Convertible Debts

What is the value to the issuer on the conversion feature of convertible debt?

For the issuer, the conversion feature of the convertible debt may offer the following advantage. First, convertible debt offers a lower interest rate compared to the nonconvertible debt (Carmichael & Graham, 2012). Similarly, when planning long-range financing, the issuer may use convertible debt to raise equity capital. For instance, an increase in the value of market stock means that the issuer has the chance to obtain common stock from the conversion of the convertible debt. In such market situations, it is possible for the issuer to get rid of the conversion option and the debt. In the case when the conversion of the debt does not occur due to an insufficient increase in the market value of stock, the issuer will have gained from the cash proceeds at a low cash interest cost.

What is the value to the purchaser on the conversion feature of convertible debt?

Conversely, regarding the purchaser, the value on the conversion feature of the convertible debt gives him/her the option to obtain the face amount of debt upon maturity. Similarly, the purchaser can obtain the specific number of common shares into which the security is convertible (Carmichael & Graham, 2012). In the situation when the market price of the common stock exceeds the conversion rate, the purchaser will benefit through appreciation. The convertible debt provides the purchaser the protection of a debt security in circumstances when the value of the common stock fails to increase in the future. However, the purchase will still anticipate receiving the principal and interest.

 

Reference

Carmichael, D. R., & Graham, L. (2012). Accountants’ Handbook, Financial Accounting and General Topics. Hoboken: John Wiley & S

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