Different types of debt ( LT 8) Flashcards
Initial value of debt
This is the expected payoff that a debt holder is expected to receive
Accrued Interest
The amount of accumulated interest since the last coupon payment
dirty price of bond
- clean price + accrued interest
- The ACTUAL price you pay for a bond
sinking fund
A facility which allows a firm to pay debt over time
Payment in kind
This is when payments made by the firm are not in cash
Positive covenants
When you specify the actions a firm must take
Negative covenants
When you forbid the actions a firm takes
callable bonds
Bonds that can be repurchased by a firm before maturity. These will be repurchased by a firm when the bond is above the exercise price
Callable bonds formula
P (callable) = P(straight) - call option
What is a puttable bond?
a bond that gives investors the right to demand early repayment. ( at date t bond holders sell the bond ot the firm at par)
Bond holders have a straight bond + (long) put option.
Why are puttable bonds poisonous for the issuer?
Bond investors exercise the put option when bond price is low. this is also when the firm is introuble. Firms usually don’t have the money to redeem. Forced into default.
Convertible bonds?
Give bondolders the irhgt to exchange the bond for a prespecified number of shares.
Conversion ratio?
the number of shares in which each bond can be converted.
What is conversation price?
value of the bond divided by the number of shares in which it may be exchanged.
Market Conversion Price
= Market price of convertible bond/Conversion ratio
Conservation value?
stock price times the conversion ratio
- This is the value the holder gets if they convert
What is price of convertible?
Pt ( convertible) = Pt(straight) + ct ( CALL OPTION TO ACCQUIRE COMMON STOCK)
The value of a convertible bond must be?
greater than or equal to the larger of: straight bond value and conversion value. So i will only convert if i get more from converting than a straight bond.
If we know the market price of convertible bond, what can we calculate?
Option value = convertible price - straight bond price.
Why issue convertible bonds?
- When it is costly to assess risk of debt
- Investors are worried managers won’t act in shareholders best interest
What is share dilution?
When the number of outstanding shares increases without a corresponding increase in the company’s value, it dilutes the value of existing shares. Essentially, each share’s piece of the company’s earnings and assets becomes smaller.
This dilution can be detrimental to existing shareholders, as it can lead to a decrease in earnings per share (EPS) and potentially a decrease in the stock’s price
What is the difference between market price of convertible bond and the conversion value?
The market price of a convertible bond is its current trading price, reflecting its value as both a bond and a conversion option. The conversion value is what the bond would be worth if converted into shares right now, calculated by multiplying the current stock price by the bond’s conversion ratio.
Why is the market price of a convertible bond usually higher than its conversion value?
The market price of a convertible bond is usually higher than its conversion value as it accounts for both the value if converted and the income from interest payments until maturity, which the conversion value doesn’t consider.
What would it mean if the market price of convertible was less than conversion value?
If the market price of a convertible bond is less than its conversion value, it presents an arbitrage opportunity. In theory, an investor could buy the convertible bond at its market price, immediately convert it into shares, and then sell the shares at their market price. This would generate an immediate risk-free profit equal to the difference between the conversion value and the market price of the convertible bond.
When is it optimal to call back a callable bond?>
when call price = straight price. ( value of the bond = callable value)
At maturity when is conversion justified?
it is justified when conversion value is at least as big as the final bond payment.
