Convertible Bonds

1
Convertible Bonds

• General issues
• Price of a convertible bond
• Conversion price of the stock
• Risks associated with Convertible Bonds

2
General Issues

Convertible bond a corporate bond with a call
option to buy the common stock of the
issuer. Exchangeable Bonds grant the bondholder
the right to exchange the bonds for the common
stock of a firm other than the issuer of the
bond. Conversion ratio the number of shares of
common stock that the bondholder will receive
from exercising the call option of a
convertible/exchangeable bond
3
Conversion Price

• Conversion price par value/conversion ratio (at
  the issuance of a convertible bond)

4
Other Features

• Physical settle versus cash settle
• Put provision grants the bondholder the right to
  sell the issue back to the issuer at par value on
  designated dates (page 5).
• Hard put versus soft put

5
Minimum Value of a Conversion Bond

• the greater of
• Its conversion value
• Its value of corporate bond without the
  conversion option

6
Example
Maturity 10 years Coupon rate 10 Conversion
ratio 50 Current market price of the bond
950 Current price of the stock 17 Dividend
per share 1
7
Example

• What is the conversion price of the bond?
• What is the minimum value of the bond?

8
Market Conversion Price

• Market conversion price market price of
  convertible bond/conversion ratio
• Market conversion premium per share
• market conversion price current market price
• Market conversion premium ratioconversion
  premium per share/market price of common stock

9
Example

• At a market price of 950, a stock price of 17,
  and a conversion ratio of 50, calculate (1) the
  market conversion price, (2) market conversion
  premium per share, and (3) market conversion
  premium ratio of the bond.

10
Why Convertible Bonds?

• Stock price is low, selling stocks could dilute
  the price of the stock.

11
Exercises

• chapter 18 Problem 6