Convertible Debt

Hey Guys, I would really appreciate it if someone could give me an explanation as to why the following would be considered true: Companies are less likely to call convertible debt when stock prices are falling than when stock prices are rising. cheers

Let me see if I can answer. The relationship between the call option of convertible debt and stock price is just one of the theories floating around. For e.g. the impact on the stock prices, on just announcing the call in the market. Companies do not want to dilute their common stock by folks converting them, which is likely when the stock prices are heading up. So, there is an incentive for retiring the debt. The opposite, of bond holders not wanting to convert to equity in periods of falling stock prices is incentive for not-calling.

That’s right. EPS is one of the important considertion for investor when come to investment desicion. So, companis would avoid the dilution in EPS…

I think it’s really simpler than that. First, the dilution has pretty much happened by the very existence of the converts. All fully diluted numbers are calculated assuming the converts are converted. Calling converts is not like calling regular coupon bonds - you don’t do it to reduce interest payments, you do it to force conversion because the converts are in the money. Companies don’t want to be short gamma so they call the bonds to force the conversion.

I’m going to argue that it’s even simpler than that, although I think all that is correct. The question isn’t an absolute as it qualifies itself as “less likely” which I’d argue suggests the assumption that the firm assumes that the decline isn’t permanent. Although it would be entertaining to hear a CFO say that he/she expects their stock price to decline infinitely, but I digress. So unless things are so desperate that they have to convert because they can’t make their debt payments the firm’s got little to no incentive to convert the debt holders and cut them in on the upside action of the stock as it would send a market signal that their upside prospects are dim.

You have this messed up. A firm doesn’t call debt because they can’t make payments. In general, that would mean coming up with par + coupon instead of just coupon. In the case of a convert, calling it would mean that they still would pay par + coupon because nobody is going to convert (a company who has trouble making debt payments very likely has seriously busted converts that have almost no value as equity). Calling a convert doesn’t mean forcing conversion; it means forcing someone to convert or take the call price. Edit: Conversion is at the option of the bond holder not the issuer, if that wasn’t clear to you.

for convert debt: it is the investor that converts when there is upside: ie stock rises company on the other hand, calls, its debt back when rates are falling dot confuse convert debt with callable bonds.

Ok, thanks for the explainations, clears things up.

From Investopedia Forced Conversion “One downside is that the issuing company has the right to call the bonds. In other words, they have the right to forcibly convert them. Forced conversion usually occurs when the price of the stock is higher than the amount it would be if the bond were redeemed, or at its call date. This attribute caps the capital appreciation potential of the convertible bond. The sky is not the limit with converts as it is with common stock.” Anyone know the journal entries this would have? If converted?

JoeyDVivre Wrote: ------------------------------------------------------- > You have this messed up. A firm doesn’t call debt > because they can’t make payments. In general, > that would mean coming up with par + coupon > instead of just coupon. In the case of a convert, > calling it would mean that they still would pay > par + coupon because nobody is going to convert (a > company who has trouble making debt payments very > likely has seriously busted converts that have > almost no value as equity). Calling a convert > doesn’t mean forcing conversion; it means forcing > someone to convert or take the call price. > > Edit: Conversion is at the option of the bond > holder not the issuer, if that wasn’t clear to > you. You know I think you’re right. I was confusing this with something that came up in my M&A class which I think still holds but only in a very specific circumstance like the bond has a call date equal to the maturity date. Well no wait a minute that’s not true either because the forced conversion was at the option of the debt issuer. The debt holder might just as well be willing to force liquidation as to take equity at that point. Nevermind, I stand corrected.