Question

Suppose Disney issued a convertible (non-callable) bond with an annual coupon of 10% that matures in 5 years. The conversion ratio is 26.32 shares of stock per bond and Disney’s stock is currently trading at $30 per share. The convertible bond is priced at $900 in the market and the appropriate discount rate is 13%.

1. What is the Straight Bond Value of this convertible?
2. What is the Option Value of the Bond?
3. What is the Conversion Value of the Bond?
4. Based solely on today’s values, should you convert?

Answer 1

a

K = N

Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =5

Bond Price =∑ [(10*1000/100)/(1 + 13/100)^k]     +   1000/(1 + 13/100)^5

k=1

Bond Price = 894.48

Discount rate	0.13
Year	0	1	2	3	4	5
Cash flow stream	0	100	100	100	100	1100
Discounting factor	1	1.13	1.2769	1.442897	1.6304736	1.842435
Discounted cash flows project	0	88.49558	78.31467	69.30502	61.331873	597.0359
Price= Sum of discounted cash flows
Bond price =	894.48
Where
Discounting factor =	(1 + discount rate)^(Corresponding period in years)
Discounted Cashflow=	Cash flow stream/discounting factor

b

Conversion option value = Value of conversion bond-value of straight bond

Conversion option value = 900-894.48

Conversion option value = 5.52

c

Conversion value = Conversion ratio*current share price

Conversion value = 26.32*30

Conversion value = 789.6

d

Donot convert as conversion value is less than current price of bond