ICANBusiness, Management and FinanceSources of Finance2024

A Nigerian company raises finance by issuing a ₦500,000,000 convertible bond at 10% per annum, convertible into ordinary shares after five years. Which of the following correctly identifies a PRIMARY advantage of convertible bonds to the ISSUING company compared with a straight (non-convertible) bond of equivalent credit risk?

AConvertible bonds carry a higher coupon rate than equivalent straight bonds, increasing interest deductions under CITA
BConvertible bonds typically carry a lower coupon rate than equivalent straight bonds, reducing the company's immediate interest burdenCORRECT
CConvertible bonds eliminate the need to repay principal at maturity regardless of conversion
DConvertible bonds are classified as equity from inception under IFRS, improving the debt-to-equity ratio immediately
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Why the answer is B, and why the others tempt you.
Investors accept a lower coupon on convertible bonds because the conversion option has value — it gives them the right to participate in equity upside. This lower coupon reduces the company's cash interest payments and CITA-deductible interest expense in the short term. Option A is the opposite of reality; Option C is incorrect as principal is repaid if conversion does not occur; Option D is incorrect because under IAS 32, a convertible bond is split into a liability component and an equity component, not classified entirely as equity.
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