Question

Explain how the conversion feature of convertible debt has a value (a) to the issuer and (b) to the purchaser.

Short answer

(a) Issuer has the benefit of lower cash interest cost.

(b) Purchaser of the convertible debt are entitled to receive the face value of debt at maturity or the number of shares by way of conversion, which increases the wealth.

Step-by-step solution

Explanation on convertible bond

A convertible bond is a fixed-income corporate debt security that yields interest instalments, however, can be changed over into a predetermined number of common stock or equity shares.

The conversion feature of convertible debt has a value to the issuer:

1. From the point of view of the issuer, the change element of convertible debt brings about a lower cash interest cost. Furthermore, the issuer in arranging its long-range financing might see the convertible debt for the purpose of raising equity capital over the long term.

The conversion feature of convertible debt has a value to the purchaser:

b) The purchaser obtains a choice to get either the face measure of the debt upon maturity or the predefined number of common shares upon conversion.