Have you ever come across preference shares issued, with a equity host and a liability component? For example, the principle amount can only be redeem by a fixed number of ordinary shares, however, the instrument carries PIK interests compounded annually, which will be converted into a variable number of ordinary shares at fair value. There is a maturity date where the conversion will happen. No cash option.
In such a case, wouldn't the principal treated as an equity and the PIK interests as a liability? If that's the case, how the amount of liability should be determined?
Equity host with a liablity component
Re: Equity host with a liablity component
In this case, the principal amount should be treated as equity and the PIK amount as liability.
For example, a convertible prefs with principal amount of 1 million, paying a PIK cumulative interests of 10% every year. Principal convertible into fixed amount of shares and PIK amount into a variable amount of shares, mandatorily at end of year 3. No repayment in cash.
Assuming the market rate is also 10%.
Then, question arises as how to determine the equity and debt. Two options with totally different outcome (see screenshot). Any ideas or suggestions guys?
For example, a convertible prefs with principal amount of 1 million, paying a PIK cumulative interests of 10% every year. Principal convertible into fixed amount of shares and PIK amount into a variable amount of shares, mandatorily at end of year 3. No repayment in cash.
Assuming the market rate is also 10%.
Then, question arises as how to determine the equity and debt. Two options with totally different outcome (see screenshot). Any ideas or suggestions guys?
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Re: Equity host with a liablity component
A strict application of a compound financial instrument would lead me to the journals on the right. However, I'm trying to find a economic rational.
Re: Equity host with a liablity component
Just putting this up the chain.
Re: Equity host with a liablity component
Just moving it up in case.
Re: Equity host with a liablity component
Please don't