FM_ch17_notes - Chapter 17: Corporate Securities,...

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Chapter 17: Corporate Securities, Derivatives, and Swaps Summary Types of Convertible Securities Convertible Bonds: - Can be changed to a specified number of common shares - Conversion feature adds a degree of speculation to a bond issue, although the issue still maintains its value as a bond Convertible Preferred Shares : - Can be changes to a specified number of common shares - Normally sold with a lower stated dividend than similar-risk nonconvertible (or straight preferred shares) - Holder is assured of the fixed dividend payment associated with a preferred share and also ay receive the appreciation resulting from increases in the market price of the underlying common shares - They behave much like convertible bonds General Features of Convertibles - Almost always convertible any time during the life of the security - Only for a limited number of years (i.e. 5 or 10 years after issuance of the convertible) Conversion Ratio: - The ratio at which a convertible security can be exchanged for common shares 1. Sometimes the conversion ratio is stated in terms of a given number of common shares. To find the conversion price, which is the per-share price that is effectively paid for common shares as the result of conversion, the par value (not the market value) of the convertible security must be divided by the conversion ratio 2. Sometimes, instead of the conversion ratio, the conversion price is given. The conversion ratio can be obtained by dividing the par value of the convertible by the conversion ratio Conversion (or Shared) Value: - This is the value of the convertible measured in terms of the market price of the common shares into which it can be converted - Conversion value can be found simply by multiplying the conversion ratio by the current market price of the firm’s common shares Effect on Earnings : - Basic EPS is calculated without regard to any contingent securities. o It’s found by dividing earnings available for common shareholders by the number of common shares outstanding - Diluted EPS is calculated under the assumption that all contingent securities that would have dilutive effects are converted into common shares 1
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Chapter 17: Corporate Securities, Derivatives, and Swaps o It’s found by adjusting the basic EPS for the impact of converting all convertibles and exercising all warrants and options that would have dilutive effects on the firm’s earnings Financing with Convertibles Motives for Convertible Financing - Convertible securities are advantageous to both the issuer and the holder - The issuer doesn’t have to give up immediate control as it would have to if it were issuing common shares - The holder of a convertible security has the possibility of a future speculative gain Determining the Value of Convertible Bond Straight Bond Value: - The price at which it would sell in the market without the conversion feature - The value is found by determining the value of a nonconvertible bond with similar payments and time to maturity issued by a firm with the same risk
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FM_ch17_notes - Chapter 17: Corporate Securities,...

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