REAL

OPTIONS A NEW
WAY TO THINK

REAL OPTIONS

A real option is an alternative or choice with

a business investment opportunity

They are referred to as real because they

usually pertain to tangible asset

Goals of real options

Identify flexibility in investment
Increase return on capital

BONDS
It

is a debt security, under which the issuer

owes the holders a debt and, depending on
the terms of the bond, is obliged to pay them
interest (the coupon) and/or to repay the
principal at a later date, termed the maturity.
Interest is usually payable at fixed intervals
(semiannual, annual, sometimes monthly).

BONDS

abondis an instrument of indebtedness of the bond

issuer to the holders.
It is a debtsecurity, under which the issuer owes the
holders a debt and, depending on the terms of the bond,
is obliged to pay theminterest(thecoupon) and/or to
repay the principal at a later date, termed thematurity
Interest is usually payable at fixed intervals (semiannual,
annual, sometimes monthly).
Thus a bond is a form ofloanorIOU: theholderof the
bond is the lender (creditor), theissuerof the bond is
the borrower (debtor), and thecouponis the interest.
Bonds provide the borrower with external funds to
finance long-terminvestments, or, in the case
ofgovernment bonds, to finance current expenditure.

COMPARISON WITH EQUITY

Bonds andstocksare bothsecurities, but the

major difference between the two is that
(capital) stockholders have anequitystake in
the company (i.e. they are owners), whereas
bondholders have a creditor stake in the
company (i.e. they are lenders).
Another difference is that bonds usually have
a defined term, or maturity, after which the
bond is redeemed, whereas stocks may be
outstanding indefinitely. An exception is an
irredeemable bond, such asConsols, which is
aperpetuity, i.e. a bond with no maturity

CONVERTIBLE BONDS

Aconvertible bondis a bond issued by a

corporation that, unlike a regular bond, gives
the bondholder the option to trade in the bond
for shares in the company that issued it.
The holder of a convertible bond has the option
to convert the bond into equity (in the same
value as of the bond) of the issuing firm
(borrowing firm) on pre-specified terms.
This gives the bondholder both a fixed-income
investment withcouponpayments as well as
the potential to benefit from an increase in the
company's share price.

CONVERTIBLE BONDS

Convertible bonds(converts for short) arecorporate bondsoffered

by a publicly traded company, that give the bond holder the right
to exchange the bond for a pre-determined quantity of stock.

A convertible bond issue, like that of other bonds, will state the
maturityand thecouponon the bond. A convertible bond also has
information about the conversion option, or how many shares will
be received for the bond if it is converted.

It costs the company less. Convertible bonds pay a lower yield

than if the company issued a non-convertible bond with the same
characteristics (interest, maturity date).

Convertible bonds behave like a bond when the issuing company is

having problems. If the company goes intobankruptcy, convertible
bond holders are in a superior position than stock holders. On the
other hand, if a company does really well convertible bond holders
can convert their bonds to sock and make a really big pay-off

General Issues

A primary disadvantage of convertible bonds is

theirliquidityrisk. In theory, when a stock declines,
the associated convertible bond will decline less,
because it is protected by its value as a fixedincome instrument. However, CBs can decline in
value more than stocks due to their liquidity risk.
Convertible securities also bring with them the risk
of diluting control of the company and forced
conversion, which occurs when the price of the
stock is higher than the amount it would be if the
bond were redeemed. This feature caps thecapital
appreciation potential of a convertible bond.

Example
Maturity = 10 years
Coupon rate = 10%
Conversion ratio = 50
Current market price of the bond = $950
Current price of the stock = $17
Dividend per share = $1

DEBENTURES

Adebentureis a document that either creates a debt or acknowledges

it, and it is a debt without collateral.
Incorporate finance, the term is used for a medium- to long-term
debtinstrumentused by large companies to borrow money.
In some countries the term is used interchangeably withbond,loan
stock ornote.
A debenture is thus like a certificate of loan or a loan bond evidencing
the fact that the company is liable to pay a specified amount with
interest and although the money raised by the debentures becomes a
part of the company's capital structure, it does not becomeshare
capital.
Debentures are generally freelytransferableby the debenture holder.
Debenture holders have no rights to vote in the company's general
meetings of shareholders, but they may have separate meetings or votes
e.g. on changes to the rights attached to the debentures. The interest
paid to them is a charge against profit in the company'sfinancial
statements

MEANING :
Debenture is an instrument in writing for a
fixed period given by a company acknowledging
the liability for total amount received as a result
of issue of debenture and agreeing thereby to
pay the money raised after the expiry of
stipulated period at a certain rate of interest per
annum.

