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Warrants & Convertibles

by sonika-soni





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Warrants & Convertibles Group Members: ‡ Puneet Singh ‡ Sonika Soni ‡ Harini ‡ Saurabh Khandelwal ‡ Payal Nagrani Brief Outline about Convertible Bond y y y y y y y y What is Convertible Bond? Why Companies issue Convertible Bond? Why investors willing to pay a premium? What is difference between Convertible Bonds and Call options? How Co. can force conversion of convertible bond? Step-up pricing Conversion Ratio & Conversion Pricing Role of Sebi What is Convertible Bond? Convertible bonds are debt instruments that can be converted into equity shares of the company at a future date. y The security has features of both debt and equity. It pays periodic coupon interest just like any other debt instrument. y At the time of redemption of the bond, the investors can choose to receive shares of the company instead of cash. y Value of Convertible Bond y The value of convertible bond has 3 components: ‡ ‡ ‡ Straight bond value Conversion value Option value Why Companies issue Convertible Bond? y Companies issue convertible bonds because: ‡ ‡ The interest rate is lower than on a straight issue. This type of security may be the only device for allowing a small firm access to the capital markets. The convertible allows the firm to effectively sell stock at a higher price than that possible when the bond was initially issued (but perhaps at a lower price than future price potential might provide). ‡ Why Investors buy Convertible Bonds? y The investors in a convertible bond have the advantage of equity and debt features. They earn coupon income in the initial stages, usually when the company·s project is in its nascent stage. The possibility of capital appreciation in the investment once the debentures are converted into equity. Moreover, the issuer does not have to repay the debt on maturity since shares are issued in lieu of repayment. y y y Why investors are willing to pay a premium? Investors are willing to pay a premium over the theoretical value for a convertible bond issue because of the future prospects for the associated common stock. y Thus, if there are many years remaining for the conversion privilege, the investor will be able to receive a reasonably high interest rate and still have the existing option of going to common stock if circumstances justify. y What is difference between Convertible Bonds and Call options? y y y y When a warrant is exercised, a firm must issue new shares of stock. When call option is exercised, the number of shares the firm has outstanding remains unchanged. Shares of the Co.·s stock is simply transferred from one individual to other. When warrants are exercised , however, the number of shares outstanding increases. This can have the effect of diluting the claims of existing shareholders. How Companies can force conversion of convertible bond? A firm may force conversion of a bond issue through the use of the call privilege. y When the bond is called, the holder has about 30 days to choose between the following: 1. Converting the bond to common stock at the conversion ratio. 2. Surrendering the bond and receiving the call price in cash. y StepStep-up pricing y y A "step-up" in conversion price is that, which will increase with the passage of time and likewise the conversion ratio will decline. Before each step-up, there is an inducement for bondholders to convert to common at the more desirable price. Conversion Ratio & Conversion Pricing y Conversion ratio is defined as the number of shares of stock a bondholder will receive upon conversion. Conversion price is the effective price investors pay for the common stock when conversion occurs y Suppose if debenture face value = ` 1000 A debenture holder can exchange a bond for 20 shares So, a Conversion price= Face value of bond/ Shares received= 1000/20= ` 50 Conversion ratio= Face value/Conversion price =1000/50= 20 shares Understanding the Concepts: ABC Ltd. issued ` 4,00,000 worth of 8 percent convertible debentures. Each convertible bond has a face value of `1,000. Each convertible bond can be converted into 24.25 shares of common stock anytime before maturity. The stock price is ` 31.25, and the market value of each bond is ` 1180 a) What is the conversion ratio? b) What is the conversion price? c) What is the conversion premium? d) What is the conversion value? y Role of Sebi y Brief Outline about Warrants y y y What is Warrants? Its Features. Why it is used by Companies? Difference Warrants? between Convertible Bonds & y Why warrants are issued at a premium? What is Warrants? y Warrants are securities usually issued by companies along with a debenture to make the debt issue more attractive to the investors. Warrants give the investors in the debentures, the right to buy shares of the company in the future. Warrants are usually attached to a debenture issue of the company to make the debenture more attractive that is why it is also called sweeteners. y y Features of Warrants y y y y Warrants may be traded on the stock exchange as a security separate from the debenture with which it was issued. Warrants usually have a longer lifetime (usually in years) as compared to option contracts which they closely resemble. Warrants may be used by promoters to increase their stake in the company. SEBI requires that shares issued to promoters as a result of exercising the option on the warrant will have a lockin of three years from the date the shares are allotted. Why it is issued by Companies y Warrants may be used to sweeten a debt offering or as part of a merger offer or a bankruptcy proceeding. Explain how convertible bonds and warrants are similar and different. y y y y Convertible bonds and warrants are similar in that they give the security holder a future option on the common stock of the corporation. They are dissimilar in that a convertible bond represents a debt obligation of the firm as well. When it is converted to common stock, corporate debt will actually be reduced and the capitalization of the firm will not increase. A warrant is different in that it is a valuable instrument on its own merits, and also its exercise will increase the overall capitalization of the firm. Why warrants are issued at a premium? y y y Warrants may sell above their intrinsic value because the investor views the associated stock's prospects as being bright. There is a reasonable amount of time to run before the warrant expires. Warrants also allow for the use of leveraged investing. Role of SEBI in investor·s protection Sebi of its Dip guidelines in Feb 2009 has increased minimum upfront amount of paying 10% at the time of allotment has been increased to 25% of the conversion amount y Minimum lock in period is increased from 1 year to 3 year for the promoter·s holding after exercising the warrants. y Minimum price at which the preferential allotment of shares can be made has been spelt out. The price has to be at least the higher of average of the weekly high and low of the closing prices of the shares quoted on the stock exchange during the 6 months or two weeks preceding the relevant date, which is thirty days prior to the date of shareholders meeting called for the purpose of consideration of the preferential allotment. y Few recent examples of Companies issuing warrants y JSW Steel said it has raised as much as ` 1,849 crore by issuing warrants to a promoter group firm, Sapphire Technologies mainly to cut its widening debt
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