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Convertible Subordinated Debt Valuation and "Conversion in Distress"

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Author Info
Marco Realdon
Abstract

This paper presents new formulae for the valuation of convertible debt and shows how it can be rational for convertible holders to convert not only when the debtor's equity value increases, ut also when the debtor approaches distress. Even if debt cannot be enegotiated, "conversion in distress" averts costly bankruptcy. If ankruptcy costs are high, neglecting "conversion in distress" may ntail a significant undervaluation of subordinated convertibles. Conversion in distress" makes convertible debt less sensitive than on-convertible debt to the recovery value of assets in bankruptcy. So onvertible financing can reduce the cost of borrowing when lenders are symmetrically informed about the debtor's assets recovery value.

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 03/18.

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Handle: RePEc:yor:yorken:03/18

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Related research
Keywords: Subordinated convertible debt; Default; Bankruptcy costs; "Conversion in distress";

Find related papers by JEL classification:
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Hayne E. Leland., 1998. "Agency Costs, Risk Management, and Capital Structure," Research Program in Finance Working Papers RPF-278, University of California at Berkeley. [Downloadable!]
    Other versions:
  2. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(1), pages 37-68. [Downloadable!] (restricted)
  3. Brennan, M J & Schwartz, Eduardo S, 1977. "Convertible Bonds: Valuation and Optimal Strategies for Call and Conversion," Journal of Finance, American Finance Association, vol. 32(5), pages 1699-1715, December. [Downloadable!] (restricted)
  4. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-52, September. [Downloadable!] (restricted)
    Other versions:
  5. In Joon Kim & Krishna Ramaswamy & Suresh Sundaresan, 1993. "Does Default Risk in Coupons Affect the Valuation of Corporate Bonds?: A Contingent Claims Model," Financial Management, Financial Management Association, vol. 22(3), Fall.
  6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June. [Downloadable!] (restricted)
  7. Hayne Leland., 1994. "Bond Prices, Yield Spreads, and Optimal Capital Structure with Default Risk," Research Program in Finance Working Papers RPF-240, University of California at Berkeley.
  8. Mella-Barral, Pierre & Perraudin, William, 1997. " Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-56, June. [Downloadable!] (restricted)
  9. Fan, Hua & Sundaresan, Suresh M, 2000. "Debt Valuation, Renegotiation, and Optimal Dividend Policy," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 13(4), pages 1057-99.
  10. Ingersoll, Jonathan Jr., 1977. "A contingent-claims valuation of convertible securities," Journal of Financial Economics, Elsevier, vol. 4(3), pages 289-321, May. [Downloadable!] (restricted)
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