Fin431x (Ch 185) 1 Convertible Bonds

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Fin431x (Ch 185) 1 Convertible Bonds

  1. 1. Convertible Bonds <ul><li>General issues </li></ul><ul><li>Price of a convertible bond </li></ul><ul><li>Conversion price of the stock </li></ul><ul><li>Risks associated with Convertible Bonds </li></ul>
  2. 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. 3. Conversion Price <ul><li>Conversion price = par value/conversion ratio (at the issuance of a convertible bond) </li></ul>
  4. 4. Other Features <ul><li>Physical settle versus cash settle </li></ul><ul><li>Put provision: grants the bondholder the right to sell the issue back to the issuer at par value on designated dates (page 5). </li></ul><ul><li>Hard put versus soft put </li></ul>
  5. 5. Minimum Value of a Conversion Bond <ul><li>the greater of </li></ul><ul><li>Its conversion value </li></ul><ul><li>Its value of corporate bond without the conversion option </li></ul>
  6. 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. 7. Example <ul><li>What is the conversion price of the bond? </li></ul><ul><li>What is the minimum value of the bond? </li></ul>
  8. 8. Market Conversion Price <ul><li>Market conversion price = market price of convertible bond/conversion ratio </li></ul><ul><li>Market conversion premium per share </li></ul><ul><li>= market conversion price – current market price </li></ul><ul><li>Market conversion premium ratio=conversion premium per share/market price of common stock </li></ul>
  9. 9. Example <ul><li>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. </li></ul>
  10. 10. Why Convertible Bonds? <ul><li>Stock price is low, selling stocks could dilute the price of the stock. </li></ul>
  11. 11. Exercises <ul><li>chapter 18: Problem 6 </li></ul>

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