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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