Financial policy : Question 3
Why should a highly geared company issue convertible bonds rather mandatory convertible bonds?
The following factors should be taken into account when choosing between convertible bonds and mandatory convertible bonds.
- the issuer of a convertible bond is not sure at the time of issue that the bond will be converted on maturity and that it will not have to be repaid in cash. By definition, this risk is not a factor with mandatory convertible bonds as they will always be repaid in shares.
- On financial markets, especially right now, mandatory convertible bonds are very difficult to place as they are not very competitive compared with shares. There is very little difference between a mandatory convertible bond and a share. On the other hand, there is a lot of investor appetite for convertible bonds, which have less in common with shares than do mandatory convertible bonds, since the risks and returns fall between those of a share and an ordinary bond.
- In financial analysis, mandatory convertible bonds are treated as equity as they have to be repaid in shares, while convertible bonds are treated as debt, at least for as long as the share price does not exceed the conversion price.
Consequently, a highly geared company would be better off issuing mandatory convertible bonds than convertible bonds if investors were prepared to subscribe.
For more information, see chapter 24 of the Vernimmen.
- the issuer of a convertible bond is not sure at the time of issue that the bond will be converted on maturity and that it will not have to be repaid in cash. By definition, this risk is not a factor with mandatory convertible bonds as they will always be repaid in shares.
- On financial markets, especially right now, mandatory convertible bonds are very difficult to place as they are not very competitive compared with shares. There is very little difference between a mandatory convertible bond and a share. On the other hand, there is a lot of investor appetite for convertible bonds, which have less in common with shares than do mandatory convertible bonds, since the risks and returns fall between those of a share and an ordinary bond.
- In financial analysis, mandatory convertible bonds are treated as equity as they have to be repaid in shares, while convertible bonds are treated as debt, at least for as long as the share price does not exceed the conversion price.
Consequently, a highly geared company would be better off issuing mandatory convertible bonds than convertible bonds if investors were prepared to subscribe.
For more information, see chapter 24 of the Vernimmen.