33:390:400 Lecture Notes - Lecture 9: Debenture, Agency Cost

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limeherring262

11 May 2018

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Chapter 24: Convertible Bonds

Convertible Bond: Gives the bond holder the right to exchange it for a given # shares of stock at

any time up to and including the maturity date of the bond

Conversion Ratio: The number of shares received per bond

Conversion Price: (Face Value of the Bond ~ usually $1,000) / (Conversion Ratio)

Conversion Value: (Conversion Ratio) x (Stock issue price)

Conversion Premium: [ (Conversion Price / Actual C/S Price) – 1 ] = x%

Ex: 11/01/06 - Company raises $1mm in 6.75% convertible subordinated debenture due in 2022.

- Stock price on issue date was $22.625

Face Value of bond: $1,000

Promised $33.75 interest every 6 months; 6.75% / 2 = 3.375%

6-month interest rate on straight A rated bonds was 4%

Conversion Ratio: 23.53 shares per bond

Conversion Price: ($1,000) / (23.53 shares per bond) = $42.50

Conversion Value: (23.53 shares per bond) x ($22.625) = $532.37

- This is what the bonds would be worth if immediately converted into C/S

Conversion Premium: [ ($42.50/$22.625) – 1] = 87.8%

- The conversion price is 87.8% higher than the actual C/S price

The Value of Convertible Bonds

3 components to value a convertible: Straight bond value, Conversion value, option value

1. Straight Bond Value

- What the convertible bonds would sell for if they couldn’t be converted into C/S

- The PV of bond payments assuming the bond is never converted

Straight Bond Value = Discounting semiannual coupon payment and principal @ 4%

- To the 32nd b/c 16 years (2006 – 2022), so 32 semiannual payments

The straight bond value is a minimum value. The price of the convertible bonds could not go

lower than the straight bond value

- Straight Bond alue depends on firm value:

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2. Conversion Value

- What bonds would be worth today if they were immediately converted into C/S @ P0

- A convertible bond cannot sell for less than its conversion value

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Document Summary

Promised . 75 interest every 6 months; 6. 75% / 2 = 3. 375% 6-month interest rate on straight a rated bonds was 4% Convertible bond: gives the bond holder the right to exchange it for a given # shares of stock at any time up to and including the maturity date of the bond. Conversion ratio: the number of shares received per bond. Conversion price: (face value of the bond ~ usually ,000) / (conversion ratio) Conversion value: (conversion ratio) x (stock issue price) Conversion premium: [ (conversion price / actual c/s price) 1 ] = x% Ex: 11/01/06 - company raises mm in 6. 75% convertible subordinated debenture due in 2022. 3 components to value a convertible: straight bond value, conversion value, option value: straight bond value. Conversion price: (,000) / (23. 53 shares per bond) = . 50. Conversion value: (23. 53 shares per bond) x (. 625) = . 37. Conversion premium: [ (. 50/. 625) 1] = 87. 8%

Related Questions

An investment company recently issued convertible bonds with a $1,000 par value. The bonds have a conversion price of $25 a share. At the time of issue, the company's underlying stock price is $20.

a. Calculate the convertible issue's conversion ratio?

b. After issuance, will the bond likely increase, decrease, or not change in value if the underlying stock price changes to $23 per share and everything else remains constant? Why?

c. The bondholder converts the bond to common stock when the price of the underlying stock reaches $35. What is the total market value of the new shares?

d. How does the company's balance sheet change at the point the bondholders convert their bonds to common stock? Explain?

e What are 3 advantages to the investor in buying convertible bonds instead of the stock itself?

lemonsnail127

ou are the CFO of RealNetworks on Julyâ 1, 2008. Theâ company's stock price is $9.74 and its convertible debt is now callable. See the tableâ below:

Convertible Subordinated Notes
Issued under U.S. SEC Rule 144A
Aggregate principal amount	â$100 million
Proceeds net of offering costs	â$97.0 million
Coupon	â0%
Conversion ratio	107.5650 shares per $1,000 principal amount
Call date	Julyâ 1, 2008
Call price	â100%
Maturity	Julyâ 1, 2010

a. What is the value of the shares the bondholders would receive per $1,000 bond if theyâ convert?

b. What is the value per $1,000 bond they would receive under theâ call?

c. If you call theâ bonds, will the bondholders convert into shares or accept the callâ price?

sapphirecockroach774

Prospect Corporation is a venture capital company.It was incorporated and listed on the GrowthEnterprise Market (GEM) four years ago.Since incorporation, the company has been rather successful and its shares are currently trading at $4.5 per share.

Apart from ordinary shares, Prospect has issued 8% convertible bond, redeemable in 2020.The face value of the convertible bond is $1,000, with coupons payable semi-annually and a conversion price of $5.Conversion may take place at any time over the next two years. Current market price of Prospectâs convertible bond is $950.Yield to maturity of coupon bonds of a similar risk profile is 10%.

Assume now is the end of 2010 and bond interest has already been paid.The board of directors expect Prospectâs share price to rise at 12% per year.No dividend is anticipated for coming two years.

(a)As a holder of Prospectâs convertible bond, which of the following actions would you choose to maximize the value of your investment?Explain your decision with a comparison of payoff from each action.

(i) Hold the bond until maturity

(ii) Sell the bond immediately

(iii) Convert the bond to shares now

(iv) Convert the bond at the end of second year.

(b)Explain the differences in payoffs from actions (i), (ii) and (iii).

(c)What are the factors to be considered when using convertible bond as a way of raising finance?

mauvebear267

33:390:400 Lecture Notes - Lecture 9: Debenture, Agency Cost

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