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After studying this chapter you will be able to understand: Effective / equivalent periodic rate of return, convertible debt, efficient market hypothesis, effective / equivalent periodic rate of return for non-annual cash flows, convertible debentures, convertible debentures – calculation method,. | Investment Analysis Lecture: 18 Course Code: MBF702 Outline RECAP Effective / equivalent periodic rate of return Convertible debt EFFICIENT MARKET HYPOTHESIS Effective / equivalent periodic rate of return for non-annual cash flows Rate = p.a., therefore, if the cash flows are made on a periodic basis other than annual, an effective rate is needed which is calculated by the following formula: (1+a) = (1+e)en Where, a – annual rate e – effective periodic rate en – number of periods in one year (e.g. quarterly =4) Convertible debentures Convertible debentures or loan stock allow the investor to choose between redeeming the debentures at some future date or converting them into a pre-determined number of ordinary shares in the company. In order to find the cost of debt of convertibles it is necessary to be able to determine which option the investor will exercise and at what date. This will normally involve the following stages: Convertible debentures – calculation method This will . | Investment Analysis Lecture: 18 Course Code: MBF702 Outline RECAP Effective / equivalent periodic rate of return Convertible debt EFFICIENT MARKET HYPOTHESIS Effective / equivalent periodic rate of return for non-annual cash flows Rate = p.a., therefore, if the cash flows are made on a periodic basis other than annual, an effective rate is needed which is calculated by the following formula: (1+a) = (1+e)en Where, a – annual rate e – effective periodic rate en – number of periods in one year (e.g. quarterly =4) Convertible debentures Convertible debentures or loan stock allow the investor to choose between redeeming the debentures at some future date or converting them into a pre-determined number of ordinary shares in the company. In order to find the cost of debt of convertibles it is necessary to be able to determine which option the investor will exercise and at what date. This will normally involve the following stages: Convertible debentures – calculation method This will normally involve the following stages: Calculate all cash flows from all options at the time of the decision making and opt for the option with maximum value. In case where conversion option is with the debt holder, with respect to WACC, redemption would be taken the higher cost to the company, i.e. the redemption of debt or the conversion into shares, whichever results in higher cost to the company. Possible options: Convertible debentures – calculation method Option Calculations to perform Immediate selling of debt Discount future cash flows @ market rate of debt Immediate conversion of debt Number of shares x current market price Holding the debt till redemption All future cash flows discounted @ required rate of return of investor Convertible debentures – calculation method All comparisons should be made at the same point in time i.e. all options should be at any one point in time level Question may ask for a possible growth rate in share price or share price at the end of debt period
