Mogen Inc

1291 Words6 Pages
To: MoGen, Inc. Senior Management
From: Mr. Dar Maanavi, Managing Director, Equity-Linked Capital Markets Group of Merrill Lynch

Re: $5 Billon Convertible Debt Offering Proposal

Dear Gentlemen:

We are pleased to present to you the salient features of our proposed $5B convertible debt offering for your careful review and approval. We deemed it appropriate to walk you through the analytical process in coming up with the right mix of conversion premium and coupon rate. We initially consider a conversion premium of 25% and determine its corresponding coupon rate. We then explore the appropriateness of such a premium and explore other conversion premium-coupon rate combinations and determine which combination would be optimal for
…show more content…
This is because of the nature of Mogen’s business, wherein most of the company’s assets are intangibles, which is typical of a risky company. This makes issuance of straight debt more expensive at around 5.75%, as the market will demand higher premium.

Given the above market perception of risk and growth opportunity, issuing a convertible bond is appropriate because it would allow the company to raise capital at more advantageous terms than it would when it issues straight debt. Investors would be willing to supply funds at a lower rate if they can have the opportunity to benefit from the upside potential of the stock. Hence, the value of convertible bonds becomes insensitive to the risk of the company. Investors would not be materially affected if the company becomes more volatile as a result of added risk in the future because the call option value of the convertible bond will likewise increase. Upside returns due to increase in risk will also accrue to investors holding a convertible bond, while having a downside protection because of the part-debt nature of the convertible.
What is the method used to calculate the coupon rate?

We first derive the implied volatility of Mogen’s stock using the Black-Scholes option pricing model The implied volatility of each of the eight outstanding options on MoGen’s stock was obtained using the following information on Exhibit 3 - type of option, days to maturity in years, exercise price and closing
Get Access