Convertible Bond
Convertible Bonds
A convertible bond is a bond that can be converted into shares of common stock. Therefore, these are two sources of value for this security: the value of the bond components, and the value from possibly converting the security into shares of common stock. Features of a Convertible Bond The basic features of a convertible bond can be illustrated by a hypothetical example. On November 1, 2003 ("today"), Apple, had $400 million in 8.80 percent (annual payments) convertible bonds due in 2013. The bonds are convertible into the common stock of Apple anytime before the maturity at a conversion price of $50.00 per share. Because each bond had a face value of $1,000, the holder of a Apple convertible bond could exchange that bond for $1,000/50 = 20 shares of Apple common stock. The number of shares received for each bond, 20 in this example, is called the conversion ratio. The conversion ratio is found by dividing par value by the conversion price. Of course, the conversion price (and conversion ratio) must be established when the bond is issued. When Apple issued its convertible bonds, its common stock was trading at $32.625 per share. The conversion price of $50 was thus (50 - 32.625)/32.625 = 53.26% higher than the actual common stock price. This 53.26% is called the conversion premium. Now that the bond trades in the secondary market, a similar calculation can be made if the existing stock price is below the conversion price. Value of a Convertible Bond A convertible has two possible sources of value: the straight bond value and the conversion value. At any moment, both values must be determined in order to see which dominates, i.e. which is the driving force in the current value of the convertible. straight bond value The straight bond value is what the convertible bond would sell for if it could not be converted into common stock. This is determined in exactly the same was as a standard bond—by observing the relevant market interest rate
A convertible bond is a bond that can be converted into shares of common stock. Therefore, these are two sources of value for this security: the value of the bond components, and the value from possibly converting the security into shares of common stock. Features of a Convertible Bond The basic features of a convertible bond can be illustrated by a hypothetical example. On November 1, 2003 ("today"), Apple, had $400 million in 8.80 percent (annual payments) convertible bonds due in 2013. The bonds are convertible into the common stock of Apple anytime before the maturity at a conversion price of $50.00 per share. Because each bond had a face value of $1,000, the holder of a Apple convertible bond could exchange that bond for $1,000/50 = 20 shares of Apple common stock. The number of shares received for each bond, 20 in this example, is called the conversion ratio. The conversion ratio is found by dividing par value by the conversion price. Of course, the conversion price (and conversion ratio) must be established when the bond is issued. When Apple issued its convertible bonds, its common stock was trading at $32.625 per share. The conversion price of $50 was thus (50 - 32.625)/32.625 = 53.26% higher than the actual common stock price. This 53.26% is called the conversion premium. Now that the bond trades in the secondary market, a similar calculation can be made if the existing stock price is below the conversion price. Value of a Convertible Bond A convertible has two possible sources of value: the straight bond value and the conversion value. At any moment, both values must be determined in order to see which dominates, i.e. which is the driving force in the current value of the convertible. straight bond value The straight bond value is what the convertible bond would sell for if it could not be converted into common stock. This is determined in exactly the same was as a standard bond—by observing the relevant market interest rate