medium · Investment Banking rx-dcm-ecm

In an LBO scenario, why might a financial sponsor prefer the target to have out-of-the-money convertible bonds rather than in-the-money bonds?

1. The coupon interest rate on ITM bonds is structurally higher than on OTM bonds.
2. OTM bonds simply allow the sponsor to avoid paying any equity control premium at all.
3. In-the-money bonds increase the equity purchase price by adding to the diluted share count.
4. Out-of-the-money bonds are automatically and fully wiped out upon any change-of-control event.

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