Covered Bonds
February 12, 2025
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In the previous article, we studied the concept of convertible debt and some of the common terms which are used while discussing convertible debt. In this article, we will have a closer look at some of the advantages and disadvantages of using this form of debt.
Many companies continue to use convertible debt. This is because it provides several advantages over plain vanilla debt bonds. The advantages have been explained in detail in this article:
Later, by the time, investors have exercised the option to convert the debt to equity, the company would be at a higher stage of growth. As such, the valuation that the firm would realize using convertible debt is more than the valuation which the firm would realize in other scenarios. Hence, many companies look at convertible debentures as a form of obtaining delayed equity financing.
Every financial instrument has its own pros and cons and convertible debt is no exception either. Some of the common disadvantages associated with convertible debt have been mentioned below:
The end result would be a large number of shareholders. Hence, from the next year onwards, the profit will be divided between a larger pool of investors. Hence, each individual investor would earn a smaller earning per share. If companies issue excessive convertible debt, they could face backlash from existing shareholders who would obviously be opposed to the idea.
Since these firms generally have a higher risk compared to other firms, the debt that they issue also tends to have a higher risk as compared to other firms. Hence investors who put their money in fixed income securities must be aware that their money is not as safe in convertible bonds as it would be in other bonds.
Hence, it would be fair to say that convertible debt offers a lot of advantages to certain types of firms. The disadvantages can also be significant. However, if a company is able to plan ahead, then it may be able to mitigate some of the risks that result from convertible debt.
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