Long-Term Financing Through Convertible Bonds: Understanding the Basics
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Chapter 1: Introduction to External Sources of Finance
External financing refers to funds that originate outside a business. Among these sources, convertible bonds play a significant role. When companies require funds for an extended period—typically exceeding five years—they turn to long-term financing options.
The capital needed for acquiring Fixed Assets, or Non-Current Assets, varies greatly. For instance, purchasing lower-value assets like vehicles necessitates a smaller financing amount. In contrast, acquiring high-value assets, such as new machinery for production lines, demands a considerably larger investment.
Section 1.1: Understanding Convertible Bonds
Convertible bonds, also known as convertible debentures, are unique financial instruments that allow holders to convert their bonds into shares of the issuing company. Each bond can be exchanged for a predetermined number of shares of the company's common stock.
These bonds are classified as hybrid securities due to their dual characteristics of debt and equity. Typically, they come with a maturity period that exceeds ten years, offering a long-term financing solution.
The bondholder has the flexibility to convert the bond into stock at designated times throughout its lifespan, usually at their discretion.
Subsection 1.1.1: Characteristics of Convertible Bonds
Section 1.2: The Significance of Convertible Bonds
What sets convertible bonds apart? They possess a blend of both debt and equity features.
- Debt Features: A convertible bond operates as a fixed-income corporate debt security, providing interest payments to the investor. It has a set principal amount, a fixed interest rate that is paid at regular intervals, and a designated maturity date.
- Equity Features: The unique aspect is the ability to convert the bond into a specific number of common shares. Thus, while it functions as a debt instrument, it also offers the potential for equity ownership.
In summary, convertible bonds can be transformed into shares after a specified duration, contingent upon the bondholder's request. Once this conversion occurs, the issuing company is no longer obligated to repay the bond, as the debt has effectively been converted into equity.
Chapter 2: The Impact of Convertible Bonds on Companies
By understanding the mechanics of convertible bonds, businesses can strategically leverage this financing option to balance their capital structure and drive growth.