What is used to discount the cash flows for the liability component of a convertible loan?

The rationale for using the market rate for non-convertible instruments to discount the cash flows for the liability component of a convertible loan is rooted in the principle of recognizing the time value of money while appropriately reflecting the risk associated with the non-convertible portion of the instrument.

When valuing the liability component of a convertible loan, it is important to consider the rate of return that would be expected by investors in similar, non-convertible debt instruments. This market rate incorporates all relevant factors related to the credit risk and interest rate environment prevalent at the time of issuance. By using this market rate as the discount rate, the valuation accurately reflects what investors would require for comparable risk without the additional potential upside provided by the conversion feature.

This approach ensures that the liability portion is separated appropriately from the equity component created by the conversion feature, allowing for a true representation of the company’s financial obligations. In contrast, the other options do not capture the specific characteristics of the convertible loan's liability component in the same way.