1.

Subscribing to convertible securities limits the downside risk of investors and provides
them with the option of converting debt into tradable securities. Discuss in detail the
benefits of convertible securities for the issuing company as well as the investors. Briefly
discuss the potential drawbacks of convertible securities for both.

Ans. Financial products known as convertible securities give investors the choice to convert their
debt investments into equity investments. The convertible securities have the opportunity to convert
into bonds or preferred shares and provide the possibility of positive returns. Let's talk about the
advantages and potential disadvantages of convertible securities for investors and issuers.

Advantages to the Issuing Company

 Lower Interest Rates: Because investors are ready to accept lower interest rates in exchange
for the conversion option, corporations are able to offer lower interest rates on convertible
securities than on standard bonds.

 Greater Flexibility: When compared to traditional bonds or equity, convertible securities give
the issuing company more freedom. There are numerous methods to structure them in
addition to allowing the corporation to profit from possible share price growth by setting the
conversion option at a premium to the existing share price.

 Investor Base Diversification: Convertible securities have the potential to draw in a wider
spectrum of investors, including those who might not be drawn to conventional bonds or
stocks. The company's cost of capital may be lowered by this investor base diversification.

 Advantages for Investors:

 Potential Upside: Through the conversion option, convertible securities give investors
the chance for potential future gains. The convertible securities can be converted into
shares at a discount if the value of the company's shares rises, allowing investors to
profit from the rise in share value.

 Lessening Downside Risk: Because the conversion option sets a floor for the
investment's value, convertible securities offer some degree of downside protection to
investors. The value of the convertible security may decrease if the price of the
company's shares declines, but the investor will still get their main investment back at
maturity.

 Income generation: Compared to standard bonds, convertible securities frequently

offer a greater yield, giving investors a source of income.

 Potential Consequences for Investors:

  Limited Upside: Since the convertible security may not be converted into equity, the
investor may lose out on possible gains if the company's stock price does not rise.

 Convertible securities are exposed to interest rate risk, just like any other bond. The
value of the convertible asset could fall if interest rates increase.

 Liquidity Risk: If there is little demand, investors may find it difficult to sell
convertible assets since they may be less liquid than traditional bonds or equity.

2. Evaluate the three initial options (as given in Table II) provided to the RPL TOCD
holders on the basis of yield to maturity. Assume that a TOCD holder sold the RPL
shares and each warrant (in the case of Option I) issued in September 1993 at Rs. 22 and
Rs. 5 respectively in September 1997. Calculate the YTM on the basis of number of years
completed.

Ans. We must determine each option's yield to maturity (YTM) in order to assess the three first
options offered to RPL TOCD holders. We are informed of the following:

RPL shares are trading at Rs. 70 right now.

At the moment, RPL warrants are trading at Rs.

The face value of a TOCD is Rs.

Option I's conversion cost is Rs. 60.

Option II has a conversion cost of Rs. 65.

Option III has a conversion cost of Rs. 70.

Assuming a TOCD holder sold the RPL shares and warrants in September 1997 for the indicated
prices, let's calculate the YTM for each option:

Option I

4 RPL shares and 1 warrant can be obtained from TOCD; the value of 4 RPL shares is equal to 4 x Rs.
70, or Rs. 280.

One warrant is worth 15 rupees.

4 RPL shares total value plus 1 warrant equals Rs. 295

TOCD conversion value is 4 x 60 rupees, or 240 rupees.

Yield to maturity is equal to [(295/240)(1/4)- 1] times 100, or 6.57%.

Option II:

3 RPL shares can be obtained by converting TOCD.

3 RPL shares are worth 3 x Rs. 70, or Rs. 210.

TOCD conversion value is 3 x 65 rupees, or Rs. 195.

Yield to maturity is calculated as [(210/195)(1/3) - 1] x 100 = 5.22%

Option III:

You can exchange TOCD for two RPL shares.

2 RPL shares are worth 2 x Rs. 70, or Rs. 140.

TOCD conversion value is 2 x 70 rupees, or 140 rupees.

0% yield to maturity

As a result, Option I is the most alluring for the TOCD holder, followed by Option II and Option III,
depending on yield to maturity.

It is significant to remember that YTM is only one aspect to take into account while analysing these
possibilities. It is also important to consider other aspects including liquidity, volatility, and the
possibility of capital gains or losses.

The following are some possible disadvantages of convertible securities for both the issuing
corporation and the investors:

The following are some possible disadvantages of convertible securities for both the issuing
corporation and the investors:

 If convertible securities are converted into equity, this could reduce the shareholding of
current shareholders in the issuing business. Additionally, to make up for the option value of
the securities, the company might need to charge a higher interest rate or dividend.
 Investors may find convertible securities to provide lower yields than non-convertible
securities, and if the price of the underlying stock does not rise, the conversion feature may
become meaningless. Convertible securities might also be more difficult to value and more
complicated than non-convertible securities.

3. Determine the RPL share price that would make an investor indifferent towards
converting non-convertible debentures and detachable warrants into equity shares in
 September 1997 or redeeming non-convertible debentures and selling the detachable
warrants Assume that an investor would opt for conversion in September 1997 only
when the yield earned is atleast equal to the yield earned on the redemption of non-
convertible debentures and sale of the warrants. (Note: The warrants can be sold at Rs.5
in September 1997).

Ans. Assume that a shareholder possesses non-convertible debentures and detachable warrants of
RPL that they wish to convert into equity shares, or they wish to redeem the debentures and sell the
warrants.

Option 1: Converting debt obligations and stock options

If the investor decides to convert the debentures and warrants into equity shares, they will receive
10 equity shares and one warrant for every 100 rupees of debentures held. The investor can sell each
warrant for Rs. 5 in September 1997 based on the information provided.

Assume that P is the RPL share price at which the investor is unable to decide between the two
options. The investor will receive the following if they decide to convert the debentures and warrants
into equity shares:

For every 100/P equity shares and 100/R debentures held

warrants of 50/P for every 100 rupees in debentures held

The total value obtained from this option, assuming the investor sells the warrants for Rs. 5 apiece, is
as follows:

100/P * P + 50/P * 5 = 105/P

We need to compare the yields earned from each option to find the RPL share price at which an
investor would be apathetic about either redeeming non-convertible debentures and selling the
detachable warrants in September 1997, or converting non-convertible debentures and detachable
warrants into equity shares.

The investor will receive the face amount of the debentures (Rs. 100 per debenture) and Rs. 5 per
warrant if they decide to redeem the non-convertible debentures and sell the warrants.

The following will be the total value of this option:

100 + 2.5 * 5 = 112.5

Now that the two options have been equated, we can determine the RPL share price at which the
investor has no preference between the two:

105/P = 112.5

P = 106.67

Therefore, Rs. 106.67 is the RPL share price at which an investor would be unconcerned about either
redeeming non-convertible debentures and selling the detachable warrants in September 1997 or
converting non-convertible debentures and detachable warrants into equity shares.