FI.Chapter21 - i r trre$errcq S*ek#yEsnEd Fece*aeeErcg...

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i: r #yEsnEd Fece*aeeErcg: trre$errcq! S€*ek, Werrsert*" *srd C@**srertEfu€es hc use of corveriible securities- but bv only 70ti of ihe siock's perccntage bonds or prcfcrred stocks that can be incrense. Fl vcver iJ the sbck declincs, the con- exchange.l for common stock of thc vertiblc wi]1 decline blr only 50"/" of tho siock's issuing corporation-has soart'd durht thr dechre. Thus, r'hiie convcrtibles arc more last deca(te. Why do companicli Lrse convert' risk!, than straight bonds, thc), are less riskt ibles so heavilv? To .rnswer ihis ctucstiqr, ihan commol sbcks. first recognize that converlibles f.irlually To illusirate, colsider, which ahlays have couporr ratcs that arc lol\,er lhan inJanuary l99q issued ljl.25 billion ofcon rvould be requircd on siraighi, nonconvert- vertible bonds, thc largest srlch offeflnts Ln ible bcnrds or prefcrr€d stocks. Therefore, if a hisk)ry. ADrazon's bonds had a par vallre of compiny raises Xi100 million by issujng con' !j1,000 and a 4.75% coupor ratc. During vcrtible bonds, its interest expcnse will tre 1999 Amazor's conlertibles took thcir hold- lolver than if it financcd rvith nonconveriible ers on a r{'ild ride. Amazon's stock rose debt. But rvhy wollcl inlcstors bc willing to about 70% durnrg the first four months, bu)' such.r bonLl, Biven its b{,er inlerest pny- causing its converiiblcs io risc to li],500. ments? Thc ans{er lics in the conversior fea During the ncxt four months, the stock lost ture if thc price of the issucr's stock riscs, nrore than 60% of its value, to a lcvel 30% ihe converiible bondholder clrn cxchangc it below where it had bccn tradjn8 rvher Ior sbck nnd rcalizc a capital gain rhe Jur,\.rrihl. . sc'e i.-rr'rl. Thr. A convertible bond's valuc is based partly thc convertiblcs' price to be cut in half, to on inierc$t rates in ihc econo y, partly on tLre tj750. Three nonths later Amazon's stoc( issuin8 conpanv's rq+rlar bond risk, ard paftl)' rebo nded, and its convortibles oncc igain on the price of the sbck into N'hich it is con tradod above 51,500. But thc)' droppcd once vertible. In conirasi, a nonconvertible boncl's more, and by year-cnd 1999, the converiibles pricc is based cntirely on intcrest ratcs a d rvcre back io their $1,0U0 issuc price. Thus, companv risk. Thorcfore, convcrtibles' prices sorreone holdint lhe convertiblcs for the are much nore lolafilc than rc$lar bonds' entirc l,ear rvould have ended up close to prices, \^,hich make convcrtiblcs riskier than where hc or she siarted, with a toial rcturn siraight bonds. An aticle in ir(r'/rcs reported just shy of the 4.7570 coupor rate, but prob- that if a corrpany's conlmorr sk)ck jncrcases iI ably also wiih a bnd case of hearib rn and a value, the reiums on its convortibles also rise, fe\,gray hairs. s.vr. .r John Go,hom, "Cl\iclsn tilre,' Forbe5, 0e.ember 27, 1999, 200.
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743 In previous chapters we examined common stocks and various types of long{erm debt. In this chapter, we examine three other securities used to mise tong+erm caplta\ 11) prct'etaed stocft, which is a hybrid security ihat represents a cross between debt and common equity; (2)
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This note was uploaded on 06/08/2009 for the course FI 601-602 FI601-602 taught by Professor Prof.geary during the Spring '09 term at New Haven.

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FI.Chapter21 - i r trre$errcq S*ek#yEsnEd Fece*aeeErcg...

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