The value of a conventional convertible bond is the value of a straight bond plus the value of the option to exchange it for a specified number of shares of common stock. First, I develop a closed-form contingent-claims convertible bond valuation model that quantifies the value of the exchange option when the short-term riskless rate, the firm's credit spread, and its share price are stochastic. I model the firm's decision to force early conversion as a stopping time problem in which the firm forces conversion as soon as the conversion value reaches the forced conversion barrier. I empirically validate the model by comparing model and market prices for a sample of 148 corporate convertible bonds issued between 2006 and 2010. The average median and mean pricing errors are −0.18% and 0.21%, respectively, which are within the average bid–ask spread for convertible bonds during the sample period. I use the model to quantify the disruptive impact that the prohibition on short selling during the recent financial crisis had on convertible bond prices.

This paper demonstrates that refunding discounted debt represents a form of tax arbitrage that is profitable to taxpaying corporations when the present value of the additional tax shields, created through the refunding, exceeds the sum of the present value of the overall increase in pre-tax debt service requirements, after-tax transaction costs, and any tax incurred on the gain. The paper contrasts the factors that give rise to profitable opportunities to refund high-coupon debt and discounted debt. It also shows that, of the analytical approaches previously suggested for calculating the net advantage of refunding discounted debt, discounting the change in after-tax debt service payments at the after-tax cost of money for the refunding issue is the only one consistent with preserving debt service parity.

We document the ability of the credit default swap (CDS) market to anticipate favorable as well as unfavorable credit rating change (RC) announcements based on more extensive samples of credit rating events and CDS spreads than previous studies. We obtain four new results. In contrast to prior published studies, we find that corporate RC upgrades do have a significant impact on CDS spreads even though they are still not as well anticipated as downgrades. Second, CreditWatch (CW) and Outlook (OL) announcements, after controlling for prior credit rating events, lead to significant CARs at the time positive CW and OL credit rating events are announced. Third, we extend prior results by showing that changes in CDS spreads for non-investment-grade credits contain information useful for estimating the probability of negative credit rating events. Fourth, we find that the CDS spread impact of upgrades but not downgrades is magnified during recessions and that upgrades and downgrades also differ as to the impact of simultaneous CW/OL announcements, investment-grade/speculative-grade crossovers, current credit rating, market volatility, and industry effects.

We examine a link between bond exchange-traded fund (ETF) creation and redemption processes and the underlying bond market liquidity. Using daily creation and redemption data, we find that including a bond in a creation or redemption basket has a favorable impact on the bond’s liquidity for both high-yield and investment-grade markets. The improvement in liquidity persists during times of market stress with this impact being stronger for redemptions than creations. Our results suggest that ETF mispricing arbitrage explains the improvement in bond liquidity. However, we also find evidence that transaction costs and bond inventory management limit the ETF arbitrage.

I. FOUNDATIONS. 1. Introduction and Overview. 2. The Financial Environment: Concepts and Principles. 3. Accounting, Cash Flows, and Taxes. II. VALUE AND CAPITAL BUDGETING. 4. The Time Value of Money. 5. Valuing Bonds and Stocks. 6. Business Investment Rules. 7. Capital Budgeting Cash Flows. 8. Capital Budgeting in Practice. III. RISK AND RETURN. 9. Risk and Return: Stocks. 10. Risk and Return: Asset Pricing Models. 11. Risk, Return, and Capital Budgeting. 12. Risk, Return, and Contingent Outcomes. 13. Risk, Return, and Agency Theory. IV. CAPITAL STRUCTURE AND DIVIDEND POLICY. 14. Capital Market Efficiency: Explanation & Implications. 15. Capital Structure Policy. 16. Managing Capital Structure. 17. Dividend Policy. V. LONG-TERM FINANCING. 18. Issuing Securities and the Role of Investment Banking. 19. Long-Term Debt. 20. Leasing and Other Asset-Based Financing. 21. Derivatives and Hedging. VI. WORKING CAPITAL MANAGEMENT. 22. Cash and Working Capital Management. 23. Accounts Receivable and Inventory. 24. Financial Planning. VII. SPECIAL TOPICS. 25. Mergers and Acquisitions. 26. Financial Distress. 27. International Corporate Finance.

This paper provides a rationale for the use of convertible securities as the medium of exchange in corporate change-of-control transactions. We argue that convertible securities can resolve the information asymmetry about the bidder’s value while at the same time mitigating the information asymmetry about the target’s value. In contrast, deals with cash or stock can only address one information asymmetry or the other but not both. Empirically, we find that a bidder is more likely to offer convertible securities, rather than all cash or all stock, when both the bidder and its target face large asymmetric information problems. We also find that both bidders and targets in convertible deals enjoy positive abnormal stock returns around takeover announcements. These findings provide empirical support for the use of convertible securities to resolve the double-sided asymmetric information problem. Finally, we find that bidder returns in convertible deals are larger than in all-cash and all-stock deals, but that target returns in convertible deals are smaller than in all-cash and all-stock deals.