Convertible Bonds: How Much Equity, How Much Debt?
Posted: 5 May 2005
Financial analysts need accurate estimates of debt, equity, leverage, and EPS. The method proposed here, based on the probability of conversion, yields new estimates of the debt and equity in a convertible bond issue. When this method is used, the value of the equity component in a hypothetical issue is found to be substantial - larger than the value of the options and clearly larger than zero, which is assigned under current accounting rules. The estimate of the debt component is smaller than recorded under current accounting rules. Thus, the leverage of convertible bond issuers is substantially lower when this method is used.
Keywords: Debt Investments, Bonds with Embedded Options, Financial Statement Analysis, Financial Accounting Standards and Proposals, Financial and Ratio Analysis
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