What is the value to the issuer on the conversion feature of convertible debt? What is the value to the purchaser on the conversion feature of convertible debt?
Just do response each posted # 1 to 3 down below only.
According to our digital book, Intermediate Accounting 16th Edition, a convertible bond is defined as a, “Bond that permits its holder to exchange it for (“convert it to”) other corporate securities (typically common stock) for a specified period of time after issuance. The sale of a convertible bond is recorded like a straight-debt issue; upon conversion, the company records the securities exchanged for the bond at the carrying amount (book value) of the bond. The company amortizes, either at its maturity or upon conversion, any discount or premium that results from the issuance of the bond”, Kieso, D., et al, pg. 870). Investors buy convertible bonds to gain guaranteed interest, principal and the choice to convert without surrendering ownership and to acquire funding for debt at lower interest rates. Without the conversion privilege, the company would only be able to issue debt at high rates. Convertible debt must be recorded when it is initially issued, at the time of conversion and once the bonds are retired. The requirements of IFRS regarding convertible debt are for the issuer to record liability and equity separate.
A business can raise funds via debt financing, equity financing, or convertible debt. Convertible debt is a hybrid form of obligation that both lender and borrower had an agreement to repay a part or all of the loan by converting it into stock shares. One of the reasons for a business to raise funds via convertible debt is that it could attain lower interest rates on this type of loan due to the conversion option provides upside potential for the shareholders. Besides, it would be a little hard for a startup business to borrow money from creditors like banks since it does not have much capital or reputation (brand name). Another thing is by issuing convertible debt, it could attract lenders and investors. Finally, the borrowing company could reduce the taxable income when converting to stocks.
On the other hand, from the investor standpoint, by investing in a company’s obligation they can receive interest payments on the debt. It would be a better option to lend money to a company than to individuals because it is more secure. Besides, if the business goes bankrupt, as creditors they are entitled to claim on its asset before shareholders. If the company succeed, lenders can elect to acquire stock to become shareholders who can earn part of the company’s ownership and then may sell the stock when it’s increasing in value to earn more money.
There are 2 options for business owners when they want to raise money for their company, there is debt or equity. A debt is a loan that must be paid back per agreement in the contract. “The issuer has lower cash interest cost than in the case of nonconvertible debt, which allows raising equity capital over long term.” The purchaser has options of what to receive such as the face value at maturity or a certain amount of common shares when converted.
Kieso, D. E., Weygandt, J. J., & Warfield, D. T. (2016).Intermediate Accounting; 16th Edition. Various: John Wiley & Sons, Inc.