Value of the Convertible Bond as a Hybrid Security

In between these extreme stock prices, convertible security is usually negotiated at premium price over its equity value and above its debt value.

The conversion ratio used is of 40 shares for each convertible bond of 6% and 20 years till maturity. The market rate of interest (or required rate of return) used is 8%. Prices of a convertible bond can also be determined by using excel software.

The value of conversion as stock is determined by using the following equation:

Conversion value = price per share of common stock X conversion ratio

In occasions when stocks have a low price ($5 and $10 per share), the price in the market of convertible bonds will be the same as its straight debt value, and premium over stock price will be large

At $25 per share, the price of conversion, the market price for convertible will be of $1020 which exceeds the value of the debt  (in $216.41) as well as the value as stock (in $20).

At a high and significant stock price of $40 for this company, the market price of convertibles is the same as its value as stock, and premium over debt value is too high ($796.41). This example illustrates that when stock prices increase, the paid premium over the value of convertible bond as straight debt also increases.

This increase in premium happens because of the importance the conversion feature has over convertibles, and because of the fact that straight debts become somewhat less important in periods in which stock prices increase.

There is also the possibility for the bond to be called, which would force to conversion when stock prices are higher than conversion price.

Let’s imagine, for example, that convertible bonds were bought at $1410 and the company calls in the bonds when stock prices are being negotiated at $35. Convertible bondholders would not turn in their bonds for $1000 per bond, on the contrary, they would convert them in equity, receiving  $1400  per bond (40 x $35) instead, which ends up in a $10 per bond loss for the bondholder.  

On the other hand, when stock prices go up, a downward pressure is exerted in premium over stock prices, and the market price for convertibles converge with the convertibles stock value.

Most convertible securities are negotiated at premium over stock value or its value as straight bond.

Beginner Money Investing Convertible Bonds The Value of Convertible Bonds as Stock Value of the Convertible Bond as Debt Value of the Convertible Bond as a Hybrid Security Risk of Convertible Bonds, Purchase and Sale The Advantage of Convertible Bonds Disadvantages of Convertible Securities What the Conversion Premium of Discount Means