CFA Practice Question

CFA Practice Question

The correct relationship concerning interest expense is ______
A. a bond with warrants is greater than a conventional bond, which is greater than a convertible bond.
B. convertible bond is greater than a conventional bond, which is greater than a bond with warrants.
C. a conventional bond is greater than a bond with warrants, which is greater than a convertible bond.
Explanation: Issuing debt with equity features lowers interest expense.

User Contributed Comments 11

User Comment
fanfare And how exactly is a bond with warrants having greater interest rate expense that that of a convertible bond?
lemec Amortization of bond discount in bonds with discounts cause a higher interest expense. Follow these guidelines:

Interest expense: convertible bond(cb)<bond with warrants(bw)<conventional bond(Cvb)

Liability: bw<cvb=cv (since warrants are listed as equity

CFO: cvb<bw=cb

Coupon rate: cb=bw<cvb (opposite of CFO)
andrewsutton Can anyone help me? I thought that a bond had the same interest expense whether it is sold at premium, par or discount. If I borrow $1000 and the market interest rate is 10%, the interest expense will be $100, totally independent of the coupon/discount I decide to go for, which has no relevence to the true cost of the loan and is really just a cosmetic difference.
bawejate but if a bond has warrant or conversion feature its coupon would be lower than the conventional bonds.
wollogo This question has nothing to do with the bond being at a premium or discount or even coupon rate. The basic way of looking at is: A bond with warrants is more valuable than without warrants therefore it will be more expensive and have have a lower yield. Convertible bond is even more valuable than one with warrants so again this will be more expensive and have a lower yield. Lower yield => lower interest expense.
jayjunk Instead of saying interest rate expense, the clearer way would be "yield to maturity" of bond being sold. But I guess this is accounting, not finance...
Dinosaur why does the warrant have to yield more than the convertible?
sagania because you may or you may not be able to exersize the warrants, but the convertibles can be converted at any time to equity, so you have to get less coupon for the extra featureof the convertibles...
cjpatel Alternatively folks,
Bonds with EO's have lower coupon compared to Optionfree bonds.

Because the issuer has to 'SWEETEN' the deal with more bells and whistles so it will cost the issuer less to issue the debt as Convertible bonds/Bonds with warrants then OptionFree Bonds!!!
chesschh The greater the chance of converting to equity, the lower the interest that has to be paid
pigletin the equity features make the bond less risky, so you won't ask for a large risk premium, thus lower interest expense for the issuer.
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