# Exchangeable Bonds Debt to Total Capital Ratio

Greetings, everybody LOS 43.a (Schweser notes 2006) The notes say that “overall, the smaller the gain (larger the loss) as a proportion of the principal value (for exchangeable bonds), the lower is the resulting debt to total capital ratio.” I can not get it. For example, let’s say assets are 10\$ (\$5 is market value of stocks to be exchanged for exchangeable bonds) = liability \$4 (\$3 exchangeable bonds) + equity \$7 Therefore debt to total capital ratio = 4/10 If bonds are exchanged, loss is 5-3=2. (is it correct?) and debt to capital ratio is 1/5=2/10, and ratio is lower then original. But if market value of stock were to be \$6, then the loss would be larger 6-3=3, and the debt to total capital ratio would be ¼, which is higher then ratio with lower loss. I know that I’m missing something but I do not know what exactly. Thank you in advance.

1. It sure looks like we have 10 = 4 + 7 up there which isn’t right 2) When they exchange those bonds assets and liabilities fly out the door, reducing total capital so the denominator is no longer 10.

what about scenarios below? Scenario 1 Original Exchange Assets Stocks to be exchanged 4 0 Other Assets 6 6 Total 10 6 Liabilities Exchangeable Bonds 3 0 Other LTD 1 1 Total 4 1 Equity Retained Earnings 6 5 Total 6 5 Gain/Loss from Bond Exchange 0 -1 Lower loss Debt to Total Capital Ratio 0.40 0.17 Lower Ratio Scenario 1 Original Exchange Assets Stocks to be exchanged 5 0 Other Assets 5 5 Total 10 5 Liabilities Exchangeable Bonds 3 0 Other LTD 1 1 Total 4 1 Equity Retained Earnings 6 4 Total 6 4 Gain/Loss from Bond Exchange 0 -2 Higher Loss Debt to Total Capital Ratio 0.40 0.20 Higher Ratio Where is the mistake??? Thank you in advance.

Ok I think your examples are good and you are correctly calculating everything. So i would say the statement is just wrong.