Question

What value do we assign to shares issued in a bond conversion?

Group of answer choices

Book value of shares.

Market value of bonds.

Market value of shares.

Book value of bonds.

Answer 1

Answer :

c) Market value of shares

Explanation for the answer :

A bond conversion is the process of changing a bond into shares. The number of shares that a bond can be converted into depends on the conversion ratio, while the conversion price determines the cost per share. Convertible securities are a way of raising capital in volatile debt and equity markets. The ability to convert bonds to stock is an attractive investment option, encouraging investors to buy in the hope that they can make a good return when the company’s value increases. The most common type of bond to be converted are convertible bonds. These are normal corporate bonds that have a predetermined number of shares that they can be converted into (this is the conversion ratio). The ability to change the bond into stock means that the bond holder could benefit from an increase in the underlying stock price. However, if the underlying stock performs badly, the investor won’t be able to convert the bond and will receive a smaller return. The bond’s maturity date prevents huge losses being incurred, but the bond holder is left in a far weaker position than investors with non-convertible bonds if the issuing company goes bankrupt. The success of the bond conversion relies heavily on the conversion price. If the shares don’t reach the conversion price, the bond cannot be converted. To make conversion more advantageous, investors usually set the conversion price higher than the current stock price, allowing for the share value to increase before the bond can be converted.

You can easily work out the conversion price of a bond using the conversion ratio:

Price of one share ÷ conversion ratio (number of shares one bond is equal to)

So if one share of stock costs £30 and the conversion ratio is 3, the conversion price is £30 ÷ 3 = £10.

The higher the conversion ratio, the lower the conversion price and vice versa.