convertibles - Matching Financial and Real Options...

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File name: Convertibles – matching financial and real options 1 Matching Financial and Real Options Convertible bonds are best suited for companies with abundant investment options such as high-tech and biotech firms. This explains the recent surge in the use of these securities. During the 1990s convertible bonds emerged as an important source of financing for U.S. corporations. These bonds are fixed-income securities that can be converted into a pre-determined number of shares of the issuer. The interest rate offered is lower than on conventional bonds to offset the valuable conversion option they include. Through embedded call provisions, issuers of convertible debt can force conversion of these securities into equity when the share price crosses a certain threshold (but not before a predetermined lapse of time — typically three to five years). While other forms of equity-linked securities have sprouted over the past few decades — such as convertible preferred shares — convertible bonds are by far the most widely used, accounting for the bulk of equity-linked securities issued. North American corporations have issued a total of US$42 billion in 1999, a threefold increase over the past five years. Over US$21 billion worth of convertible securities was issued during the first quarter of 2000. But why has interest in these securities picked up so suddenly after being available for many years? An article in the Journal of Applied Corporate Finance, Spring 2000 points to the changing investment needs of corporations. Its author, David Mayers of the University of California at Riverside, argues that more firms are currently faced with sequential investment opportunities , the funding of which is best done with convertible bonds. Mayers points out that the popular justification for convertible bonds — namely, that they provide issuers with ‘cheap’ debt that can be converted into ‘premium-priced’ equity — is flawed. This argument incorrectly compares convertible debt to the conventional kind in one situation (when conversion does not occur), and to common stock in another situation (when conversion does occur). In retrospect, companies
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This note was uploaded on 04/18/2010 for the course FINANCE 936116531 taught by Professor Wuyiling during the Spring '10 term at Nashville State Community College.

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convertibles - Matching Financial and Real Options...

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