Foreign currency exchangeable bond

Foreign Currency Exchangeable Bond or FCEB refers to a bond by an Indian company expressed in foreign currency. The principal, interest, all the transactions are done in foreign currency.

The name also suggests that the bonds are convertible in nature, indicating that investors not only receive principal and coupon payments but also offer the option of converting their bonds into stocks.

These bonds are issued by the issuing company, subscribed by a person residing outside India. These bonds are exchangeable for shares of another company. FCEBs give Indian companies an opportunity to raise money abroad by leveraging their shareholdings. Transfer of FCEB between non-residents do not lead to any income tax on capital gains in the country. The minimum maturity for FCEB is 5 years. Prior approval from RBI is mandatory for issuance of FCEB. Issuance of FCEB has limited effect on sharing price of the offered company as the shareholding is dilution-free

FCEBs allow both the investor and the corporation issuing bonds to share risk and reward. Investors take on risk by putting faith in the corporation doing well financially, while companies are able to raise money in different currencies to finance their operations.

Benefits of FCCBs

To the company issuing foreign currency convertible bonds:

The coupon rates on FCCB’s are generally lower than traditional bank interest rates, reducing the cost of debt financing.

If converted, the company is able to reduce its debt as a result of foreign currency convertible bonds and thus gains additional, much-needed equity capital.

If there is a favorable move in the exchange rate, the company may benefit from a reduction in the cost of debt.

Drawbacks of FCCBs

To the company issuing foreign currency convertible bonds:

If the stock market is in a negative cycle, the demand for foreign currency convertible bonds decreases.

Ownership will be diluted, and earnings per share will decrease with each issuer who decides to convert their bonds into stocks.

If the issuing company’s currency does not perform well compared to the bondholder’s domestic currency, the principal and coupon payments will become more costly.

It is possible that bondholders choose not to convert at all. This will mean that the issuing company has to pay out the debt and interest in full.

To the bondholders:

Foreign currency convertible bonds are subject to exchange rate risk and credit risk.

The issuing company may bankrupt, following which the repayment of face value at maturity will no longer be plausible.

Bondholders have no control over the established conversion rates and prices.