InvestorQ : What is debt swapping or debt swaps?
Kalyani Sundaram made post

What is debt swapping or debt swaps?

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Mary Joseph answered.
11 months ago

Debt swap is a method that is used by the companies to reduce the outstanding debt amount by exchanging the debt for a predetermined amount of equity. Normally, companies have to pay in cash a large amount for interest on debt and repayment of debt. However, if the lender and the company both agree then the payment of the debt in cash is not required. In debt swapping something equivalent to the value of debt can be paid to the lender instead of paying in cash. Debt swapping gives an option to convert the debt into stock or equity.

Debt swapping mostly done when a company is undergoing some financial difficulties and it is difficult for the company to repay the Debt. When the company cannot pay the amount of debt then debt swap offer is given to lenders. These financial difficulties have a large impact on the company’s capital structure. Debt swapping is done to reduce the cash burden of the company. Sometimes, Debt swaps are also done when the management wants to improve the cash flow, maintain a target debt-equity ratio and restructure the financial structure of the company. Debt swaps can also happen when a company wants to go for bankruptcy.

In debt swaps, the lender receives less than the due amount of debt but more than the market value. Debt swaps reduce the chances of default in repayment of debts as the payment to lenders is made in other securities. The internal rate of return is less than the asking rate of interest on the debt. Debt swap is a good method for converting the unpayable debt into the other securities. However, debt swaps are to be done in such a way that the position of shareholders is not exploited.