Convertible debt
Convertible debt combines debt cash flows with an equity conversion feature. Relevant terms include interest, maturity, the number of shares received and when conversion is allowed. In simplified FM valuation, compare the expected conversion value with cash redemption at the relevant date, then discount the likely terminal value and interest. The issuer's cost uses after-tax interest where relief is available, with the terminal amount treated consistently. The share-price forecast is uncertain, and more advanced valuation recognises the option feature rather than treating conversion as guaranteed. Conversion can dilute existing shareholders.
Worked example
A $100 nominal bond can be redeemed for $105 or converted into 20 shares at maturity. If the expected share price then is $6, conversion value is $120, so a simplified valuation uses $120 rather than $105 as the expected terminal value, alongside preceding coupons.
Common mistake
Choosing cash redemption without comparing conversion value, or treating the forecast future share price as certain.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Direct | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |