Question

Explain why corporations issue convertible securities. Discuss the similarities and differences between convertible debt and debt issued with stock warrants.

Answer 1

Companies issue convertible securities due to a lot of reasons:

1) Convertible bond holders receive only a fixed coupon payment until conversion. As a result, the company share its profits with the shareholders and the newly converted bond owners.

2) Bond interest payments are an expense for the company which helps in the company getting tax rebates

3) Convertible bond holders have an option to convert to equity, hence these bonds can be sold at lower coupon payment rates than the prevailing market rate

4) This also leads to lesser dilution in equity as the controlling shareholders have voting control

The similarities between a convertible debt and debt issued with stock warrants is that that both of these are debt instruments which can be converted to stock. However, convertible debt has a call option wherein which the company can ask the holder to convert it into common stock and the holder will have to oblige. On the other hand, debt with stock warrants is an instrument where the holder has an option to convert the bond to a common stock at a price. For example, if at the moment, the price of the stock is high, the warrant holder can take advantage of the fact and convert the bonds into stocks. This is however not applicable for holders of convertible debt.