What is a BOND?

• "A Bond is simply an 'IOU' in which an investor agrees to loan money to a company or government in exchange for a predetermined interest rate.”

• When a corporation needs funds, one way is to arrange funds is from banks or borrow money. But a generally less expensive way is to issue (sell) bonds. The organisation agrees to pay some interest rate on the bonds and further agree to redeem the bonds (i.e., buy them back) at some time in the future (the redemption date).

What is FCCB?• Foreign Currency Convertible Bond is a type of

convertible bond issued in a currency different than the issuer's domestic currency.

• It is a quasi-debt instrument which are attractive to both investors and issuers. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock.

• Due to the equity side of the bond, which adds value, the coupon payments on the bond are lower for the company, thereby reducing its debt-financing costs.

ISSUE OF FCCBS

• An Indian company or a body corporate, created by an Act of Parliament may issue FCCBs not exceeding US $ 500 million in any one financial year to a person resident outside India under the automatic route, without the approval from Government or the Reserve Bank.

• Where the amount of fund to be raised is to be USD 20 million or less the minimum maturity period should be not less than three years.

• If the amount to be raised is more than USD 20 million and upto 500 million the minimum maturity period should not be less than 5 years.

• FCCBs upto USD 20 million can also carry a call and put option provided the option shall not be exercised until minimum maturity period of 3 years has expired.

• In terms of paragraph (x) of Schedule II of the notification the issue of FCCB is required to be reported to the Reserve Bank through the designated branch of an authorised dealer.

• Authorised dealers may forward the same to the concerned Regional Office of the Reserve Bank for obtaining a loan registration number.

• While forwarding the offer documents to Reserve Bank the authorised dealers shall ensure that the FCCBs are issued strictly in accordance with the notification.

WHY FCCBS ARE POPULAR?

• Being hybrid instruments, the coupon rates on FCCB are particularly lower than pure debt or zero, thereby reducing the debt financing cost.

• FCCB are book value accretive on conversion.

• Saves the risk of immediate equity dilution as in the case of public shares.

Lucrative offer for investors:-

• Assured returns to investors on bond in the form of fixed coupon rate payments.

• Ability to take advantage of price appreciation in the stock by means of warrants attached to the bonds, which are activated when price of a stock reaches a certain point.

• Significant Yield to Maturity (YTM) is guaranteed at maturity.Lower tax liability as compare to pure debt instruments due to lower coupon rates.

REMEDIES TAKEN BY GOVERNMENT

• Promoters or issuers of foreign currency convertible bonds (FCCBs) may be allowed to buy back the bonds if they go in for prepayment.

• Also, promoters are likely to be allowed to utilise the unused portion of the foreign currency-denominated borrowings parked overseas. This could also be utilised to meet the redemption pressure after the bonds mature.

CONTD…..

• It has now been decided to permit premature buyback of FCCBs. For the buyback of FCCBs out of rupee resources the RBI has fixed a minimum discount of 25% on the book value. The amount of the buyback is limited to US $50 mn of the redemption value per company wherein this window will be kept open till March 09.

• To Buyback FCCB out of Foreign Currency minimum discount of 15% on the book value.

IS THIS ENOUGH?

FOR R-COM

Reliance Communication would most likely be the first company to announce buy back of its Foreign Currency Convertible Bonds (FCCBs)

R-Com had issued zero-coupon FCCBs in February 2007, to raise USD 1 billion. The bonds are now trading at a 35% discount to the issue price, meaning, its bonds worth has now come down to US$650 million

RCom, as it currently has over Rs.100 billion in cash reserves, which also includes about US$ 600 million worth of investments in mutual funds overseas

This move to buy back by Rcom is good, as it would help the company reduce its liability and also bring down its forex exposure.

TATA MOTORS

• Tata Motors has cumulative outstanding FCCBs worth Rs.44.87bn.

• Compared to current market price of Rs.152 the FCCB’s is at a 85% discount compared to the conversion price. Considering the large capex program planned by the company and the downturn in automobile industry, shut down of production facilities, likely increase in borrowings to fund JLR, it could face difficulties in terms of cash flow management in near term future and is unlikely to opt for pre-payment option for FCCBs.

• Thus many companies Like Tata Motors which are already under high debts are unlikely to buyback due to limited cash flows

• Examples:SUBEX,AMTEK AUTOS,HOTEL LEELA et al.

• Also $50million sum with limit of 25% discount is only a small step for large FCCB issues.Many companies will not be able to meet the requirements.

CONCLUSION• Two to three years back Indian markets were on

high growth and FCCBs became popular for raising funds from overseas market. With the fall in the market, many FCCBs has gone down, which means no money and more problem in the market.

• Issuing companies will now have to search for resources to repay the debt along with redemption period whenever it matures. For this companies will seek to fresh borrowings, with high interest rates, which in turn would impact their profitability.Another option, which companies have is to reset the conversion clause, to bring it closer to reality.