Exchangeable Debt
What Is Exchangeable Debt?
An exchangeable debt is a type of hybrid debt security that can be changed over into the shares of a company other than the responsible company (generally a subsidiary). Companies issue exchangeable debt for a number of reasons, including tax savings and stripping a large stake in another company or subsidiary.
Figuring out Exchangeable Debt
Straight debt can be defined as a bond that doesn't give the investor the option to change over into equity of a company. Since these investors don't get to participate in any price appreciation in the shares of a company, the yield on these bonds is typically higher than a bond with a embedded option to change over. One type of bond that has a convertibility feature is the exchangeable debt.
An exchangeable debt is just a straight bond plus an embedded option which gives the bondholder the right to change over its debt security into the equity of a company that isn't the debt issuer.
More often than not, the underlying company is a subsidiary of the company that issued the exchangeable debt. The exchange must be finished at a foreordained time and under specific conditions illustrated at the hour of issuance.
In an exchangeable debt offering, the terms of the issue, for example, the conversion price, the number of shares into which the debt instrument can be changed over (conversion ratio), and the debt maturity are determined in the bond indenture at the hour of issue.
Due to the exchange provision, exchangeable debt generally conveys a lower coupon rate and offers a lower yield than comparable straight debt, just like with convertible debt.
Exchangeable Debt versus Convertible Debt
Exchangeable debt is very like convertible debt, the major difference being that the last option is changed over into shares of the underlying issuer instead of shares of a subsidiary similarly as with exchangeable debt.
At the end of the day, the payoff of exchangeable debt relies upon the performance of a separate company, while the payoff of convertible debt relies upon the performance of the responsible company.
An issuer chooses when an exchangeable bond is exchanged for shares though with a convertible debt the bond is changed over into shares or cash when the bond develops.
Esteeming Exchangeable Debt
The price of an exchangeable debt is the price of a straight bond plus the value of the embedded option to exchange. Subsequently, the price of an exchangeable debt is consistently higher than the price of a straight debt given that the option is an additional value to an investor's holding.
The conversion parity of an exchangeable bond is the value of the shares that can be changed over because of practicing a call option on the underlying stock. Contingent upon the parity at the hour of exchange, investors decide if changing over exchangeable bonds into underlying shares would be more productive than having the bonds recovered at maturity for interest and par value.
Stripping With Exchangeable Debt
A company that needs to divest or sell a large percentage of its holdings in another company can do as such through exchangeable debt. A company selling off its shares quickly in another company might be seen negatively in the market as a signal of financial wellbeing deterioration.
Additionally, raising an equity issue might bring about the undervaluation of the recently issued shares. Consequently, stripping utilizing bonds with an exchangeable option might act as a more beneficial alternative for issuers. Until the exchangeable debt develops, the holding company or issuer is as yet qualified for the dividend payments of the underlying company.
Features
- Exchangeable debt is a hybrid debt security that can be changed over into the shares of a company other than the responsible company; generally a subsidiary.
- The conversion price, the conversion ratio, and the debt maturity are determined in the bond indenture at the hour of issue of exchangeable debt.
- In view of the convertible idea of exchangeable debt, they carry a lower coupon rate and offer a lower yield than comparable straight debt (debt without a conversion provision).
- The price of an exchangeable debt is the price of a straight bond plus the value of the embedded option to exchange.
- Primary reasons that companies issue exchangeable debt are for tax savings and stripping large stakes in another company or subsidiary.
