Generally, companies issue debentures to raise capital from the public as a loan for their business functions. There are different types of debentures that a company can issue. A convertible debenture is one among them, where the debentures holders can convert their holdings partially or fully into equity shares of the company. This article will discuss partially convertible debentures and their features, advantages, and disadvantages.
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What are Partially Convertible Debentures?
Partially convertible debentures (PCD) are debt instruments where the investors can convert only some portion into equity shares of the company on the expiry of the specified period. The investor can redeem the remaining portion of the debenture at maturity. Also, the company decides the ratio of conversion for these debentures at the time of issue. Furthermore, after partially converting these debentures into equity, the debenture holders become the shareholders of the company to the extent of their holdings.
Moreover, a PCD is suitable for companies with an established track record. The conversion also leads to a lower equity capital base. Thus, they are not very popular among investors.
Features of Partially Convertible Debentures
The following are the key features of a partially convertible debenture –
The conversion price is the price at which the actual equity share was issued and allotted to the holder. The conversion price is based on several factors, such as the current book value, market price, expected appreciation in the value of equity shares, etc. Thus, the conversion price of these debentures should not be set too low or too high.
The conversion ratio is the number of equity shares that the holder receives in exchange for a PCD.
Quantum of Conversion
The number of debentures converted is specified in the terms of percentage of its face value.
Further, the partial amount to be converted is translated into the number of equity shares based on price.
The conversion value of a PCD depends on the investor’s right to receive equity shares. Thus, to arrive at the convertible value, they have to multiply the conversion ratio by the current market price per equity share.
Time of Conversion
It varies depending on the time period of the partially convertible debenture, which usually ranges between one year from the date of allotment to five years.
The coupon payments of a PCD depend on the company’s credit quality and the current interest rate. As per the clause during the issue, the company pays the coupon payments half-yearly or annually.
The conversion value and investment value helps to determine the market price of the PCD. Thus, this instrument is a combination of debt and an option to buy a company’s equity share.
Advantages of Investing in Partially Convertible Debentures
The following are the advantages.
- Investors of PCD receive fixed interest payments called coupons.
- If the company’s stock prices are declining, the bondholders have an option to continue to hold the security until maturity.
- In the event of liquidation, the bondholders of partially convertible debentures are paid before the shareholders.
- Being a hybrid instrument, investors receive fixed interest payments and can partially convert their loan into equity when the company is performing well or when stock prices are increasing.
Disadvantages of Investing in Partially Convertible Debentures
The following are the disadvantages.
- The holders no longer receive interest payments on the debt portion once converted into equity.
- Partially Convertible debentures receive lower interest payments compared to other traditional debt instruments.
- In case of bankruptcy, secured creditors are paid on priority. Thus, the partially convertible debenture holders will be paid only after secured debt holders are satisfied.
- After partially converting debentures into equity shares, the investors could lose part of their money if the company stock prices decline.
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