Financial Institutions, Markets, and Money, Eleventh Edition

CHAPTER EIGHT

Bond Markets

ITIS WEDNESDAY, MARCH 4, 2009, and you are starting the day with a headache. The value of your equity portfolio, whose composition is similar to the S&P 500 index, is below what it was 12 years ago. Adding to your headache is the worry that Ford Motor Corporation will soon default on various issues of its debt, of which you also have significant holdings. You are hardly alone in this apprehension: Ford's bonds trade at very deep discounts, below 30 cents on the dollar, reflecting the expectations of imminent default among investors. The severe recession badly hurt the North American automakers, who were already struggling in the battle with the leaner Japanese competitors.

Later in the day Ford announces a majordebt-restructuring initiative. Holders of the $4.88 billion of face value of convertible notes due December 15, 2036, are offered 108 shares of Ford common stock and a cash incentive of $80 for each $1,000 in notes to be exchanged. You have until April 3 to decide. Ford's already depressed common stock price falls a little more upon the announcement due to the potential dilution effect of the conversion and closes the day at $1.87 per share. You quickly compute that, at the current stock price, the value of the offer is an unimpressive $282 per $1,000 of par value of the convertible notes, even with the $80 cash incentive. However, you also understand that converting debt to equity will reduce Ford's interest payments as well as the probability ...