Convertible Bonds and Convertible Preferred Stock

1
Chapter 18

• Convertible Bonds and Convertible Preferred Stock

2
Features Common to Convertible Bonds

• Convertible into common stock at holder's option
• Interest (coupon) and maturity date
• Importance of the call feature

3
Convertible Bond

• Three possible outcomes
• conversion
• retirement at maturity
• default

4
Conversion Ratio

• Face value divided by the conversion price
• 1000 / 20 50 shares

5
Conversion Price

• Face value divided by the number of shares into
  which the bond may be converted
• 1000 / 50 shares 20

6
A Convertible Bond's Value as Stock

• The conversion ratio times the price of the stock

7
Relationship

• Between the price of a stock and the conversion
  value of the bond

8
Value of a Convertible Bond as Debt

• Investment value of a convertible bond
• Model for the valuation of a bond

9
Value of a Convertible Bond as Debt
10
Minimum Price

• Minimum price of the bond combines
• the value of the bond as stock, and
• the value as debt.

11
Minimum Price
12
Actual Price of a Convertible Bond
13
The Premiums

• The premiums paid over
• The bond's value as stock
• The bond's value as debt

14
The Premiums
15
Breakeven Analysis

• Determines how long the convertible bond's
  interest advantage covers the premium over the
  bond's value as stock

16
Convertible Preferred Stock

• The features associated with convertible bonds
  apply to convertible preferred stock.
• Except
• the instrument is equity, and
• it lacks the safety associated with debt.

17
Put Bonds

• The investor has the option to sell the bond back
  to the issuer.
• The option is exercised if interest rates rise.
• The put feature reduces
• interest rate risk, and
• reinvestment rate risk.