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Chapter 21

Chapter 21. CONVERTIBLE DEBENTURES AND WARRANTS. LEARNING OBJECTIVES. Explain the features and valuation methods of convertible debentures Focus on the characteristics and valuations of warrants

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Chapter 21

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  1. Chapter21 CONVERTIBLE DEBENTURES AND WARRANTS

  2. LEARNING OBJECTIVES • Explain the features and valuation methods of convertible debentures • Focus on the characteristics and valuations of warrants • Discuss the features of capital market instruments like the zero-interest debentures or deep-discount bonds

  3. CONVERTIBLE DEBENTURES • A convertible debenture is a debenture that can be changed into a specified number of ordinary shares, at the option of the owner. • The most notable feature of this debenture is that it promises a fixed income associated with debenture as well as chance of capital gains associated with equity share after, the owner has exercised his conversion option.

  4. Characteristics of Convertible Debentures • Conversion ratio and conversion price

  5. Valuation of Convertible Debenture The market value of a convertible debenture will depends on: • market price of ordinary share, • conversion value, and • the value of the nonconvertible or straight debenture, called investment value.

  6. Value of a Convertible Debenture

  7. Why Issue Convertible Debenture? • Sweetening debentures to make them attractive. • Selling ordinary shares in future at a higher price. • Avoiding immediate dilution of earnings. • Using low cost capital initially.

  8. Warrants–Definition A warrant entitles the purchaser to buy a fixed number of ordinary shares at a particular price during a specified time period. It is similar to an American call option.

  9. Warrants–Features • Exercise Price • Exercise Ratio • Expiration Date • Detachability • Right

  10. Warrants–Valuation • Theoretical Value = (Share Price – Exercise Price)* Exercise Ratio • If the share price is less than the exercise price the warrants theoretical value is zero. • The difference between the warrants’ market value and its theoretical value is called the premium. • Black–Scholes Model (after required adjustment) can be used to value warrants.

  11. Market Value of a Warrant

  12. Why Issue Warrants • Sweetening Debt • Deferred Equity Financing • Cash Inflow in Future • Other Advantages • Warrants keep the share prices high. • Investor enabled to have access to shares without investing now. • Enables promoters to increase their holdings.

  13. Zero-Interest Debentures (ZID) • ZID or zero coupon bonds or deep discount bonds do not carry an explicit rate of interest. The difference between the face value of the bonds and its purchase price is the return to the investors. • Mahindra & Mahindra was the first company in India to issue convertible zero interest bonds in January 1990. • The purely zero-interest debenture was issued by Best and Crompton Engineering Company in December 1990.

  14. Secured Premium Notes • Secured premium note is a secured debenture redeemable at a premium. It is a medium to long term debenture. • TISCO issued SPNs with warrants attached in India for the first time to raise Rs 346.5 Cr.

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