Financial Management (Case Study-1)
Reliance Industries Limited
Triple Option Convertible Debentures
Abhishek Kumar (BLP038)
Aparna Chowdhry (BLP040)
Maninder Bisen (BLP042)
Vivek Kumar (BLP044)
Manjesh Bharati (BLP046)
Raman Girdhar (BLP048)
Discuss in detail the benefits of convertible securities for the issuing company as well as the investors. Briefly discuss the potential drawback of convertible securities for both?
Benefits to Issuer:
* Companies have incentive to raise convertible debt, rather than traditional debt, because the interest payments on ...view middle of the document...
Drawback for Issuer:
* The possibility of forced conversion is only one of the downsides of convertible securities.
* Another disadvantages for convertible security issuers is that financing with convertible securities runs the risk of diluting not only the EPS of the company's common stock, but also the control of the company.
* If a large part of the issue is purchased by one buyer, typically an investment banker or insurance company, conversion may shift the voting control of the company away from its original owners and toward the converters.
Benefits to Investors:
* Since convertible securities combine the benefits of stocks and bonds, investors in such bonds benefit from interest payment and the underlying stock increases in terms of higher prices of the bonds.
* Convertible securities, or converts, give the holder the option to exchange the security for a predetermined number of shares in the issuing company.
* Because of its dual nature as a security and an equity option, convertible securities allow investors to participate possibly in the upside gains of the stock while protecting possible downside through the guaranteed continuous coupon payments.
Drawbacks for Investors:
* Convertible securities offer a lower interest rate. In addition, if the stock price declines the security price will also drop.
* One downside of convertible securities is that the issuing company has the right to call the securities.
* Because convertibles can be changed into stock and thus benefit from a rise in the price of the underlying stock, companies offer lower yields on convertibles. If the stock performs poorly there is no conversion and an investor is stuck with the security’s sub-par return (below what a non-convertible corporate security would get). As always, there is a tradeoff between risk and return.
Most convertible securities are structured as unsecured debt for the issuer, meaning that if the issuing company were to become bankrupt and default on the security, the buyer of the security has a lower priority claim on the company's assets, after the secured straight debt holders have been paid off. Therefore, although the possible upside gains on the convertible security is higher than a normal security; its default risk is also relatively higher.
Evaluate the three initial options provided to the RPL TOCD holders on the basis of yield to maturity. Assume that a TOCD holder sold the RPL shares and each warrant (in the case of Option I) issued in September 1993 are Rs. 22 and Rs. 5...