
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). Because of the convertible nature of exchangeable debt, they carry a lower coupon rate and offer a lower yield than comparable straight debt (debt without a conversion provision). The conversion price, the conversion ratio, and the debt maturity are specified in the bond indenture at the time of issue of exchangeable debt. The price of an exchangeable debt is the price of a straight bond plus the value of the embedded option to exchange. Straight debt can be defined as a bond that does not give the investor the option to convert into equity of a company. 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. An exchangeable debt is simply a straight bond plus an embedded option which gives the bondholder the right to convert its debt security into the equity of a company that is not the debt issuer. 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.

What Is 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.





Understanding 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 the 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 the 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.
Related terms:
Bond Floor
Bond floor refers to the minimum value a specific bond should trade for. The bond floor is derived from the discounted value of a bond's coupons, plus its redemption value. read more
Busted Bond
A busted bond is one where an issuer has failed to pay required interest payments and/or principal amounts to the debt holder. read more
Call Option
A call option is a contract that gives the option buyer the right to buy an underlying asset at a specified price within a specific time period. read more
Contingent Convertibles (CoCos)
Contingent convertibles (CoCos) are similar to traditional convertible bonds in that there is a strike price, which is the cost of the stock when the bond converts into stock. read more
Conversion Parity Price
The conversion parity price is the price paid for converting the security from debt to shares. read more
Conversion Price & Example
The conversion price is the price per share at which a convertible security, like corporate bonds or preferred shares, can be converted into common stock. read more
Conversion Ratio
The conversion ratio is the number of common shares received at the time of conversion for each convertible security. read more
Convertible Bond
A convertible bond is a fixed-income debt security that pays interest, but can be converted into common stock or equity shares.There are several risks read more
Coupon Rate
A coupon rate is the yield paid by a fixed income security, which is the annual coupon payments divided by the bond's face or par value. read more
Debt Security
A debt security is a debt instrument that has its basic terms, such as its notional amount, interest rate, and maturity date, set out in its contract. read more