NISM Series IIA: Chapter III — Other Securities

This chapter covers hybrid and international instruments that companies use to raise capital, combining characteristics of equity and debt, or allowing domestic companies to access foreign capital markets.

1. Warrants

Warrants are specialized financial securities that give their holders the right to purchase the equity shares of a company at a future date.

Key Characteristics of Warrants

• Issuance Method: Warrants are usually issued by companies alongside a debenture. This is done strategically to make the primary debt issue more attractive and sweeten the deal for potential investors.
• Rights of the Holder: A warrant provides the debenture holder with the right—but not the obligation—to buy equity shares of the company in the future.
• Pre-determined Terms: The terms of the warrant are specified precisely at the time of issue, which include:
  • The exact number of shares the warrant entitles the holder to subscribe to.
  • The price at which those shares can be bought (exercise price).
  • The exercise period during which the warrant can be converted into shares.
• Separability and Trading: Once issued, warrants can often be detached and traded on a stock exchange as an independent security, separate from the parent debenture with which they were originally issued.
• Maturity Comparison: While warrants closely resemble option contracts, they typically have a much longer lifetime (usually spanning several years) compared to exchange-traded options.

2. Convertible Debentures

Convertible Debentures are hybrid debt instruments that can be converted into equity shares of the issuing company at a future date. They combine features of both debt and equity capital.

Operational Features & Investor Benefits

• Debt Phase: Prior to the conversion date, convertible debentures behave like traditional debt instruments, paying a periodic coupon interest to the investor.
• Equity Phase: At the time of redemption, investors have the option to receive equity shares of the company instead of cash.
• Issuer Advantage (Lower Cost of Debt): The key advantage for the issuing company is that convertible debentures usually carry a lower coupon rate than pure (unconvertible) debt instruments.
• Investor Motivation: Investors accept a lower coupon rate because their total expected yield is not restricted to the interest payments alone; it also includes the potential for capital appreciation once the debentures are converted into equity shares.

3. Depository Receipts (DRs)

Depository Receipts (DRs) are negotiable financial instruments that represent shares of a local (domestic) company but are listed, traded, and settled on a stock exchange outside the home country.

How Depository Receipts Work

1. Lodgement of Shares: A domestic company lodges a specific quantity of its underlying equity shares with a custodian bank in its home country.
2. Authorization and Issuance: The custodian bank authorizes an overseas depository bank to issue depository receipts to international investors against those lodged shares.
3. Currency & Trading: DRs are denominated and issued in foreign currency, most commonly in US Dollars ($).
4. Conversion: Depending on the regulatory conditions of the issuing country and the terms of the issue, DRs can be converted back into the underlying equity shares.

Classifications of Depository Receipts

The nomenclature of a Depository Receipt is determined by where it is listed and traded:

• American Depository Receipts (ADRs): These are depository receipts listed and traded on a stock exchange within the United States of America, such as the New York Stock Exchange (NYSE).
• Global Depository Receipts (GDRs): These are depository receipts listed and traded on international stock exchanges located outside the United States.

Regulatory Note on Listing: Stock exchanges across different countries have varying listing requirements. These differences commonly pertain to the size of the issuing company, the state of its financial health, its overall shareholding pattern, and its ongoing disclosure requirements.

4. Foreign Currency Convertible Debentures (FCCBs)

Foreign Currency Convertible Debentures (FCCBs) are foreign-currency-denominated debt instruments raised by companies in international markets, which carry an option for conversion into equity shares before maturity.

Essential Characteristics of FCCBs

• Currency Denomination: FCCBs are raised in foreign currencies (usually US Dollars) in international markets.
• Servicing Currency: Both the periodic interest (coupon) payments and the final repayment of the principal (if not converted) must be made in the foreign currency.
• Conversion Premium: The conversion price—the price at which the debt converts into equity shares—is typically set at a premium relative to the current market price of the shares at the time of issuance.
• Corporate Benefits:
  • Lower Rates: They enable domestic companies to raise debt at much lower interest rates abroad compared to domestic debt markets.
  • Efficiency: The administrative time required to raise funds through FCCBs is often lower than what it takes to raise traditional, pure debt in international markets.

Comparative Matrix: Key Features of Other Securities