Business
Convertible Bonds
Convertible bonds are corporate bonds that can be converted into a predetermined number of the issuer's common stock. They offer investors the potential for capital appreciation if the stock price rises, while also providing downside protection through the bond's fixed-income characteristics. This hybrid nature makes convertible bonds an attractive investment option for both bond and equity investors.
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10 Key excerpts on "Convertible Bonds"
eBook - PDFBond and Money Markets
Strategy, Trading, Analysis
- Moorad Choudhry(Author)
- 2003(Publication Date)
- Butterworth-Heinemann(Publisher)
The decision to convert is solely at the discretion of the bondholder. 1 Once converted into ordinary shares, the shares cannot be exchanged back into bonds. As a result of their structure and option feature, in the market convertibles display the characteristics of both debt and equity instruments; as such they are often referred to as hybrid instruments. In addition to Convertible Bonds, there are also convertible preferred stock , which are essentially preference shares that are convertible into ordinary shares, again under terms specified at the time of issue. Convertibles are an important element of corporate finance and have benefited from the development of complex valuation models as applied in the option markets. Due to their hybrid nature, convertibles have presented some issues in their analysis and valuation in the past, but modern techniques have essentially resolved this and issue volumes have been steadily increasing during the 1990s, with volumes usually highest during rising stock markets. The sustained bull-run in global equities markets during the second half of the 1990s, led by Wall Street but also observed in other markets, has also witnessed growth in convertibles volumes. This reflects the fact that issuing a right to share in future equity price growth is most attractive during times of rising markets, and this allows cor-porates to issue convertibles on favourable terms. In this chapter we review the basic characteristics of convertible securities, and the advantages and disad-vantages of the bonds for both issuers and investors. The following chapter reviews the valuation and analysis of Convertible Bonds. Convertible bond issues in 1998 by currency $billion US dollars 96 Sterling 16 French francs 7 Other currencies 7 Table 16.1: Convertible bond issuance in 1998.
eBook - PDF- (Author)
- 2022(Publication Date)
- Wiley(Publisher)
7. Convertible Bonds • describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income securities and whether such provisions benefit the borrower or the lender A convertible bond is a hybrid security with both debt and equity features. It gives the bond- holder the right to exchange the bond for a specified number of common shares in the issuing company. Thus, a convertible bond can be viewed as the combination of a straight bond (option-free bond) plus an embedded equity call option. Convertible Bonds can also include additional provisions, the most common being a call provision. From the investor’s perspective, a convertible bond offers several advantages relative to a non-convertible bond. First, it gives the bondholder the ability to convert into equity in case of share price appreciation, and thus participate in the equity upside. At the same time, the bond- holder receives downside protection; if the share price does not appreciate, the convertible bond offers the comfort of regular coupon payments and the promise of principal repayment at maturity. Even if the share price and thus the value of the equity call option decline, the price of a convertible bond cannot fall below the price of the straight bond. Consequently, the value of the straight bond acts as a floor for the price of the convertible bond. Because the conversion provision is valuable to bondholders, the price of a convertible bond is higher than the price of an otherwise similar bond without the conversion provision. Similarly, the yield on a convertible bond is lower than the yield on an otherwise similar non-convertible bond. However, most Convertible Bonds offer investors a yield advantage; the coupon rate on the convertible bond is typically higher than the dividend yield on the underlying common share. From the issuer’s perspective, Convertible Bonds offer two main advantages.
