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Consider a convertible bond as follows: par value = $1,000; coupon rate = 9.0% market price...

Consider a convertible bond as follows: par value = $1,000; coupon rate = 9.0% market price of convertible bond = $1,000 conversion ratio = 37 estimated straight value of bond = $500 yield to maturity of straight bond = 18.1% Assume that the price of the common stock is $20 and that the dividend per share is $0.75 per year. Answer the below questions.

(a) Calculate each of the following (1) conversion value, (2) market conversion price, (3) conversion premium per share, (4) co nversion premium ratio, (5) premium over straight value, (6) favorable income differential per share, and (7) premium payback period.

(b) Answer the below questions if the price of the common stock increases from $20 to $40. What will be the approximate return realized from investing in the convertible bond?

Solutions

Expert Solution

1) Conversion value = Stock price * Conversion ratio

Conversion value = $20 * 37

Conversion value = $740

2) Market conversion price = Convertible security market price / Conversion ratio

Market conversion price = $1000 / 37

Market conversion price = $27.03

3) Conversion premium per share = Market conversion price - Market price per share

Conversion premium per share = $27.03 - $20

Conversion premium per share = $7.03

4) Conversion premium ratio = Conversion premium per share / Market price per share

Conversion premium ratio = $7.03 / $20

Conversion premium ratio = 0.3515 or 35.15%

5) Premium over straight value = Market price of bond - Straight value of bond

Premium over straight value = $1,000 - $500

Premium over straight value = $500

6) Favourable income differential per share = Coupon of bond per share - Dividend per share

Here

Coupon of bond per share = (Par value * Coupon rate) / Conversion ratio

Coupon of bond per share = ($1,000 * 9%) / 37

Coupon of bond per share = $2.43 per share

Dividend per share = $0.75 per share

Now,

Favourable income differential per share = $2.43 - 0.75

Favourable income differential per share = $1.68

7) Premium payback period = Market conversion premium per share / Favourable income differential per share

Premium payback period = $7.03 / $1.68

Premium payback period = 4.19 years

jeff jeffy answered 1 year ago
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