Convertible Debentures (Sept 06 Q4)

Discussion in 'SP5' started by didster, Apr 15, 2008.

  1. didster

    didster Member

    Last minute question - maybe someone can answer it.

    Looking at September 2006 question 4.

    I thought debentures would receive some investment return (being a bond?) whether they are convertible or not.
    Therfore I thought that the zero coupon meant that there were no coupons eg annually, but that it would be issued at discount say 95%.

    Both ASET and the examiners took the price of the debenture to be 100%.
    Is this what we should use in exams?

    I find this strange as in another exam (april 2005 or 2006 i think) the examiners were surprised that very few candidates were aware that loans would cashed in for the nominal value.

    Another thing is that they deducted the company's dividend yield from the yield on the preference share to give a rate expected from the standard shares.

    Is there more to this than the expectation that the equity would yield more than preference shares?

    If you're reading this in time (and needing it like I am)- Good luck in the exam!!

    Thanks
     
    Last edited by a moderator: Apr 15, 2008
    didster, Apr 15, 2008
    #1
  2. Colin McKee

    Colin McKee ActEd Tutor Staff Member

    Considerations

    I see what you mean. Sorry - I suspect I am too late in answering this one, but (in my defence) it was placed on the forum pretty late!!
    The debenture is redeemed at nominal £100 par value. You are correct in assuming that it may have been issued at a price below par. It would have definitiely been issued below par if it had no conversion option. But the examiner gave no details - so the only sensible assumption is that it is around par. I agree though that the question would be clearer if this was stated.
    Second point: the examiner was only calculating a "break even" rate when comparing the pref to the equity. In reality the equity would be expected to give a higher return in the long term.

    Hope the exam went well.

    :eek:
     
    Last edited: Apr 17, 2008
    Colin McKee, Apr 17, 2008
    #2
  3. didster

    didster Member

    Thanks Colin - your reply won't go to waste.
     
    didster, Apr 17, 2008
    #3

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