A convertible bond is a hybrid security that can be converted into shares of the issuing company's equity at a predetermined price. It gives the bondholder the option to exchange the bond for a set number of shares. Convertible bonds offer upside potential if the stock price rises through conversion while also providing downside protection through interest payments and repayment of principal. They are attractive to companies with high growth potential but also high risk, as the conversion feature allows the company to strengthen its equity base if its stock price appreciates.

1. CONVERTIBLE BOND
• Convertible bond have been issued and traded since 1880s
• A convertible bond is a bond that can be converted into a
predetermined amount of the company's equity at certain times
during its life, usually at the discretion of the bondholder.
• Convertible bonds, or converts, give the holder the option to
exchange the bond for a predetermined number of shares in the
issuing company.

2. • It is a hybrid security with debt and equity
• A convertible bond typically has a coupon rate lower than
that of similar non-convertible debt
• The investor receives the potential upside of conversion into
equity while protecting downside with cash flow from the
coupon payments and the return of principal upon maturity
• These properties lead naturally to the idea of convertible
arbitrage, where a long position in the convertible bond is
balanced by a short position in the underlying equity.

3. 3
Convertible bonds
• Various features in convertible bonds
• Issuance of convertibles - perspectives of corporate treasurers
- conversion into shares
- call (hard and soft provisions)
- put
- reset on conversion number
. Decomposition of convertibles into different components
• Valuation of convertibles
- interest rate sensitivities (duration analysis)
- binomial tree calculations

4. Bondholder has the right to convert the bond into common shares at
some contractual price (conversion number may change over time).
Conversion value: stock price x conversion number
Conversion premium: (bond price – conversion value) / conversion value
Bond floor value: sum of present value of coupon and par

5. 5
Analytics of convertible bonds figures
(hypothetical figures)
stock price $30.00 per share
stock dividend $0.50 per share
convertible market price $1,000
coupon rate 7.00%
maturity 20 years
conversion price $36.37
Stock dividend yield = annual dividend rate
/ current stock price
= $0.50 / $30.00 = 1.67%

6. 6
Conversion ratio
= number of shares for which one bond may be exchanged
= par / conversion price
= $1,000 / $36.37 = 27.50 shares
Conversion value
= equity value or stock value of the convertible
= stock price x conversion ratio
= $30.00 x 27.50 = $825.00
Conversion premium
= (convertible price – conversion value)
/ conversion value
= ($1,000 – $825) / $825.00 = 21.21%

7. 7
Types of companies as convertible issuers
Companies that are characterized by strong performing, high-
visibility, sub-investment grade, high-growth potential have
comparative advantage in the convertible market versus the
fixed income market.
• They lack a long-term track record and have volatile capital
structures – high coupon must be offered.
• They can transform the high volatility into a benefit since the
warrant is more expensive.
• When the company grows, they may call the bonds. This in turn
will strengthen the company’s equity base at the moment when it is
most needed.

8. Analysis of a convertible
bond
• Conversion value
• Minimum value of a convertible bond
• Market conversion price
• Market conversion premium per share
• Market conversion premium ratio
• Downside risk with a convertible bond
• Upside potential of a convertible bond