Convertible Debt

1. Convertible Debt

Companies have to ways in raising money and financing their plans: issue debt or equity. Debt comes in the form of loans and equity in the form of shares. There is a wide range of methods for both ways, with different instruments and multiple options. In this study we will focus on debt and especially in convertible debt. A convertible debt is a loan that can convert to equity under certain circumstances, usually at the holder's discretion.

A convertible debt is usually issued in the form of convertible bonds, which is similar (but not the same) to a bond with warrants. A warrant is a certificate, usually issued along with a bond or preferred stock, entitling the holder to buy a specific amount of securities at a specific price, (usually above the current market price at the time of issuance), for an extended period, anywhere from a few years to forever. A bond is a certificate of debt that is issued by a government or corporation in order to raise money with a promise to pay a specified sum of money at a fixed time in the future and carrying interest at a fixed rate. So, a convertible bond is a bond with warrants with the only difference that the latter can be separated into different securities whereas a convertible bond can’t. A convertible bond gives the holder the right to exchange it for a given number of shares of stock anytime up to and including the maturity date of the bond (Ross, Westerfield, Jaffe, Corporate Finance).

Convertible bonds are hybrid instruments: they are never as good as bonds when yields fall and they never perform as well as stocks in a bull market , but they always deliver better returns than the mix of the two(Ahmed Talhaoui, Incisive Media Investments Ltd. 2005). From an issuer point of view, they look interesting as they are cheap (the coupon is usually lower than for conventional bonds) and it is a way of selling stock at a premium (as at issue, the conversion option is out of the money). Convertibility is usually added as a deal sweetener in bonds to attract investors.

For