CONVERTIBLE DEBENTURES AND WARRANTS CHAPTER 21. LEARNING OBJECTIVES Explain the features and valuation methods of convertible debentures Focus on.

CONVERTIBLE DEBENTURES AND WARRANTS

CHAPTER 21

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

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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.

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Characteristics of Convertible Debentures

Conversion ratio and conversion price

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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.

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Value of a Convertible Debenture

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Why Issue Convertible Debenture?

1. Sweetening debentures to make them attractive.

2. Selling ordinary shares in future at a higher price.

3. Avoiding immediate dilution of earnings.

4. Using low cost capital initially.

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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.

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Warrants–Features

1. Exercise Price

2. Exercise Ratio

3. Expiration Date

4. Detachability

5. Right

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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.

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Market Value of a Warrant

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Why Issue Warrants

Sweetening Debt Deferred Equity Financing Cash Inflow in Future Other Advantages

1. Warrants keep the share prices high.

2. Investor enabled to have access to shares without investing now.

3. Enables promoters to increase their holdings.

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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.

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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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