A company is considering the issue of a convertible bond compared to a straight bond...

CIMA F3 Question Answer

A company is considering the issue of a convertible bond compared to a straight bond issue (non-convertible bond).

Director A is concerned that issuing a convertible bond will upset the shareholders for the following reasons:

• it will dilute their control

• the interest payments will be higher therefore reducing liquidity

• it will increase the gearing ratio therefore increasing financial risk

Director B disagrees, and is preparing a board paper to promote the issue of the convertible bond rather than a non-convertible.

Advise the Director B which THREE of the following statements should be included in his board paper to promote the issue of the convertible bond?

The convertible bond may not dilute control as the bond holder has an option to choose conversion.

The coupon rate on the convertible bond will be lower than that on a non-convertible bond.

When converted into shares, the company will receive a cash inflow which can be used for future investments.

Issuing a convertible bond will have a more favourable impact on the gearing ratio than a non-convertible bond.

Over the life of the bond, a convertible will be more expensive than a non-convertible.

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