Answered: Some market participants say that…

Some market participants say that convertible bonds are “debt when you want them to be equity, and equity when you want them to be debt”. Explain why this would be the case.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter20: Hybrid Financing: Preferred Stock, Warrants, And Convertibles

Section: Chapter Questions

Problem 4Q

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Some market participants say that convertible bonds are “debt when you want them to be equity, and equity when you want them to be debt”. Explain why this would be the case.

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Why think that convertibles are riskier than straight bonds?
What are convertibles are riskier than straight bonds?
What are the reasons for issuing convertible bonds rather than straight debt?
Why do companies find the issurance of convertible bonds to be an attractive form of financing?
Consider the investors who purchase callable bonds. Usually, the investors will execute the call provision if interest rates rise so that they can get the face value amount back and reinvest it elsewhere at higher rates. True or False
Which of the following statements is CORRECT? a. Convertible bonds generally have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains. b. A debenture is a secured bond that is backed by some or all of the firm's fixed assets. c. Junk bonds typically provide a lower yield to maturity than investment-grade bonds. d. A company's subordinated debt has less default risk than its senior debt. e. Senior debt is debt that has been more recently issued, and in bankruptcy it is paid off after junior debt because the junior debt was issued first.
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Which of the following statements about convertible bonds is correct? Before conversion, convertible bonds are treated as equity because they can be potentially converted to equity shares. Holders are more likely to convert bonds to equity shares if stock price declines significantly. Upon conversion, a gain or loss will be recognized. The company who sells convertible bonds will pay interest at a lower interest rate.