Chapter 22 Convertibles, Exchangables, and Warrants

Exchangeable Bond

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?