DIFFERENC
E
Basis of

Shares

Debentures

These are part of Owners fund

These are part of borrowed funds

Owners of Company

Creditors of Company

They get voting rights

They don't get voting rights

Control of company lies in hands of

They have no control over the

equity shareholders

affairs of the company

Equity shareholders have no right

They have legal right to get

to get regular return in case of

regular amount of interest even

loss.

when company is not earning

difference
1. Nature

2. Status
3. Voting Rights
4. Control

5. Right to return

profit.

ISSUE OF DEBENTURES
The issue aspect of debentures can be studied from different angles are
given below:

1.

From consideration point of view: Debentures can be issued either

for consideration in cash or for consideration other than cash or collateral
security.

For consideration in cash. Debentures can be issued for consideration in

L..F. entry
Dr. (Rs.)
Cr. (Rs.)
cash either at par orParticulars
at discount or at premium. The journal
will be
:

Bank A/c

Dr.

Discount on debentures A/C (if issued at discount)

Dr.

To Debentures A/c
To Debentures premium A/c (if issued at premium)

For consideration other than cash. When debentures are issued to the vendors in lieu
of purchase consideration, that is known as issue of debentures for consideration other than
cash. The journal entries in this case will be:

(i)

For purchase of assets

Particulars

Dr. (Rs.)

Cr. (Rs.)

For issuing debentures for payment of purchase consideration

Particulars
L.F. Dr. (Rs.)

Cr. (Rs.)

Sundry Assets A/c

L.F.
Dr.

To Vendor A/c

(ii)

Vendor A/c

Dr.

To Debentures A/c

In this case also debentures can be issued at par or at discount or at premium for which
due adjustment is to be made in the second entry above like the previous case.

As collateral security : When debentures are issued as subsidiary or secondary

security in addition to the principal security against a loan or a bank overdraft, such
an issue of debentures is known as issue of debentures as collateral security.

The basic objective of such an issue is that

if the company does not repay the loan and the interest and the main security is
not sufficient, the bank will be entitled to sell the debentures in the market or the
bank may keep the debentures with it.

If the company repays the loan, the bank will return the debentures issued as
collateral security to the company.

2.

From price point of view : Debentures can be issued either at par or at

discount or at premium.

When the amount collected on debentures issued is equal to the face value as
issue of debentures of Rs. 100 for Rs. 100, it is said to be issued at par.

When the amount collected is more than the face value of a debenture as
issue of debenture of Rs. 100 at Rs.105, it is said to be at premium.

Debentures is said to be issued at discount when the amount collected is less

than the face value as issue of Rs. 100 debentures for Rs. 95.

3. From condition of redemption point of view. When debentures are issued

with certain conditions at which redemption can be made, there are five cases
which are given as follows:
Case I

Conditions of issue

Conditions of redemption

(a)

Issued at par

Repayable at par

(b)

Issued at premium

Repayable at par

(c)

Issued at discount

Repayable at par

(d)

Issued at par

Repayable at premium

(e)

Issued at discount

Repayable at premium

(f)

Issued at premium

Repayable at premium

REDEMPTION OF DEBENTURES
Redemption of debentures refers to the discharge of liability on
account of debentures. Following three problems require attention
when company wants to redeem the debentures.

1) Time of redemption of debentures

2) Amount to be paid on debentures
3) Sources of finance

DISADVANTAGE OF
DEBENTURES/BOND
S

Their issue results in legal obligation of paying

interest and principal, which, if not paid can
force the company into liquidation.

Their issue increases the firm's financial leverage

and reduces its ability to borrow in future.

They must be paid at maturity and therefore at

some point, it involves substantial cash outflows.

They may contain restrictive covenants which may

limit the firm's operating flexibility in future.