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hey mike
why is that for convertible loan stock, when we discount the future cash flows we use the effective interest ? why dont we use the stated/nominal as this is the real interest and not the effective interest?
also why is that the effective rate is higher than the nominal rate always?
Because the present value of servicing that loan is what we are looking for and when we look at the future cash flows, we use the actual interest payable, not the effective rate
“why is that the effective rate is higher than the nominal rate always” – because the share exchange option has a value and so the effective rate is higher than the coupon rate to take account of that value
OK?
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