Can you explain forced conversion better? - ProProfs Discuss
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Can you explain forced conversion better?

Asked by Maitland, Last updated: May 23, 2021

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John Smith

John Smith

John Smith
John Smith

Answered Sep 08, 2016

When the bond holder issues debt, the money they raise represents a loan that they must pay interest on and must also pay back the principal amount of the loan upon maturity. So corporations may consider issuing convertible debt that converts into common shares, and create a clause that allows the corporation to call back the debt and pay par to the investor.

When the price of the common stock rises above the conversion price, the corporation would likely announce that they are calling the debt and will be paying investors par for their debt securities. The investor now has 2 choices: 1. convert the debt into common shares. This is the preferable action because the value of the converted shares would be greater than what the issuer is going to be paying; or, 2. Do nothing and wait for the call date to arrive and receive par for their debt securities. This is not a good move for the investor because he or she would be losing out on the higher value that the common shares represent. This is how the debt holder forces investors to convert their shares. This process represents a huge advantage for the issuer, because the moment all the investors convert their debt into common shares, the issuer no longer needs to make interest payments, and no longer has a loan to pay back.

All the money the issuer borrowed from the original convertible debt issue would now be converted into common share capital and no longer would carry a requirement of having to pay the money back. There is no minimum face value protection for real return bonds, so deflation could result in a final payment that is lower than the original principal. In other words, you don't want to be keeping pace with deflation by holding a real return bond when prices are falling.

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