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change each bond into a stated number of shares of common stock. Bondholders
convert their bonds into stock only when the market price of the stock is such
that conversion will provide a profit for the bondholder. Inclusion of the conversion feature by the issuer lowers the interest cost and provides for automatic conversion of the bonds to stock if future stock prices appreciate noticeably.
The call feature is included in nearly all corporate bond issues. It gives the
issuer the opportunity to repurchase bonds prior to maturity. The call price is the
stated price at which bonds may be repurchased prior to maturity. Sometimes the
call feature can be exercised only during a certain period. As a rule, the call price
exceeds the par value of a bond by an amount equal to 1 year’s interest. For
example, a $1,000 bond with a 10 percent coupon interest rate would be callable
for around $1,100 [$1,000 (10% $1,000)]. The amount by which the call
price exceeds the bond’s par value is commonly referred to as the call premium.
This premium compensates bondholders for having the bond called away from
them; to the issuer, it is the cost of calling the bonds.
The call feature enables an issuer to call an outstanding bond when interest
rates fall and issue a new bond at a lower interest rate. When interest rates rise,
the call privilege will not be exercised, except possibly to meet sinking-fund
requirements. Of course, to sell a callable bond in the first place, the issuer must
pay a higher interest rate than on noncallable bonds of equal risk, to compensate
bondholders for the risk of having the bonds called away from them.
Bonds occasionally have stock purchase warrants attached as “sweeteners”
to make them more attractive to prospective buyers. Stock purchase warrants are
instruments that give their holders the right to purchase a certain number of
shares of the issuer’s common stock at a specified price over a certain period of
time. Their inclusion typically enables t...
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