Convertible Debentures and Bonds?

What Are Convertible Debentures?

Convertible debentures are debt instruments that can be changed into equity shares of the company at a future date.

This security also has types of both debt and equity. It rewords periodic coupon/interest just like any other debt mechanism till conversion.

And, at a pre-defined time, this debt mechanism may get transformed into equity shares. These debentures may be of diverse kinds:

Fully convertible debentures (FCD): where the whole face value of the debenture is transformed into equity shares

Partly convertible debentures (PCD): where a part of the debenture is converted into equity

The non-convertible part continues to stand as debentures, making interest income and repaying on redemption.

Optionally convertible debentures (OCDs): were convertible into equity shares considering the debenture holders, who may choose to convert them into equity or continue to hold the tool as debt depending on their wish and conversion terms.

The issuer specifies the conversion details at the time of making the issue itself. These will generally include:

·       The date on which or before the conversion may be made

·       The ratio of conversion, i.e., the investor who has the number of shares will be eligible to get for each debenture.

·       Price at which the shares will be allotted to the investor on conversion. Generally, this is at a discount on the market price.

·       The proportion of the debenture that will be converted into equity shares (in case of partially convertible debentures)

·       The advantage to the issuer of convertible debenture lies in the information that convertible debentures usually have a lower coupon rate than pure debt instruments.

·       This is for the reason that the yield to the investor in such debenture is not from the coupon alone but also the possibility of capital appreciation in the investment once the debentures are converted into equity shares.

·       Furthermore, the issuer does not have to repay the debt on maturity since shares are issued in lieu of repayment.

·       The Limitation to this is that stakes of the existing shareholders get weakened when new shares are issued on conversion.

·        When more shareholders come in, the proportionate holding of existing shareholders drops. The investors in a convertible debenture benefit from equity and debt characteristics.

·       They earn coupon income in the preliminary stage, usually when the company’s project is in its budding stage. And once the debenture is converted into shares, they may gain from the appreciation in the value of the shares.