Convertible Bonds

Summaries

The owner has the right to convert the bond into a number of shares. Therefore, it is equivalent to buying a bond with stock call options:

Callable convertible bond value = bond value + stock call option value – bond call option value    

Conversion ratio: number of shares for which a convertible bond can exchange

Convertible bond can have call option or put option

1)      Call option: if the issuer call the bond when the bond price > call price, it is optimal for holder to convert to share instead of selling at lower price

2)      Put option:

a.      Hard put: issuer must pay cash

b.      Soft put: issuer have payment choice

Conversion value = market price of share X conversion ratio

Straight value – value of the bond as if it were not convertible

Minimum value of a convertible bond = max(straight value, conversion value)   **** Not need to consider dividend of the share! (because the current price of the share takes that into account already)

Market Conversion Price = market price of convertible bond / conversion ratio

Market Conversion Premium per share = market conversion price – market price

Market Conversion Premium Ratio = Market conversion premium per share / market price per share

Premium payback period = Market conversion premium per share/ favorable income difference per share

Favorable income difference per share = (coupon – conversion ratio x dividend per share)/ conversion ratio

Downside risk = premium over straight value = market price of bond/ straight value -1

*** this premium is NOT market conversion premium per share!