Suppose a company simultaneously issues $50 million of convertible bonds with a couponrate of 9% and $50 million of nonconvertible bonds with a coupon rate of 12%. Bothbonds have the same maturity. Because the convertible issue has the lower coupon rate, isit less risky than the nonconvertible bond? Would you regard the cost of capital as beinglower on the convertible than on the nonconvertible bond? Explain. (Hint: Althoughit might appear at first glance that the convertible’s cost of capital is lower, this is notnecessarily the case, because the interest rate on the convertible understates its true cost.Think about this.)
Debenture Valuation
A debenture is a private and long-term debt instrument issued by financial, non-financial institutions, governments, or corporations. A debenture is classified as a type of bond, where the instrument carries a fixed rate of interest, commonly known as the ‘coupon rate.’ Debentures are documented in an indenture, clearly specifying the type of debenture, the rate and method of interest computation, and maturity date.
Note Valuation
It is the process to determine the value or worth of an asset, liability, debt of the company. It can be determined by many processes or techniques. Many factors can impact the valuation of an asset, liability, or the company, like:
Suppose a company simultaneously issues $50 million of convertible bonds with a coupon
rate of 9% and $50 million of nonconvertible bonds with a coupon rate of 12%. Both
bonds have the same maturity. Because the convertible issue has the lower coupon rate, is
it less risky than the nonconvertible bond? Would you regard the cost of capital as being
lower on the convertible than on the nonconvertible bond? Explain. (Hint: Although
it might appear at first glance that the convertible’s cost of capital is lower, this is not
necessarily the case, because the interest rate on the convertible understates its true cost.
Think about this.)
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