Investors may realize diversification benefits since the bond and the common stock are from different companies.
Investors may realize diversification benefits since the bond and the common stock are from different companies.
Potentially, diversification leads to a higher valuation for the exchangeable versus the convertible.
A major disadvantage is that the difference between the cost of the bond and the market value of the exchanged common stock, at the time of exchange, is treated as a capital gain. A convertible gain is not recognized until the common stock is sold.
Valuation of an Exchangeable
To obtain a lower interest rate.
Warrant – A relatively long-term option to purchase common stock at a specified exercise price over a specified period of time.
To obtain a lower interest rate.
To raise funds when the firm is considered a marginal credit risk.
To compensate underwriters and venture capitalists when founding a company.
Warrants are employed as “sweeteners”:
Warrants
The warrant contains provisions for:
The warrant contains provisions for:
the number of shares that can be purchased per warrant.
the price at which the warrant can be exercised.
the warrant expiration date.
Warrant holders are not entitled to any dividends nor do they have any voting power.
The exercise price is generally adjusted for any common stock dividends and splits.
Warrant Features
FunFinMan, Inc., is currently financed entirely with common stock. The firm is composed of $10 million in common stock ($5 par value) and $20 million in retained earnings. The company is considering issuing $20 million of 8%, 20-year debentures including 1 warrant per bond that can be converted into 5 shares of common stock at an exercise price of $40 per share. How will this impact the capitalization of the firm?
