What is a Compulsory Convertible Debenture?
A compulsory convertible debenture (CCD) is a kind of bond that has to be converted into a stock by a specified date. Technically, CCD is termed hybrid security, as it isn’t wholly a stock or a bond either.
A debenture is a medium to long term security that a particular company issues as a means of borrowing money at a fixed rate of interest. The only support a CCD has is the faith and the credit of the issuing company. It isn’t safeguarded by collateral.
This article quickly takes you through the concept of CCD, and also how investors trade CCDs.
The Concept of CCD
At the outset, take a look at the concept of the convertible debenture. A convertible debenture may be converted into the company’s equity after the stipulated time. Investors look upon at the convertibility as a significant benefit. So, they are ready to accept a lower rate of interest to buy convertible debentures.
Now, a CCD also is a convertible debenture. The only difference here, as the name suggests, is the compulsion on the owner’s side to accept the stock in the company at the time of maturity, instead of availing the option to receive cash or stock.
Companies can use CCD to repay the debt without spending cash, and investors, on the other hand, can avail a return in interest, and ownership of shares in the company at the later stage.
How do Investors trade CCDs?
CCDs are looking upon at as equity, but their structure resembles a debt. The investors may be given a put option that demands the issuing company to buy the shares back at a fixed price. CCDs don’t carry a credit risk for the issuing company, as they convert to equity.
Besides, they also reduce some downward pressure that a pure equity issuance puts on the underlying stock. It is because CCDs don’t convert to shares immediately.
Usual Model of Convertible Note:
The CN shall convert into Equity Shares based on a price per share (“Conversion Price”) arrived as per the formula below:
Where,
Discount Price = (Price per Security issued in the Qualified Equity Financing)*Discount Rate “Discount Rate” = (100 – X) %, expressed as a percentage.
X = [!]% up to a period of 12 months from the Closing Date
X = [!]% as increased by [!]% for every completed month from the 13th month from the Closing Date OR X = [!]% where Qualified
Financing Round is between 13 – 18 months of Convertible Note.
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