1. ©2012 McGraw-Hill Ryerson Limited 1 of 36 Learning Objectives 1.Distinguish between and outline the uses of forwards, futures and options. (LO1) 2.Calculate the hedge on futures and the value of call and put options. (LO2) 3.Characterize the securities offered by a corporation that are convertible into common shares at the option of the investor and are a means of raising funds. (LO3) 4.Examine the benefits of a convertible security, including a fixed rate of return and the potential for capital appreciation. (LO4)

2. ©2012 McGraw-Hill Ryerson Limited 2 of 36 Pure bond value $785.18 Price of common stock ($) Conversion value 10 20 30 40 50 60 70 Market price of convertible bond Bond values ($) Premium Figure 19-4 Price movement pattern for a convertible bond 200 400 600 800 1000 1200 1400 LO4

3. ©2012 McGraw-Hill Ryerson Limited 3 of 36 Yield to Maturity on Issue; Coupon; Conversion Market Yield toBonds of Similar Risk and MaturityRating Value Value Maturity and Maturity Algonquin Power 7% June 2017 BBB (low) $1,345.30 $1,375.40 0.45% 4.91% Pembina Pipeline 5.75% Nov. 2020 BBB (high) $887.25 $1,045.00 5.13% 4.69% Yellow Media 6.25% Oct. 2017 BB 11.25 $535.00 19.60% 7.11% Pricing of Convertible Debentures September 2011 LO4

4. ©2012 McGraw-Hill Ryerson Limited 4 of 36 Advantages and Disadvantages of Convertible Securities Advantages to the corporation: lower interest rate than on a straight bond Convertible feature acts as a sweetener that allows access to the bond market attractive to a corporation that believes its stock is currently undervalued Disadvantages to the corporation: If stock price rises above the conversion price, firm could raise capital with fewer shares than obtained from the conversion of the securities accounting considerations regarding convertibles (potential dilution of EPS) LO4

5. ©2012 McGraw-Hill Ryerson Limited 5 of 36 Accounting Considerations with Convertibles Convertible securities may generate additional common stock in the future which will impact diluted earnings per share Financial reporting requires full disclosure Diluted earnings per share = adjusted aftertax earnings Shares outstanding + Shares from conversion LO4

6. ©2012 McGraw-Hill Ryerson Limited 6 of 36 Review of Formulas (a) 1. Face value = Conversion price X Conversion ratio (19-1) 2. DilutedAdjusted aftertax earnings earnings = (19-2) per share Shares outstanding + Shares from Conversion LO4