The conversion value is the minimum price a convertible bond should sell for when evaluating it from an equity perspective. The conversion value is calculated by multiplying the stock price by the conversion ratio, which is the number of shares received per bond. This premium reflects the value investors place on the convertible bond apart from its role as an interest-bearing, fixed-income security.Ī convertible bond’s conversion value represents what the convertible bond is worth if it is converted into stock. The difference between a convertible bond’s market price and its investment value is the investment premium. Most convertible bonds sell for more than the investment value. This investment value is a floor below which the convertible bond price rarely falls. How Convertible Bonds Are Analyzed and PricedĬonvertible bonds have a fixed income component and equity component consisting of an option that gives a holder the right, but not the obligation, to convert the bond into stock.Ĭonvertible bonds can be analyzed by separately evaluating the bond component and the equity component relative to the convertible’s market price.Ī convertible bond’s investment value is its intrinsic value based on the bond’s fixed-income characteristics, such as prevailing interest rates, including the yield on the issuer’s nonconvertible bonds. The higher conversion ratio compensates the convertible bondholder for corporate events that increase the number of stock shares or puts downward pressure on the company’s stock. Most convertible bond issues contain a provision that increases the conversion ratio if the company pays a cash or stock dividend, issues additional stock shares, or there is a stock split. The bond issue’s prospectus details the conversion ratio and other conditions that must be met for the bond to be converted into stock. The conversion ratio is the number of common stock shares the bondholder will receive in exchange for the bond’s par value. Convertible bonds that cannot be called usually have shorter maturities than those that can be called.Ĭonvertibles are distinct from traditional bonds because the convertible bondholder has the option prior to the bond’s maturity to exchange the bond for a fixed number of common stock shares. Some convertible bonds can be redeemed or called early by the issuer, but the trend over the last decade is for most convertible bonds not to have a call feature. On the maturity date, the bond’s par value, which is generally $1,000, is returned to the bondholder if the bond wasn’t converted into common stock. Similar to traditional bonds, convertibles pay interest, usually semi-annually, based on the coupon rate. ![]() “Convertibles capture more return on the upside than on the downside.” – Michael Youngworth, CFA, Vice President, Equity Derivatives Research at Bank of America Merrill Lynch To delay the conversion, the stock price at which conversion makes economic sense for the convertible bondholder is typically at least 20% higher than the stock price when the convertible bond is issued. ![]() Unless total earnings increase, when a company issues more stock shares, earnings per share could go down.Įventually, when the convertible bonds are converted into stock, additional shares will be issued that dilute the common stock shareholders. More common stock requires total earnings and dividends to be divided among more shares. Dilution means more common stock shares are outstanding, lowering the ownership percentage of each share. Using convertible bonds, a company can issue debt at a lower interest rate because investors get the protection of a senior debt security combined with the opportunity to participate in the company’s growth if its stock price increases.Ĭompanies also issue convertible debt so they don’t have to go through the time-consuming process of having the bond issue rated by a credit rating agency.įinally, convertible bonds allow companies to raise capital without immediately diluting existing common stock shareholders. This feature is attractive to companies with growing revenues that have yet to turn a profit.ĭefault risk is elevated for a company suffering losses, so bondholders demand higher interest rates. Companies choose to issue convertible bonds because the interest rates are lower than on nonconvertible debt.
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