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Accounting Across the Organization

Accounting Across the Organization - bonds came due...

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Accounting Across the Organization Christian Kober/Getty Images. During the boom times of the late 1990s, many rapidly growing companies issued large quantities of convertible bonds. Investors found the convertible bonds attractive because they paid regular interest but also had the upside potential of being converted to stock if the stock price increased. At the time, stock prices were increasing rapidly, so many investors viewed convertible bonds as a cheap and safe way to buy stock. As a consequence, companies were able to pay much lower interest rates on convertible bonds than on standard bonds. When the bonds were issued, company managers assumed that the bonds would be converted. Thus the company would never have to repay the debt with cash. It seemed too good to be true—and it was. When stock prices plummeted in the early 2000s, investors no longer had an incentive to convert, since the market price was below the conversion price. When many of these massive
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Unformatted text preview: bonds came due, companies were forced either to pay them off or to issue new debt at much higher rates. The drop in stock prices did not change the debt to total assets ratios of these companies. Discuss how the perception of a high debt to total assets ratio changed before and after the fall in stock prices. Answer: When stock prices fell, the debt to total assets of these companies was unchanged: The debt was outstanding before the fall, and it was outstanding after the fall. However, before the fall, many investors did not worry if a company had a high debt to total assets ratio; they assumed that the debt would be converted to stock and so would never have to be repaid with cash. After the fall it became clear that the debt would not be converted to stock; suddenly, a high debt to total assets ratio was a real concern....
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