Convertible Debt

CFA Level I
#1

Cameron Inc. has $10 million of bonds outstanding that are convertible into common shares. The current price per share is $44 and the stated conversion price is $49 per share. Cameron also has exchangeable bonds issued for $20 million that are to be exchanged for shares of Adam Inc. worth $20 million (therefore no gain or loss is realized on the exchange). Based solely on the facts provided above, what effect should the convertible bonds and exchangeable bonds have on an analyst’s assessment of Cameron’s fundamental debt to total capital ratio? I answered this correctly, but this part of the conclusion confused me: The exchangeable bond transaction has no gain or loss so there is no effect on equity. But the liabilities will be reduced by $20 million and so this will decrease the debt to total capital ratio. ----------- Shouldn’t equity increase by $20M, since they are converting these bonds from debt to equity? Is there really no change in equity if there is no gain/loss, even though we are subtracting $20M from debt?

#2

A = L + SE liabilities down 20 equity up 20 no change in total capital

#3

I think it should be assets down 20 liabilities down 20 Basically Cameron is currently holding 20 mill worth of Adam stock (an asset) which will be used to pay off the 20 mill of debt Debt to capital goes down because the % decrease in debt is larger than the % decrease in assets.

#4

yeah assets down, and debt down by 20. as a result D/E goes lower and the first part of the question i think is meaningless, unless stock price was higher, no one would want to convert it.

#5

hmm i thought it was about paying back a bond with stock i don’t understand the question

#6

actually i think it makes sense now they have another company’s stock, and they will use it to pay off $20M of liabilities is that what the question is saying?

#7

Yeah thats right…the key word is “exchangeable”…that means you exchange the outstanding bonds for another company’s shares…convertible means for your own company’s shares

#8

ahh makes sense, thanks

#9

Thanks for the help guys. I agree that this question is vague.