Debentures are a popular form of investment instrument issued by companies to raise funds from investors. A debenture is a type of debt instrument that is not secured by any collateral, but instead, it is backed by the creditworthiness of the issuer. There are different types of debentures, one of which is fully convertible debentures (FCDs). In this blog, we will discuss fully convertible debentures, their features, advantages, and disadvantages.
What are fully convertible debentures (FCDs)?
Fully convertible debentures (FCDs) are a type of debt instrument that can be converted into equity shares of the issuing company. In other words, FCDs are debt securities that can be converted into equity shares at a predetermined price and time. The conversion ratio and price are determined at the time of issuance of the debentures.
Features of fully convertible debentures (FCDs)
- Conversion ratio: The conversion ratio is the number of equity shares that an FCD holder can receive for each debenture. The conversion ratio is fixed at the time of issuance of the debentures.
- Conversion price: The conversion price is the price at which an FCD holder can convert the debentures into equity shares. The conversion price is also fixed at the time of issuance of the debentures.
- Interest rate: FCDs carry a fixed rate of interest, which is paid to the debenture holder until the conversion of the debentures into equity shares.
- Maturity date: FCDs have a fixed maturity date, after which the issuer is required to repay the principal amount to the debenture holder.
Advantages of fully convertible debentures (FCDs)
- Lower cost of capital: FCDs are a cheaper source of capital for the issuing company as they carry a lower rate of interest than other debt instruments.
- Equity dilution: FCDs allow the issuer to raise funds without diluting the ownership of existing shareholders. The conversion of debentures into equity shares takes place at a predetermined price and time, which reduces the risk of equity dilution.
- Attractive to investors: FCDs are attractive to investors as they offer the potential for capital appreciation in addition to the fixed rate of interest.
- Flexible investment: FCDs offer investors the flexibility to convert their debentures into equity shares or hold them until maturity, depending on the market conditions and their investment objectives.
Disadvantages of fully convertible debentures (FCDs)
- Risk of default: FCDs carry a credit risk as they are unsecured debt instruments. In case the issuer defaults, the debenture holder may lose their investment.
- Limited liquidity: FCDs may have limited liquidity as they are not actively traded in the secondary market.
- Dilution of existing shareholders: If the issuer decides to convert the FCDs into equity shares, it may result in the dilution of the ownership of existing shareholders.
Fully convertible debentures (FCDs) are popular among companies that want to raise capital without diluting their ownership. They can offer a lower cost of capital compared to other debt instruments as they offer the potential for conversion into equity shares. In addition, FCDs offer investors the flexibility to convert their debentures into equity shares or hold them until maturity, depending on market conditions and their investment objectives.
FCDs are usually issued with a conversion ratio that determines the number of equity shares that an FCD holder can receive for each debenture. The conversion ratio is fixed at the time of issuance and remains the same throughout the life of the FCD. The conversion price is also fixed at the time of issuance and determines the price at which the FCD holder can convert the debentures into equity shares. This provides investors with a predetermined price and time to convert their debentures into equity shares, reducing the risk of dilution.
FCDs are particularly attractive to investors who are looking for a flexible investment option. They can benefit from the fixed rate of interest paid on the debentures and the potential for capital appreciation if the equity shares increase in value. The conversion of debentures into equity shares can be done at any time before the maturity date, giving investors the flexibility to take advantage of market conditions and maximize their returns.
However, FCDs also carry some risks. As unsecured debt instruments, they carry a credit risk, and in case the issuer defaults, the debenture holder may lose their investment. In addition, FCDs may have limited liquidity as they are not actively traded in the secondary market, making it difficult for investors to sell their holdings.
Another disadvantage of FCDs is the potential for dilution of existing shareholders. If the issuer decides to convert the debentures into equity shares, it may result in the dilution of the ownership of existing shareholders, which can negatively affect their voting rights and dividend payments.
Conclusion
fully convertible debentures (FCDs) can be an attractive investment option for investors seeking a flexible investment option and companies looking to raise funds at a lower cost of capital. However, investors should be aware of the credit risk and potential for dilution, and consider their investment objectives and risk tolerance before investing in FCDs. Companies should also carefully evaluate the benefits and risks of FCDs before deciding to issue them as a fundraising option.
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Frequently asked questions (FAQs) about fully convertible debentures:
Q: What are fully convertible debentures?
A: Fully convertible debentures (FCDs) are debt instruments that can be converted into equity shares at the discretion of the debenture holder. They offer the potential for capital appreciation if the equity shares increase in value, as well as a fixed rate of interest paid on the debentures.
Q: How do fully convertible debentures work?
A: FCDs are issued with a fixed conversion ratio and conversion price. The conversion ratio determines the number of equity shares that an FCD holder can receive for each debenture, and the conversion price determines the price at which the FCD holder can convert the debentures into equity shares. FCDs can be converted into equity shares at any time before the maturity date, giving investors the flexibility to take advantage of market conditions and maximize their returns.
Q: What are the benefits of investing in fully convertible debentures?
A: FCDs offer investors the potential for capital appreciation, a fixed rate of interest paid on the debentures, and the flexibility to convert the debentures into equity shares at any time before the maturity date. They can also offer a lower cost of capital for companies compared to other debt instruments.
Q: What are the risks of investing in fully convertible debentures?
A: FCDs carry a credit risk, as they are unsecured debt instruments. If the issuer defaults, the debenture holder may lose their investment. FCDs may also have limited liquidity, as they are not actively traded in the secondary market, making it difficult for investors to sell their holdings. Additionally, the conversion of debentures into equity shares may result in the dilution of existing shareholders, negatively affecting their voting rights and dividend payments.
Q: How are fully convertible debentures different from other debt instruments?
A: FCDs offer the potential for conversion into equity shares, providing investors with the potential for capital appreciation. They also offer a fixed rate of interest paid on the debentures, and the flexibility to convert the debentures into equity shares at any time before the maturity date. Other debt instruments, such as bonds and traditional debentures, do not offer the potential for conversion into equity shares.
Q: How can companies benefit from issuing fully convertible debentures?
A: FCDs can offer a lower cost of capital compared to other debt instruments, as they offer the potential for conversion into equity shares. This can be attractive to companies that want to raise capital without diluting their ownership. Additionally, FCDs can offer greater flexibility in terms of timing and pricing of the capital raise compared to equity issuance.
