To help clarify some of these concepts, we present a hypothetical example in the table below and graphically in Figure 2-6. Assume that a new issue convertible has come to market. It has a 5 percent coupon and 10 years to maturity. The issuing company has other 10 year debt that carries an 8 percent yield, and the company's stock is currently trading at $42.
|Straight bond yield to maturity
|Current stock price
||20 shares per bond
Hypothetical Convertible Bond
The bond indenture specifies a conversion price of $50. Since we know that the conversion price is the effective price for conversion into stock with the bond at par, we divide the par value of the bond ($1,000) by $50, resulting in a conversion ratio of 20 shares. To calculate the current conversion value, we know that the stock price is currently $42. Multiplying $42 by 20 shares, we get a current conversion value of $840. If the issue is sold at par, then the conversion premium would be 19 percent ([$1,000 - 840]/840). The investment value of the convertible at issuance would be the security with the 5 percent coupon discounted at a yield to maturity of 8 percent. The result, according to standard bond calculations, is 79.87, or a dollar value of $798.70. The investment premium would be 25.20 percent ([$1,000 - 798]/798).
The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.
Past performance is no guarantee of future results.