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Microsoft’s (MSFT) sale of convertible notes could add some energy to the otherwise lackluster convertibles market. Around June 9, 2010, the company raised $1.25 billion of interest-free financing from its first sale of convertible notes in years. The zero-coupon notes, issued under the SEC Rule 144A (for Qualified Institutional Buyers), mature in June 2013, and can only be exchanged for common shares when the stock price rises to $33.40, 33% over the previous night’s close. Microsoft may redeem the debt for cash, stock, or a combination of both. However, holders cannot convert until March 2013, except in certain circumstances. (Note: There is no prospectus available.)

Microsoft’s AAA credit rating could be an attraction for investors seeking to avoid the volatility in equity markets. But, a three-year paper with no interest payment is definitely a win-win situation for the issuer. Microsoft has indicated that proceeds will be used to repay some short-term debt outstanding.

Although Microsoft has the highest investment grade that can be assigned to any corporation, our proprietary model ranks the convertible a 5 (the lowest rank possible). Moreover, the 33% premium over conversion value indicates only fair equity participation in the activities of the underlying common stock. That is, if the stock gains 50%, the convertible should rise 17%, and if the stock falls 50%, the convertible would be expected to respond with a 12% drop. However, if we narrow our expectations to a 25% gain or loss, the leverage projections become unfavorable.

Is this a good investment? It seems only if your portfolio requires high-quality convertible bonds.