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Convertible Subordinated Debt Valuation and "Conversion in Distress"

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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.

Suggested Citation

  • Marco Realdon, "undated". "Convertible Subordinated Debt Valuation and "Conversion in Distress"," Discussion Papers 03/18, Department of Economics, University of York.
  • Handle: RePEc:yor:yorken:03/18
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    References listed on IDEAS

    as
    1. Craig M. Lewis & Richard J. Rogalski & James K. Seward, 1998. "Understanding The Design Of Convertible Debt," Journal of Applied Corporate Finance, Morgan Stanley, vol. 11(1), pages 45-53.
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    3. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    4. Ingersoll, Jonathan Jr., 1977. "A contingent-claims valuation of convertible securities," Journal of Financial Economics, Elsevier, vol. 4(3), pages 289-321, May.
    5. Hayne E. Leland, 1998. "Agency Costs, Risk Management, and Capital Structure," Journal of Finance, American Finance Association, vol. 53(4), pages 1213-1243, August.
    6. Fan, Hua & Sundaresan, Suresh M, 2000. "Debt Valuation, Renegotiation, and Optimal Dividend Policy," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 1057-1099.
    7. Pierre Mella-Barral & Pierre Tychon, 1996. "Default Risk in Asset Pricing," FMG Discussion Papers dp250, Financial Markets Group.
    8. 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 637-654, May-June.
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    10. K. G. Nyborg, 1996. "The use and pricing of convertible bonds," Applied Mathematical Finance, Taylor & Francis Journals, vol. 3(3), pages 167-190.
    11. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
    12. 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.
    13. 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.
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    More about this item

    Keywords

    Subordinated convertible debt; Default; Bankruptcy costs; Conversion in distress;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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