Question

Convertible debt and straight debt issued with warrants are similar securities, because both are debt securities that represent potential equity claims on the issuer's assets. In fact, convertible debt can be thought of as straight debt plus nondetachable warrants. However, several important distinctions do exist. Use the following table to indicate whether the characteristic listed refers to convertible bonds or to stock warrants: Characteristic Convertible Bonds Debt with Warrants These securities typically have a shorter maturity When exercised, new claims on stockholders' equity are created, but no capital is transferred. These securities tend to have higher flotation costs These securities tend to be issued by larger, less risky firms If a firm does not grow as expected subsequent to convertible or bond-with-warrant issues, does that make it more or less likely that the securities will be converted or exercised? O More likely to be converted or exercised O Less likely to be converted or exercised

Answer 1

Convertible bonds and Debt with warrants are both debt securities but differ in characteristics. Convertible bond provides an option to the holder of conversion of bond into equity, which is not a detachable option. Debt with warrants provide the holder an option to convert the "warrant" into equity or to buy equity in exchange of warrant.

Characteristics	Type
These securities typically have a shorter maturity	Convertible bond
When exercised, new claims on stockholders' equity is created, but no capital transferred	Convertible bond
These securities tend to have higher flotation cost	Debt with warrants
These securities tend to be issued by larger, less risky firms	Debt with warrants

If a firm does not grow as expected subsequent to the convertible or bond with warrants issue, it makes the securities less likely to be converted or exercised as lower growth would bring the market value of the shares down.

Under the Diluted EPS method, EPS is found based on the assumption that all convertibles and warrants are exercised rather than trying to estimate how many of them are likely to be exercised.