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- Tax Shield May Make Convertible Bonds Attractive | Stanford Graduate School of Business.
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Most CBs are issued at a 20 to 40 percent premium to the level where the stock price is currently trading, according to Tokyo bankers. But so far, the Nikkei has given back about 5 percent this year, after an April hike in the national sales tax dragged down consumption.
Japanese CBs carry a zero coupon, meaning a company faces no debt servicing costs as it would if it issued a straight bond. CBs also allow issuers to sidestep the immediate share dilution of a straight stock offering. Therefore, some Japanese companies include clauses in their CBs spelling out further conditions to blunt any potential impact on their stock price.
This will help to give a true and fair view of the Financial Statements of the organization because of the following two reasons:.
Let us go through each one of them in detail to understand the entire flow of accounting for convertible bonds. If you are new to bonds, do have a look at Bond Pricing. The split between equity and liability portion needs to be accounted for at the time of issue of bonds itself. This approach assumes that the value of the equity portion is equal to the difference between the total amount received from the proceeds of the bonds and the present value of future cash flows from the bonds.
Liability portion of the convertible bonds is the present value of the future cash flows, calculated by discounting the future cash flows of the bonds interest and principal at the market rate of interest with the assumption that no conversion option is available.
Value of the equity portion will be the difference between the total proceeds received from the bonds and the present value liability portion. On a yearly basis, coupon payments will be made to the bond holders.
As mentioned earlier, convertible bonds are issued at a lower rate of interest. The difference between the effective interest and nominal interest will be added to the value of liability at the time of interest payment. Food for thought : As you must have noticed, the liability value keeps increasing year after year and at the end of year 5 it is equal to the face value of the bond.
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The total amount added up to the Liability each year will be equal to the Equity Options amount we have arrived at the time of issue of these Convertible Bonds. Also note, the equity section of the Convertible Bonds will not change during the life of the bonds. This will change only at the time of conversion or payout, as the case maybe.
This is also known as repurchase of bonds. In this case, the bond holders are paid the maturity amount and only the liability portion accounted earlier will have to be de-recognized and the maturity amount will be paid to the bond holders.
Tax Shield May Make Convertible Bonds Attractive
Bond holders may exercise the conversion option and in this case shares will have to be issued to the bond holders as per the conversion ratio. Let us say that the conversion takes place on 31 st December An organization may decide to repurchase its bonds before maturity. In the given example, let us say that the bonds are repurchased on 31 st December Filed Under: Accounting , Liabilities in Accounting. Thank you for explaining Convertible Bonds in a clear way, I got to know what actually Convertible bonds are but I want to know a bit about Debt financing if you can explain me about this in two three sentence I would appreciate more.
Thank you. Thank Cody! Debt financing is the best way to finance an acquisitions. Debt financing is also been called as a technique of raising capital by borrowing.
Nice article Very informative notes. I would like you to send me the templates for financial statement analysis? I have already sent you the templates you can check your inbox.