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Learning Objectives

1. Distinguish between and outline the uses of forwards, futures and options. (LO1)

2. Calculate the hedge on futures and the value of call and put options. (LO2)

3. Characterize the securities offered by a corporation that are convertible into common shares at the option of the investor and are a means of raising funds. (LO3)

4. Examine the benefits of a convertible security, including a fixed rate of return and the potential for capital appreciation. (LO4)

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Pure bond value$785.18

Price of common stock ($)

Conversion value

10 20 30 40 50 60 70

Market price of convertible bond

Bond values ($)

Premium

Figure 19-4Price movement pattern for a convertible bond

200

400

600

800

1000

1200

1400

LO4

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Yield to Maturity onIssue; Coupon; Conversion Market Yield to Bonds of Similar Riskand Maturity Rating Value Value Maturity and Maturity

Algonquin Power7%June 2017 BBB (low) $1,345.30 $1,375.40 0.45% 4.91%

Pembina Pipeline5.75%Nov. 2020 BBB (high) $887.25 $1,045.00 5.13% 4.69%

Yellow Media6.25%Oct. 2017 BB 11.25 $535.00 19.60% 7.11%

Pricing of Convertible DebenturesSeptember 2011

LO4

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Advantages and Disadvantages

of Convertible Securities Advantages to the corporation:

• lower interest rate than on a straight bond

• Convertible feature acts as a sweetener that allows access to the bond market

• attractive to a corporation that believes its stock is currently undervalued

Disadvantages to the corporation:• If stock price rises above the conversion price, firm could

raise capital with fewer shares than obtained from the conversion of the securities

• accounting considerations regarding convertibles (potential dilution of EPS)

LO4

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Accounting Considerations with

Convertibles Convertible securities may generate additional

common stock in the future which will impact diluted earnings per share

Financial reporting requires full disclosure

Diluted earnings per share =

adjusted aftertax earnings

Shares outstanding + Shares from conversion

LO4

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Review of Formulas (a)

1. Face value = Conversion price X Conversion ratio (19-1)

2. Diluted Adjusted aftertax earningsearnings = (19-2)per share Shares outstanding + Shares from Conversion

LO4