The APB, Yield Indices, and Predictive Ability: A Reply.

Abstract The article focuses on considering the value of conversion rights attached to the security for purposes of determining the fair value of the security. The decision of the Accounting Principles Board (APB) to compare cash yields on risky securities with an essentially riskless rate not only creates the relative bias but also tends to reduce absolutely the probability that any convertible issue will be classified as equivalent of common stock. A reduction in the absolute probability that any given convertible issue would be classified as a common stock equivalent could be compensated for by an appropriate choice of a cut-off level for the cash yield /price ratio index. Short-run effects can distort the picture such that bonds, which were attractive, originally go unconverted and vice-versa. It was suggested that the APB should not have any real responsibility for predicting these types of movements, and therefore it would be better for the APB to develop an index that is relatively highly correlated with ultimate conversion, assuming some normal long-term upward movement in stock prices.