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What Is a Debt/Equity Swap?
A debt/equity swap is a transaction in which the obligations or debts of a company or individual are exchanged for something of value, namely, equity. In the case of a publicly-traded company, this generally entails an exchange of bonds for stock. The value of the stocks and bonds being exchanged is typically determined by the market at the time of the swap.Key Takeaways
- Debt/equity swaps involve the exchange of equity for debt in order to write off money owed to creditors.
- They are usually conducted during bankruptcies, and the swap ratio between debt and equity can vary based on individual cases.
- In a bankruptcy case, the debt holder is required to make the debt/equity swap, but in other cases, the debt holder may opt to make the swap, provided the offering is a financially favorable one.
Understanding Debt/Equity Swaps
A debt/equity swap is a refinancing deal in which a debt holder gets an equity position in exchange for the cancellation of the debt. The swap is generally done to help a struggling company continue to operate. The logic behind this is an insolvent company cannot pay its debts or improve its equity standing. However, sometimes a company may simply wish to take advantage of favorable market conditions. Covenants in the bond indenture may prevent a swap from happening without consent.
In cases of bankruptcy, the debt holder does not have a choice about whether he wants to make the debt/equity swap. However, in other cases, he may have a choice in the matter. To entice people into debt/equity swaps, businesses often offer advantageous trade ratios. For example, if the business offers a 1:1 swap ratio, the bondholder receives stocks worth exactly the same amount as his bonds, not a particularly advantageous trade. However, if the company offers a 1:2 ratio, the bondholder receives stocks valued at twice as much as his bonds, making the trade more enticing.