What Are Foreign Currency Convertible Bonds?
Foreign currency convertible bonds (FCCBs) are a hybrid financial product that combines foreign currency markets, stocks and bonds. FCCBs are issued in a currency different from the issuer's (company, bank or government) domestic currency and give the holder the option to convert the bond into stock at any time.
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Foreign Currency
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FCCBs are issued in a currency different from the issuer's domestic currency. For example, Toyota might issue bonds in dollars (Toyota's domestic currency being the yen) or an Argentinian company expanding operations to Brazil might issue bonds in Brazilian reais instead of Argentine pesos. Banks and governments can also issue bonds in foreign currency.
Convertible Bonds
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FCCBs combine stocks and bonds by allowing FCCB holders to convert the bond into stock at any time. Hence, FCCBs provide more flexibility to investors than most other financial products. Flexibility also decreases the potential risk of investing because investors have the ability to take advantage of stock appreciation or move money around if the bond market sputters.
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Benefits to Issuers
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Companies, banks and governments issue FCCBs to take advantage of exchange rates and raise capital in foreign currency. Many companies issue FCCBs when breaking into foreign markets or expanding foreign market operations, while banks and governments issue FCCBs to take advantage of favorable interest rates or exchange rates in other markets, or as a strategy to reassure investors if national currency is week or volatile.
Benefits to Investors
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The chief benefit of FCCBs for investors is flexibility, especially considering that stocks usually do well when the bond market suffers. Investors have the guarantee of interest rate payments and return of the principal (the amount originally paid in exchange for the bond) at the maturity date if the FCCB is not converted into stock beforehand.
Considerations
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There are some drawbacks and risks associated with FCCBs. The main risk is in currency conversion, as currency markets are notoriously volatile. Currency risk is much more of a concern for the issuer than the investor (assuming the bond is in the investor's domestic currency), but it's a concern for both if currency depreciation reaches levels that threaten the financial solvency of the issuer. Furthermore, as FCCBs are generally issued by companies, there is a higher risk of default associated with FCCBs than with other types of bonds.
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