A 7% annual coupon 10-year
convertible bond has a par value of $1,000.
Comparable bonds yield 8.5%. The current price of the issuing company's stock
is $19 and the conversion ratio is 50 shares.
Valued as a bond, what price would you expect to pay for this
Thank you for the opportunity to help you with your question!
convertible bonds, or converts, give the holder the option to exchange
the bond for a predetermined number of shares in the issuing company.
When first issued, they act just like regular corporate bonds, albeit
with a slightly lower interest rate. Because convertibles can be changed into stock and thus benefit from a rise in the price of the underlying stock, companies offer lower yields
on convertibles. If the stock performs poorly there is no conversion
and an investor is stuck with the bond's sub-par return (below what a
non-convertible corporate bond would get). As always, there is a
trade-off between risk and return.
(8.5/100) x 1000=$85
The conversion ratio (also called the conversion premium) determines how many shares can be converted from each bond. This can be expressed as a ratio or as the conversion price, and is specified in the indenture along with other provisions.
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