DEFINITION of 'Exchangeable Debt'

An exchangeable debt is a type of hybrid debt security that can be converted into the shares of a company other than the issuing company (usually a subsidiary). Companies issue exchangeable debt for a number of reasons, including tax savings and divesting a large stake in another company or subsidiary.

BREAKING DOWN 'Exchangeable Debt'

Straight debt can be defined as a bond that does not give the investor the option to convert into equity of a company. Since these investors do not get to participate in any price appreciation in the shares of a company, the yield on these bonds is typically higher than a bond with an embedded option to convert. One type of bond that has a convertibility feature is the exchangeable debt.

An exchangeable debt is simply a straight bond plus an embedded option which gives the bondholder the right to convert its debt security into equity of a company that is not the debt issuer. Most of the time, the underlying company is a subsidiary of the company that issued the exchangeable debt. The exchange must be done at a predetermined time and under specific conditions outlined at the time of issuance. In an exchangeable debt offering, the terms of the issue such as the conversion price, the number of shares into which the debt instrument can be converted (conversion ratio), and the debt maturity are specified in the bond indenture at the time of issue. Because of the exchange provision, exchangeable debt generally carries a lower coupon rate and offers a lower yield than comparable straight debt, as is the case with convertible debt.

Exchangeable Debt vs. Convertible Debt

Exchangeable debt is quite similar to convertible debt, the major difference being that the latter is converted into shares of the underlying issuer rather than shares of a subsidiary as is the case with exchangeable debt. In other words, the payoff of exchangeable debt depends on the performance of a separate company, while the payoff of convertible debt depends on the performance of the issuing company.

An issuer decides when an exchangeable bond is exchanged for shares whereas with a convertible debt the bond is converted into shares or cash when the bond matures.

Valuing Exchangeable Debt

The price of an exchangeable debt is the price of a straight bond plus the value of the embedded option to exchange. Thus, the price of an exchangeable debt is always higher than the price of a straight debt given that the option is an added value to an investor’s holding.

The conversion parity of an exchangeable bond is the value of the shares that can be converted as a result of exercising a call option on the underlying stock. Depending on the parity at the time of exchange, investors determine whether converting exchangeable bonds into underlying shares would be more profitable than having the bonds redeemed at maturity for interest and par value.

Divesting with Exchangeable Debt

A company that wants to divest or sell a large percentage of its holdings in another company can do so through exchangeable debt. A company selling off its shares hastily in another company may be viewed negatively in the market as a signal of financial health deterioration. Also, raising an equity issue may result in undervaluation of the newly issued shares. Therefore, divesting using bonds with an exchangeable option may serve as a more beneficial alternative for issuers. Until the exchangeable debt matures, the holding company or issuer is still entitled to the dividend payments of the underlying company.

  1. Convertibles

    Securities, such as bonds, that can be turned into common stock ...
  2. Busted Convertible Security

    A busted convertible security is a convertible bond where the ...
  3. Debt Issue

    A debt issue is a financial obligation that allows the issuer ...
  4. Premium Put Convertible

    A premium put convertible is a debt security which allows the ...
  5. Convertible Subordinate Note

    A convertible subordinate note is a short-term debt security ...
  6. Bond Floor

    The bond floor is the lowest value that convertible bonds can ...
Related Articles
  1. Investing

    Convertible bonds: pros and cons for companies and investors

    Understand what effect convertible bonds have on investors and companies. Find out the advantages, disadvantages, and what the issue means from a corporate standpoint before buying in.
  2. Investing

    What's a Debt Security?

    A debt security is a financial instrument issued by a company (usually a publicly traded corporation) and sold to an investor.
  3. Investing

    3 Best High-Yielding Convertible Bond Mutual Funds (LACFX, FACVX)

    LACFX,FACVX,VCVSX: Learn about three of the highest-yielding options available.
  4. Investing

    CWB: SPDR Barclays Convertible Secs ETF

    Read an in-depth analysis of the SPDR Barclays Capital Convertible Bond ETF, which tracks an index of high-growth potential convertible bonds.
  5. Investing

    Debt Exchanges Are The Latest Push

    Many companies are trying to cut debt levels by exchanging existing debt for a combination of new debt, cash and stock.
  6. Investing

    13 Pre-Issue Corporate Bond Questions For Businesses

    When a company needs more funding, there are many options. Corporate bonds is just one of them.
  7. Personal Finance

    Why Debt Isn’t Always a Bad Thing

    When managed properly, debt can be used to achieve a higher overall rate of return.
  8. Insights

    The National Debt Explained

    We know it's growing, but we don't know exactly how. An in-depth look why the U.S. Government's debt continues to balloon and what it all means for you.
  9. Financial Advisor

    The 4 Best Debt Reduction Services

    It can be tricky to find the best debt reduction services for your financial situation. These top 4 debt consolidation firms help make the process easier.
  1. What is the difference between convertible and reverse convertible bonds?

    The difference between a regular convertible bond and a reverse convertible bond is the options attached to the bond. While ... Read Answer >>
  2. 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 >>
  3. Why would you look at a company's net debt rather than its gross debt?

    Learn the difference between net debt and gross debt, how to calculate debt using a company's financial statements and why ... Read Answer >>
Hot Definitions
  1. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  2. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  3. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  4. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  5. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
  6. Watchlist

    A watchlist is list of securities being monitored for potential trading or investing opportunities.
Trading Center