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Hi Mike!
A issues $100,000 4% convertible loan note, convertible in 3 years time. The market rate of a similar debt without conversion option is 8%
The PV of 8% are as follows:
yr 1 0.926
yr 2 0.857
yr 3 0.794From this example, could you explain the logic of compound instrument?
How it is an equity and a liability ?
What does convertible mean?Thanks.
Calculate the present value of the cash flows necessary to service this loan (interest for 3 years + the capital amount to be repaid)
Add up those 4 amounts and deduct from the face value of the loan and the resultant difference is therefore attributable to equity
The total of the 4 figures is attributable to the loan element (the liability)and is the first figure in the table explained below
Set up your table with columns for
Brought forward Interest at 8% Less interest paid at 5% Carried forward
Can you take it from there?
Convertible means that this is not a straight forward loan of funds that will be repaid in cash sometime in the future (in the case you have quoted it would be repaid after 3 years if this were a straight forward loan)
But it’s not a straight forward loan! It’s convertible. And that entails the lender having the option to convert this amount due after 3 years into equity shares
OK?
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