Question

Advantages and Disadvantages of Mandatory Convertible Bonds to shareholders/investors

Answer 1

A convertible bond is a fixed-income corporate debt security that yields interest payments but can be converted into a predetermined number of common stock or equity shares. The conversion from the bond to stock can be done at certain times during the bond's life and is usually at the discretion of the bondholder.

Advantages of Convertible Bonds

1. Corporations can sell bonds at a lower coupon rate.
Because there is an option to purchase stocks, companies can sell convertible bonds at a lower coupon rate than standard bonds.

2 Bond interest is a deductible expense for the issuing company.
For example, if the company is in the 30 percent tax bracket, in effect the federal government needs to pay 30 percent of the interest charges in debt.

3 They help a corporation in securing equity financing in a delayed manner.
Because it takes time for the bondholders to trade their bonds for the stock, this delays the common stock and the earnings per share dilution.

4 Voting control is in the hands of common stockholders.
Bondholders cannot vote for directors. So if the management level of a company is concerned about losing voting control of the business and need an alternative means of financing, selling convertible bonds will be more advantageous than using common stock for funding.

5. Convertible bondholders receive only a fixed, limited income until conversion.
This is a great advantage for the company because a bigger chunk of the operating income is available to the common stockholders.

Disadvantages of Convertible Bonds

1They are riskier.
If the issuing company files for bankruptcy, holders of convertible bonds have a lower priority claim on the corporation’s assets.

2 They can be disadvantageous to the issuing company.
These investments can dilute the EPS of the corporation’s common stocks, not to mention the company also risks losing control.

3 The company has the right to forcibly convert them.
The issuing company has the right to call for forced conversion usually when the price of the stock is higher than the amount it would be if the bond were redeemed.

4They are complex securities.
Most new investors tend to be confused if convertible bonds are stocks or bonds because of their characteristics.

5They are traded at a premium to the current trading price.
Investors have to allow the stock to reach the conversion price in order to make the conversion effective.