Convertibles

Question 1

What are the reasons for call delay? (3)

Answer 1

1) Dividends vs (after-tax) coupons
- when the conversion rate is not adjusted for dividends
- if a firm pays dividends, it should not call
2) Costs of a failed call
- calling gives bondholders 30 days do decide, in which the price fluctuates
3) Signalling private information
- good signal about the firm’s future

Question 2

What is the arbitrage strategy for convertibles?

Answer 2

Long on : convertible securities
Short on : common stock of the issuing firm

short position determined by the convertible’s delta

Question 3

What is the reaction of the stock price if bonds are issued?

Answer 3

no effect on stock price

Question 4

What is the reaction of the stock price if equity is issued?

Answer 4

stock price declines;

negative announcement effect

Question 5

What is the reaction of the stock price if convertibles are issued?

Answer 5

in the middle, there is an effect, price slightly decreases, but less compared to when equity is issued

Question 6

What are the two ways to issue convertibles?

Answer 6

1) private

2) public

Question 7

Why do firms issue convertibles privately to big private investors?

Answer 7

• happens fast and speed is beneficial

- costs are lower

Question 8

What is wall-crossing?

Answer 8

Getting the interest of potential investors in a series of confidential conversations
(not allowed to trade on private information, even though evidence shows that in practice that does happen)

Question 9

What is short interest?

Answer 9

number of short positions as a % of shares outstanding

Question 10

Reasons for issuing convertibles (4)

Answer 10

• low interest rates
• liquidity needs
• refinancing
• pursuing growth opportunities

Question 11

When should a firm call?

Answer 11

As soon as the conversion value exceeds the conversion price