturity if the bond has not been converted?
The issuer must repay the face value, plus any agreed premium, in the foreign currency.
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