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Unformatted text preview: Chapter 19 Discussion Questions 19-1. What are the basic advantages to the corporation of issuing convertible securities? The advantages to the corporation of a convertible security are: a. The interest rate is lower than on a straight issue. b. This type of security may be the only device for allowing a small firm access to the capital markets. c. The convertible allows the firm to effectively sell stock at a higher price than that possible when the bond was initially issued (but perhaps at a lower price than future price potential might provide). d. If the bond can be called at a price above its conversion price, the bond will be converted to stock and the debt to asset ratio will decline. 19-2. Why are investors willing to pay a premium over the theoretical value (pure bond value or conversion value)? Investors are willing to pay a premium over the theoretical value for a convertible bond issue because of the future prospects for the associated common stock. Thus, if there are many years remaining for the conversion privilege, the investor will be able to receive a reasonably high interest rate and still have the option of converting the convertible bond to common stock if circumstances justify. 19-3. Why is it said that convertible securities have a floor price? The floor price of a convertible is based on the pure bond value associated with the interest payments on the bond as shown in Figure 19-1. Regardless of how low the associated common stock might go, the semiannual interest payments will set a floor price for the bond. S19-1 19-4. The price of Haltom Corporation 5 ¼ 2019 convertible bonds is $1,380. For the Williams Corporation, the 6 ⅛ 2018 convertible bonds are selling at $725. a. Explain what factors might cause their prices to be different from their par value of $1,000. b. What will happen to each bond’s value if long-term interest rates decline? Convertible bond pricing a. Haltom bonds are well above par value because its common stock has probably increased substantially. In the case of Williams, it is reasonable to assume that its common stock has declined. Also, its interest rate is probably well below the going market rate because of its low bond price. b. With the Haltom Corporation, there would be little or no impact. It is clearly controlled by its common stock value. With the Williams Corporation, its potential value is somewhat associated with interest rates (rather than just conversion), so it is likely to go up somewhat in value. 19-5. How can a company force conversion of a convertible bond? A firm may force conversion of a bond issue through the use of the call privilege. If a bond has had a substantial gain in value due to an increase in price of the underlying common stock, the bondholder may prefer to convert to common stock rather than trade in the bond at some small premium over par as stipulated in a call agreement....
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This note was uploaded on 04/10/2011 for the course ADM 474 taught by Professor Stewart during the Spring '10 term at Indiana Wesleyan.
- Spring '10