Question

Occasionally it is said that issuing convertible bonds is better than issuing stock when the firm's shares are undervalued. Suppose that the financial manager of BFC Company does have inside information indicating that the BFC's stock price is too low. BFC's future earnings will in fact be higher than investors expect. Suppose further that the inside information cannot be released without giving away a valuable competitive secret. Clearly, selling shares at the present low price would harm BFC's existing shareholders. Will they also lose if convertible bonds are issued

Answer 1

Answer:

Generally convertible bonds are cheaper than normal corporate bonds since the warrants that allow bondholders to convert them to stocks carry a price. If the stock price is undervalued, so will the warrants. This means that yes, the company will also lose money if they issue convertible bonds.

But what is really important here is what action results in the lowest loss. Issuing common stock will probably result in higher losses than issuing convertible bonds.