eBook - ePub- (Author)
- 2021(Publication Date)
- Wiley(Publisher)
As with any fixed-income instrument, convertible bond investors should perform a diligent risk–reward analysis of the issuer, including its ability to service the debt and repay the principal, as well as a review of the bond’s terms of issuance (e.g., collateral, credit enhancements, covenants, and contingent provisions). In addition, convertible bond investors must analyze the factors that typically affect bond prices, such as interest rate movements. Because most Convertible Bonds have lighter covenants than otherwise similar non-Convertible Bonds and are frequently issued as subordinated securities, the valuation and analysis of some Convertible Bonds can be complex.The investment characteristics of a convertible bond depend on the underlying share price, so convertible bond investors must also analyze factors that may affect the issuer’s common stock, including dividend payments and the issuer’s actions (e.g., acquisitions or disposals, rights issues). Even if the issuer is performing well, adverse market conditions might depress share prices and prevent conversion. Thus, convertible bond investors must also identify and analyze the exogenous reasons that might ultimately have a negative effect on Convertible Bonds.Academics and practitioners have developed advanced models to value Convertible Bonds, but the most commonly used model remains the arbitrage-free framework. A traditional convertible bond can be viewed as a straight bond and a call option on the issuer’s common stock, soValue of convertible bond = Value of straight bond + Value of call option on the issuer’s stock.Many Convertible Bonds include a call option that gives the issuer the right to call the bond during a specified period and at specified times. The value of such bonds is
eBook - PDFBasic Finance
An Introduction to Financial Institutions, Investments, and Management
- Herbert Mayo, , , (Authors)
- 2018(Publication Date)
- Cengage Learning EMEA(Publisher)
264 PART 3 Investments Review Objectives Problems Now that you have completed this chapter, you should be able to 1. Enumerate the features of convertible securities (pp. 253–254). 2. Calculate the value of a convertible security as stock (pp. 254–255). 3. Calculate the value of a convertible security as debt (pp. 256–248). 4. Describe the premiums paid for a convertible bond (pp. 259–261). 5. Explain why a convertible security is always callable and when a company may call the security (pp. 262–263). 6. Determine what affects the return on an investment in a convertible (pp. 262–263). 1. Given the following information concerning a convertible bond: Principal: $1,000 Coupon: 5 percent Maturity: 15 years Call price: $1,050 Conversion price: $37 (that is, 27 shares) Market price of the common stock: $32 Market price of the bond: $1,040 a. What is the current yield of this bond? b. What is the value of the bond based on the market price of the common stock? c. What is the value of the common stock based on the market price of the bond? d. What is the premium in terms of stock that the investor pays when he or she purchases the convertible bond instead of the stock? e. NonConvertible Bonds are selling with a yield to maturity of 7 percent. If this bond lacked the conversion feature, what would the approximate price of the bond be? Summary A convertible bond is a debt instrument that may be converted at the owner’s option into stock. The value of the bond depends on the value of the stock into which the bond may be converted and on the value of the bond as a debt instrument. As the price of the stock rises, so does the value of the Convertible Bonds. Since a convertible bond’s price rises with the price of the stock, the bond offers you an opportunity for capital gains. The bond pays interest income and its value as a debt instrument sets a floor on the bond’s price.
No longer available |Learn moreInvestments
An Introduction
- Herbert Mayo(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-300 C H A P T E R S I X T E E N Convertible Bonds and Convertible Preferred Stock 597 These risks suggest that investors should approach Convertible Bonds cautiously. However, Convertible Bonds do offer some combination of potential capital gains, in -terest income, and the safety associated with debt. If the price of the stock rises, the price of the bond must also rise, and the investor receives interest income. If the stock’s price does not rise, the convertible bond must eventually be retired because it is a debt obligation of the firm. Hence the bond does offer an element of safety that is not avail -able through an investment in stock, as well as some growth potential that is not avail -able through an investment in nonconvertible debt. CONV ERT IBL E P REFERRE D ST O C K In addition to Convertible Bonds, many firms have issued convertible preferred stock . As its name implies, this stock may be converted into the common stock of the issuing corporation. For example, the Rouse Company 6uni00A0percent preferred is convertible into 1.311 shares of the company’s common stock. (There are also mandatory convertible preferred stocks. Investors who own these shares must convert the preferred stock into the firm’s common stock on a specified date.) Several issues of convertible preferred stock are the result of mergers. The tax laws permit firms to combine through an exchange of stock, which is not taxable (i.e., it is a tax-free exchange). If one firm purchases another firm for cash, the stockholders who sell their shares have an obvious realized sale. Profits and losses from the sale are then subject to capital gains taxation. However, the Internal Revenue Service has ruled that an exchange of like securities is not a realized sale and thus is not subject to capital gains taxation until the investor sells the new shares.
