The purchaser of the issue sacrifices a portion of

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Unformatted text preview: erest cost of debt. The purchaser of the issue sacrifices a portion of interest return for the potential opportunity to become a common stockholder. Another important motive for issuing convertibles is that, generally speaking, convertible securities can be issued with far fewer restrictive covenants than nonconvertibles. Because many investors view convertibles as equity, the covenant issue is not important to them. A final motive for using convertibles is to raise cheap funds temporarily. By using convertible bonds, the firm can temporarily raise debt, which is typically less expensive than common stock, to finance projects. Once such projects are under way, the firm may wish to shift its capital structure to a less highly levered position. A conversion feature gives the issuer the opportunity, through actions of convertible holders, to shift its capital structure at a future time. Other Considerations When the price of the firm’s common stock rises above the conversion price, the market price of the convertible security will normally rise to a level close to...
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