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In: Finance

You are thinking to buy some convertible notes or bonds for Marty’s fixed income portfolio. You...

You are thinking to buy some convertible notes or bonds for Marty’s fixed income portfolio. You recall that we discussed Tesla’s recent issue of 2% convertible notes due May 15, 2024. Each $1000 note is convertible into 3.2276 common shares, equal to an initial conversion price of $309.83 per share, and the notes are non-callable. For a while following the issue, Tesla shares were trading below $200 a share, but as of last Friday Dec 13 they were up to $358.39. Demand for the convertible notes has been brisk, and as of Friday, the notes traded at 134.605 % of par.

At that price, what is the premium over conversion value for each note?

Similar maturity non-convertible notes issued by Tesla are yielding 5.3%. At that yield, what is the straight investment value of the notes? What is the current premium over investment value for each note?

Should we purchase the Tesla convertible notes for Marty’s portfolio? Why or why not?

Solutions

Expert Solution

Conversion ratio = 3.2276

Conversion value = Conversion ratio x current share price = 3.2276 x 358.39 = $ 1,156.74

Current price of the convertible bond = 134.605 % of par = 134.605 % x 1,000 = 1,346.05

Hence, the premium over conversion value for each note = Current price of the bond - conversion value = 1,346.05 - 1,156.74 = $ 189.31

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I have calculated the clean price of the straight bond using the PRICE function of excel. Please see the formula below:

The straight investment value of the notes = $ 801.24

The current premium over investment value for each note = Current price of the bond - price of the straight bond = 1,346.05 - 801.24 = $ 544.81

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We should not purchase the Tesla convertible bond for Marty's portfolio:

  • The bond is available expensive
  • The bond is trading at premium to conversion value
  • The bond is trading at significant premium to straight bond of similar yield
  • The bond is therefore over priced i.e. over valued.
  • The potential for further price rise is limited
  • We should therefore not invest in this bond

jeff jeffy answered 5 months ago
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