eBook - PDFThe Concise Guide to Mergers, Acquisitions and Divestitures
Business, Legal, Finance, Accounting, Tax and Process Aspects
- R. Brown(Author)
- 2007(Publication Date)
- Palgrave Macmillan(Publisher)
If the company has the right, it can refinance at the times allowed and frequently on more favorable terms. The two big issues are timing—when can or must it be redeemed—and price—what premium must be paid. Convertibility Convertible securities are shares that can be converted into another class of secu- rity, usually preferred shares convertible into common shares. Sometimes, they can be converted into cash, debt or an asset owned by the company. In some cases, they are convertible into shares of another company. Until conversion, such shares are usually treated the same as other stock of the same class with the same dividend and dissolution rights. Voting rights, however, may be treated differently. Convertible preferred stock might have voting that is equal to common stock on a share for share basis;•equal to the number of com- mon stock into which it is convertible;•or as a class to designate a fixed number of directors. When issuing convertible stock, the company must carefully describe: • when convertibility is allowed (fixed date, certain period or on certain events); 90 THE CONCISE GUIDE TO MERGERS, ACQUISITIONS AND DIVESTITURES • who can exercise the right (all, majority or some of the holders); • how converted (automatically or on exercise of right); • what it is converted into; • how to calculate the conversion ratio. The company must also understand what impact a conversion will have on its financial statements. Specific Types of Securities We have seen that there are two basic types of securities, common and preferred, and that they can have five main characteristics—voting, dividend, participation, redemption and convertibility. Now let’s put the types and characteristics together and describe the principal alternatives. 4 • Founders stock: the organizers of a company usually care most about par- ticipation. They want the right to a higher percentage of dividends and liq- uidation value.
- Moorad Choudhry(Author)
- 2004(Publication Date)
- Butterworth-Heinemann(Publisher)
The other disad-vantages of holding convertibles are only apparent in hindsight: if the issuer's share price does not appreciate, the investor will have accepted a below-market coupon level for the life of the bond, and possibly a drop in the price of the bond below its issue price. There a range of investor classes that may be interested in holding convertibles at one time or another. These include equity fund managers who are currently bearish of the market: purchasing convertibles allows them an element of downside market protection, 176 Part II: Corporate Debt Markets whilst still enabling them to gain from upside movements. Equity managers who wish to enhance the income from their portfolios may also be interested in convertibles. For bond fund managers, convertibles provide an opportunity to obtain a limited exposure to the growth potential and upside potential associated with an option on equities. Selected bibliography and references Calamos, J ., Convertible Securities , McGraw-Hill, 1998 Connolly, K., Pricing Convertible Bonds , Wiley, 1998 Fabozzi, F., Bond Markets, Analysis and Strategies , Prentice Hall, 1991 Kitter, G., Investment Mathematics for Finance and Treasury Professionals , Chapter 6, John Wiley and Son, 1999 Chapter 7: Convertible Bonds I 177 8 Convertible Bonds II In the previous chapter we reviewed convertible bond instruments and the features that differentiated them from conventional fixed interest bonds. In this chapter we consider the pricing and valuation of these securities. 8.1 Traditional valuation methodology Let us consider another hypothetical security issued by ABC plc, a 20-year convertible bond with a coupon of 8%. `One' bond has a nominal amount of £100 and may be converted into 10 ordinary shares of ABC plc. In November 1999 the bond is trading at £102 and the underlying shares at £2.50. In 1999 the company paid a dividend of £0.08 per share, a dividend yield of 3.20%.
