Death Spiral

DEFINITION of 'Death Spiral'

A type of loan investors give to a company in exchange for convertible debt, which, like convertible bonds, typically has provisions that allow investors to convert the bonds into stock at below-market prices. This can cause the original shareholders to lose control of the company.

BREAKING DOWN 'Death Spiral'

This type of loan is undertaken by companies that desperately need cash. It is called a death spiral because companies' stocks often plunge drastically after they take on these types of loans. It is important to note that death spirals often allow buyers to convert the bonds into shares at a fixed conversion ratio in which the buyer has a large premium.

For example, a bond with a face value of $1,000 may have a convertible value of $1,500, which means that a bondholder will receive $1,500 dollars worth of equity for giving up the $1,000 bond.

However, upon a conversion, more shares are created, which dilutes the share price. This drop in price may cause more bond holders to convert, because the lower share price means that they will be receiving more shares. Any further conversions will cause more price drops as the supply of shares increases, causing the process to repeat itself as the stock's price spirals downward.

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RELATED FAQS
  1. Where does the stock come from when convertible bonds are converted to stock?

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  2. What is a convertible bond?

    A convertible bond is a bond issued by a corporation that, unlike a regular bond, gives the bondholder the option to trade ... Read Answer >>
  3. How do I use a premium put convertible?

    Holders of convertible bonds face all the pitfalls that traditional bondholders face - liquidity risk, interest rate risk ... Read Answer >>
  4. How is convertible bond valuation different than traditional bond valuation?

    Read about bond valuation, particularly the differences between how a traditional bond is valued and how a convertible bond ... Read Answer >>
  5. Why do some investors prefer convertible over “straight” bonds?

  6. What does it mean when an investor moves a bond to equity?

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