Chapter 18 Convertible Bonds and Convertible Preferred Stock
Chapter 18 Convertible Bonds and Convertible Preferred Stock Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Features Common to Convertible Bonds • Convertible into common stock at the holder's option • Interest (coupon) and maturity date • The importance of the call feature Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Convertible Bond • The three possible outcomes – conversion – retirement at maturity – default Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Conversion Ratio • Face value divided by the conversion price • $1000 / $20 = 50 shares Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Conversion Price • Face value dividend by the number of shares into which the bond may be converted • $1000 / 50 shares = $20 Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
A Convertible Bond's Value as Stock • The conversion ratio times the price of the stock Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Relationship • Between the price of a stock and the conversion value of the bond Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Value of a Convertible Bond as Debt • The investment value of a convertible bond • Model for the valuation of a bond Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Value of a Convertible Bond as Debt Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Minimum Price • Minimum price of the bond combines – the value of the bond as stock and – the value as debt Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Minimum Price Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Actual Price of a Convertible Bond Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Premiums • The premiums paid over – The bond's value as stock – The bond's value as debt Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
The Premiums Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Breakeven Analysis • Determines how long the convertible bond's interest advantage covers the premium over the bond's value as stock Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Convertible Preferred Stock • The features associated with convertible bonds apply to convertible preferred stock • Except – the instrument is equity – lacks the safety associated with debt Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Put Bonds • The investor has the option to sell the bond back to the issuer • The option is exercised if interest rates rise • The put feature reduces – interest rate risk – reinvestment rate risk Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
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