No longer available |Learn moreIntermediate Accounting
Reporting and Analysis
- James Wahlen, Jefferson Jones, Donald Pagach, , James Wahlen, Jefferson Jones, Donald Pagach(Authors)
- 2019(Publication Date)
- Cengage Learning EMEA(Publisher)
The first case is when a company issues a convertible bond that initially has a beneficial conversion feature. A beneficial conversion feature is one in which the conversion price is below the fair value of the stock into which it is convertible. The second case occurs when the convertible debt is issued at a significant premium. The final case occurs when the company may settle the convertible debt by paying cash to the owner of the bond. These cash settled Convertible Bonds normally settle in one of three ways: • Net Share Settlement: The bond issuer pays the face value of the bonds in cash and delivers shares for the in-the-money amount of the conversion option. 9 FASB ASC 470-20-40-26: Debt, Debt with Conversion and Other Options. Copyright 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 14-27 How Do We Account for Bonds with Equity Characteristics? • Cash or Stock in Any Combination: The bond issuer pays some combination of cash and common stock in a total amount equal to conversion value. • Cash Settlement: The bond issuer pays cash equal to conversion value. Example On January 1, 2019, Jordy Company issues a $1,000 bond that pays annual interest of 1% and is convertible into 50 shares of its $5 par value common stock at the end of 3 years. Jordy may also settle the bond through a cash payment equal to the principal amount.
eBook - PDF- Laurence Booth, Ian Rakita(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
Although the underlying security is different, the conversion fea- tures operate in an identical manner, and for convenience we will discuss Convertible Bonds. Note that due to their similarity, both Convertible Bonds and preferred shares are traded on the Toronto Stock Exchange. As described in Chapter 6, Convertible Bonds are bonds that can be converted into a specified number of common shares at the option of the bondholder. In many ways, they are similar to bonds with warrants. The key difference is that when convert- ibles are converted, the bonds or preferred shares are exchanged for common shares and are no longer outstanding, whereas for debt with warrants attached, the debt remains outstanding and the exercise price is paid in cash. This means that the firm does not get any new financing when convertibles are converted; all that happens is that the debt is converted into common shares. In contrast, with warrants the firm gets new financing from the sale of new shares at the exercise price. However, even though they get no additional financing, firms issue con- vertibles because the conversion does change the firm’s capital structure by increasing the amount of common equity and reducing either debt or preferred shares. As we will discuss in Chapter 21, this increases the firm’s financial flexibility and allows it to issue more debt in the future. On June 3, 2015, the Financial Post reported the data shown in Table 19.5 for three Convertible Bonds outstanding in Canada. Like companies offering warrants, companies that issue Convertible Bonds tend to be high risk. The first company listed in Table 19.5 is 5N Plus Inc., which is a small specialty metals company headquartered in Montreal with a market value of barely $100 million. 5N Plus has a convertible bond with a 5.75-percent cou- pon selling for $85. These bonds have just four years to maturity, and a yield to maturity of 10.36 percent, since they are selling at a $15 discount to their par value.
- Dimitris N. Chorafas(Author)
- 2005(Publication Date)
- Butterworth-Heinemann(Publisher)
Part 2 The bondholder’s options, risks, and rewards This Page Intentionally Left Blank 3 Bonds defined 3.1 Introduction A bond is a loan; and as a loan it is an obligation on the issuer to provide one or more future cash flows to the buyer, and return the capital at maturity (see Chapter 10). The timing and size of these cash flow(s) may be pre-specified, or it may be depend-ent on an economic variable whose value is usually known a priori. Examples of types of bonds issued, for instance, by credit institutions are: Flat rate bonds Floating rate bonds Convertible Bonds Deeply subordinated bonds Callable bonds Zero-coupon bonds Convertible zero-coupon bonds Flat rate euro medium term notes (MTN) Fixed/flat rate euro MTNs Step-up euro medium term notes Index-linked bonds Index-linked capital protected notes (CPN). The primary critical variables of all bonds are: coupon (%), currency, face amount, maturity, credit rating of issuer, and credit rating of issue. There exist as well other important criteria, discussed in section 3.2. The term bond is generally employed when speaking of long-term obligations, but there exist several variations in its actual usage. The more prominent features of a bond include the aforementioned definite promise to pay an interest and to repay the principal amount; an established maturity; a statement of the tender or medium of payment; and identification of currency and place of payment. Also, reference to the bond indenture for other rights and powers, 1 such as: Limitations upon the issuance of additional securities Action in the event of default of interest or principal payments Curtailment of management prerogatives in the event of failure to meet prescribed conditions, and so on. The choice of bonds versus equities has always puzzled investors. Though they do not participate in market upsides like stocks do, bonds have advantages. When in 1901 Andrew Carnegie sold Carnegie Steel to J.P. Morgan for $480 million, he also
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