 To know the reasons for issuing warrants and convertibles, we need to know the difference between convertible debt and the straight debt and then convertible debt and the equity. Only then we can see that in what situation the firm is better off if it issues convertible debt and in what situations it is worse off. Let's see the first situation where we compare the convertible debt with the straight debt. Generally convertible debt pays a lower rate of interest because the similar and identical straight debt pays higher rate of interest. Investors accept a lower rate of return or lower rate of interest on convertible bonds due to the fact that there are chances of gain in case of conversion of convertible bonds. If the firm issues convertible debt, then a straight debt, then what will happen? The firm is worse off if the underlying stock performs well and the firm will be better off if the underlying stock subsequently performs poorly. In an efficient market, we know that future stock prices cannot be determined or estimated. Therefore, the dominance of convertible bonds or straight debt on each other cannot be argued. The second comparison we have that is the convertible debt and common stock. Issuance of convertible bonds rather than the issuance of a common stock, what will be the effect on firm? The firm is worse off if the underlying stock subsequently performs poorly and the firm will be better off if the underlying stock is performed well in the subsequent period. In an efficient market, as I have earlier said that the future stock prices cannot be determined or these cannot be estimated or cannot be predicted as well. So the dominance of convertible bonds or common stock on each other cannot be argued. Now the free lunch theory says that convertible debt is actually better than issuing the alternative instruments whereas the expensive lunch story says that convertible debt is inferior form of financing. So where is the reconciliation? If we go for the reconciliation, we see that in an efficient market, a lunch is neither free nor it is expensive. A convertible bond is a package of two things. The first is straight debt and the second is an option there on to buy the underlying common stock. Now the difference between the market value of a convertible bond and a straight debt is basically the price that an investor pay for the call option feature built in the deal and this price is generally known as a fair market price in the efficient capital market.