Chapter 24, Problem 2M

Summary Introduction

Case synopsis:

Company SS prepares for the first public offering. The offering was made with consultation of Person RH, the underwriter of the Firm RW, and Person CG has decided convertible bond has a maturity of twenty years. Person CG met Person MS and Person TS the owners of the Company SS to present the analysis of the convertible bonds.

After few days, Person TS and Person MS had many questions to Person CG related to the bond issue. Person TS questioned Person CG whether the rate of the convertible bond will have a lesser coupon rate when compared to the comparable bond without conversion feature. After a huge discussion and debate between the owners, Person CG goes to Person RH for help.

Characters in the case:

• Person MS
• Person TS
• Person CG
• Firm RW
• Person RH
• Person X

Adequate information:

• Person TS states that the convertible is a win-win form of financing
• The company have issued the debt at a lower cost which is below the market value
• If the company’s stock increases to the conversion value, then the company have issued the stock at a price above the present value
• Person MS does not agrees the statement of Person TS and he states that the convertible bonds are no-win form of financing
• Person MS also states that if the stock increases more than $25 then the company must sell the stock at the conversion price

To determine: Whether there is anything wrong in the argument of Person TS who states that it costs less to issue a bond with a convertible feature because it requires a lesser coupon rate.