Fancy Wall Street types who take helicopters to work and eat caviar smoothies for breakfast have plenty of dough to dabble in the stock market. Meanwhile, there are many investors out there who don't have large sums of cash, but still want to mess around in the market. They can't play the market with their own money, so they purchase shares on margin. This means they take out a loan from a brokerage firm and hope to pay it back when they make that great profit when the stock they bought skyrockets in price.
But where does the brokerage firm get the money to loan out? Answer: from a bank...see, brokerages aren't that different than people. But unlike normal humans, the call money rate a brokerage firm gets for clients' margin accounts is not available to the general public.
So, let's say Too Big to Fail Inc. wants to purchase 50,000 shares of a hot stock priced at $20 per share on their margin account. They promise to pay the money back within 30 days after they have bought and sold the stock. The brokerage firm Margin Me Today does not have that kind of cash available, so they go to a bank, who loans them the money at a call money rate of 5%.
This sounds like a great deal except the call loan rate is recalculated every day and also compounds daily until the loan is repaid or called in by the bank. No deadline is set for repayment, but the bank reserves the right to call in the loan at any time, which could force Too Big to Fail to pay back their margin loan immediately as well. (Gulp!)
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Finance: What are Convertible Bonds?9 Views
Finance a la shmoop what are convertible bonds? okay there's a joke about the
Inquisition in here somewhere or maybe something about Cossacks and 17th
century Russia what do you think animated musical or maybe a King Henry [King Henry VIII appears]
thing but yeah all that's different kind of conversion way more pedantically a
company might be having a hard time selling or issuing its bonds to Wall [Man with company briefcase for head meets man with Wall Street briefcase for a head]
Street in order for them to close the deal with their stock trading today at
25 bucks a share they might say well these bonds are convertible into 20 [Man with company for a head discussing bonds]
shares of our stock that is they would have a single thousand dollar unit of
that bond and it would convert into 20 shares which would then value the shares
at 50 bucks either thousand divided by 20 there's 50 it's an advanced calculus
sorry if you didn't have it which would sort of be you know the over/under price
at which bondholders would start to seriously look at converting their nice
safe bonds into those risky pesky equities well why would a company offer
convertible bonds instead of you know just vanilla bonds well if they were [Man discussing convertible bonds]
stuck paying 6% interest on just bonds but really could only afford to pay 4%
well they might get the interest rate discount by throwing in that equity
kicker in the bonds having that convertibility feature yes they would
suffer dilution at 50 bucks a share but that price is double and change where
the stocks out here so the company is probably thinking that it wouldn't mind
some dilution from these bonds being converted up there in stock price right [Arrow points to stock value mark on graph]
and remember the bonds pay the 4% interest along the way until they are
converted the moment those bonds are converted into equity well then the debt
on the balance sheet of the company and its obligation to pay that 4% yearly [Company balance sheet and interest highlighted]
interest goes mercifully away they print 20 more shares for each bond converted
and yes those shares may pay a dividend but as far as the convertible bonds go
they are thereafter converted and saved and remember Jesus Saves but Moses
invests
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