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Jdot514
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Joined: 12 Mar 2009
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Posted: 28 May 2009 at 13:31 \| IP Logged

The interest rate on convertible debt is usually lower than nonconvertible debt because of the value of the conversion feature.

Could someone please explain this statement? It doesn't make sense to me. Thanks!

(It seems to me that the interest rate should be higher. I think if someone issues you debt and you have the option to convert it, they would want to charge you a higher rate since you have that extra option).

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jay_usa
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Posted: 28 May 2009 at 13:49 \| IP Logged

I agree with you. Convertible bonds are often issued at more than face value because of the conversion feature ( i.e. sold at premium ) and when it is premium, it means stated rate of interest on bonds is higher than the market rate.

Not sure about that sentence, Is is in the becker book ?

Thanks

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Jdot514
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Posted: 28 May 2009 at 13:56 \| IP Logged

jay_usa wrote:

I agree with you. Convertible bonds are often issued at more than face value because of the conversion feature ( i.e. sold at premium ) and when it is premium, it means stated rate of interest on bonds is higher than the market rate.

Not sure about that sentence, Is is in the becker book ?

Thanks

I know that the statement is correct because it is the solution to Becker's MCQ CPA-05461.

Choice "a" is correct. The interest rate on convertible debt is generally lower than nonconvertible debt because of the value of the conversion feature.

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AUD - May 14 - 95!
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sanju06
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Posted: 28 May 2009 at 14:09 \| IP Logged

To my knowledge, what the sentence means is the comparison between stated interest for convertible bonds and stated interest for non-convertible bonds(not between stated and market rate of interest for convertible bonds).

That said, they don't CHARGE interest on bonds.They are paying us interest. So if the company is going to issue an extra feature(convertible option), they will be allowing us lesser interest than the non-convertible ones.

Hope it makes sense.

cpayesican
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Posted: 28 May 2009 at 14:14 \| IP Logged

Convertible debt carries a lower interest rate than non convertible debt but still can be sold at a premium. While a premium situation usually translates into stated interest rate>market interest rate, this is an exception. The holder of convertible debt has the opportunity to become a stockholder and potentially get more returns(obviously higher risk also). It is for this future benefit that the convertible debt carries a lower interest rate but still can be sold at a premium. Hope that helps!

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