Introduction to Convertible Bonds
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Questions and Answers

What is the primary reason for a company to issue convertible bonds?

  • To provide investors with a higher return than a common stock.
  • To avoid issuing new common stock.
  • To raise capital at a lower interest rate than an ordinary bond. (correct)
  • To increase the company's earnings per share.

    • What happens to the number of outstanding shares when a convertible bond is converted?

  • It decreases.
  • It stays the same.
  • It increases. (correct)
  • It depends on the conversion price.

    • What is a key advantage of investing in convertible bonds?

  • Combination of fixed income and the potential for price appreciation. (correct)
  • Higher interest rates than ordinary bonds.
  • Guaranteed high returns.
  • Lower risk than investing in common stock.

    • What is a potential disadvantage for investors in a convertible bond?

    <p>All of the above. (D)</p> Signup and view all the answers

    What is the conversion ratio for Coral Bhd's convertible bonds?

    <ol start="4"> <li>(A)</li> </ol> Signup and view all the answers

    What is the conversion premium in percentage for Coral Bhd’s convertible bonds?

    <p>66.67% (B)</p> Signup and view all the answers

    What is the earnings per share for Coral Bhd before issuing convertible bonds?

    <p>RM2.00 (D)</p> Signup and view all the answers

    Assuming a 60% conversion of Coral Bhd's convertible bonds, what will be the new number of outstanding shares?

    <p>16 million (B)</p> Signup and view all the answers

    What is the conversion value of the convertible bonds issued by Coral Bhd?

    <p>RM600 (B)</p> Signup and view all the answers

    What will be the firm's operating profit after issuing the convertible bonds, considering a 20% increase?

    <p>RM24 million (D)</p> Signup and view all the answers

    If Coral Bhd converts 60% of the convertible bonds, what will the interest expense be?

    <p>RM2.4 million (B)</p> Signup and view all the answers

    What is the effective tax payable after the conversion of the bonds if 60% of the bonds are converted?

    <p>RM6.48 million (D)</p> Signup and view all the answers

    How many shares will be outstanding if Coral Bhd does not convert any of the convertible bonds?

    <p>10 million (B)</p> Signup and view all the answers

    How much is the expected operating profit after issuing convertible bonds?

    <p>RM24 million (A), RM24 million (B)</p> Signup and view all the answers

    What is the conversion premium in percentage?

    <p>66.7% (D)</p> Signup and view all the answers

    How much is the conversion premium in RM?

    <p>RM400 (C)</p> Signup and view all the answers

    What is the total outstanding shares of Coral Bhd?

    <p>10 million shares (D)</p> Signup and view all the answers

    What will be the coupon payment for the RM100 million convertible bonds at a 6% rate?

    <p>RM6 million (B)</p> Signup and view all the answers

    What is the current market price of Coral Bhd's shares?

    <p>RM15 (A)</p> Signup and view all the answers

    What is the tax rate applied to Coral Bhd's operating profit?

    <p>30% (C)</p> Signup and view all the answers

    Flashcards

    Conversion Ratio

    A measure of shares received for each bond, calculated as Par value/Conversion Price.

    Conversion Value

    The monetary worth of a bond when converted into shares, calculated as Conversion Ratio × Market Price.

    Conversion Premium %

    Percentage indicating excess of conversion price over market price, calculated as (Conversion Price - Market Price)/Market Price × 100.

    Conversion Premium RM

    The amount by which the conversion value is less than par value or the difference between conversion price and market price.

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    Market Price

    The current selling price of a company's common shares in the market.

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    Common Share

    Ownership stake in a company that gives shareholders voting rights and dividends, if declared.

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    Operating Profit

    Profit made from business operations before taxes and interest, indicating core profitability.

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    Convertible Bonds

    Bonds that can be converted into a predetermined number of shares, offering flexibility to investors.

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    Earnings Per Share (EPS)

    Net earnings divided by the number of outstanding shares.

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    Conversion Feature

    The option for bondholders to convert their bonds into shares.

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    Advantages of Convertible Bonds

    Greater current income than dividends, fixed income, and price appreciation potential.

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    Disadvantages of Convertible Bonds

    Lower interest rates and missed capital gains if the conversion price is unappealing.

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    Tax Rate Impact

    The percentage at which a firm's income is taxed, affecting net earnings.

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    Coupon Rate

    The interest rate paid by bond issuers to bondholders, expressed as a percentage of the face value.

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    EBIT

    Earnings Before Interest and Taxes; a measure of a firm's profit that excludes interest and income tax expenses.

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    Tax Rate

    The percentage at which an individual or corporation is taxed on their earnings.

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    Study Notes

    Convertible Bond Introduction

    • A convertible bond (CB) is a bond that can be exchanged for a company's common shares.
    • When a CB is converted, it increases the number of outstanding shares, impacting earnings per share (EPS).

    Reasons for Issuing Convertible Bonds

    • The conversion feature makes convertible bonds more attractive to investors, enhancing marketability.
    • Holders can potentially become shareholders and potentially receive lower interest rates compared to ordinary bonds.
    • Issuers can delay issuing new common stock until market prices increase, needing to issue fewer shares.
    • Convertible bonds have fewer restrictive covenants than non-convertible bonds.

    Advantages of Investing in Convertible Bonds

    • Convertible bondholders receive income greater than dividends from common stock.
    • Convertible bonds combine fixed income and potential price appreciation.
    • Compared to common stockholders, convertible bondholders have yield advantages during stock price appreciation periods.

    Disadvantages of Investing in Convertible Bonds

    • Investors might lose potential profits if forced conversion occurs.
    • Interest rates on convertible bonds may be lower than ordinary bonds.
    • If the market stock price fails to exceed the conversion price, conversion may be unattractive.

    Convertible Bond Features

    • Conversion Ratio (CR): The number of shares an investor receives upon conversion.
    • Conversion Price (CP): The price at which a bond can be converted into shares.
    • Conversion Value (CV): The market value of the shares an investor would receive if the convertible bonds were converted.
    • Par Value: The face value of the bond.

    Convertible Bond Premium

    • Conversion premium (in RM): The difference between the market price and conversion value (if the market price is above the conversion value).
    • Conversion premium (in %): The percentage difference between the market price and conversion value (if the market price is above the conversion value).

    Additional Convertible Bond Considerations

    • Number of new shares issued: Calculated based on the total value of convertible bonds and conversion price.
    • Earnings per Share (EPS): Calculated by dividing net income available for common stockholders by the number of outstanding shares.

    Example Scenario (Coral Bhd)

    • Coral Bhd issues RM100 million convertible bonds with a 6% coupon rate, 10-year maturity, and a conversion price of RM25 per share.
    • Current market price of common stock is RM15 per share, and 10 million shares outstanding.
    • Operating profit is RM20 million, expected to increase by 20% after issuing bonds.
    • Tax rate is 30%.
    • Calculate conversion ratio, conversion premium (percentage and RM), conversion value, and earnings per share (before financing, before conversion, after full conversion, and after 60% conversion).

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    Related Documents

    Convertible Bond Chapter 4 PDF

    Description

    This quiz explores the fundamentals of convertible bonds, their issuance reasons, and investment advantages. It delves into how these financial instruments can enhance marketability and provide yield benefits to investors. Test your understanding of convertible bonds and their impact on shareholding.

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