A bond, for example, has a conversion ratio of 5, meaning that one bond can be exchanged for five shares of common stock. The price of the bond divided by the conversion ratio is the convertible security’s conversion price. If the bond’s par value is $1000, the conversion price is $200, which is found by multiplying $1000 by 5. The conversion price reduces to $100 if the conversion ratio is ten. As a result, for the security to be converted, the market price must catch up to the conversion price. A lower conversion ratio leads to a lower conversion price, whereas a greater conversion ratio leads to a higher conversion price.
What are some examples of convertible bonds?
Convertible bonds are frequently issued by companies with a poor credit rating but great development potential. The bonds provide more flexibility in terms of financing than traditional bonds. Convertible bonds may be more appealing to investors since they offer the possibility of future capital appreciation through stock price appreciation.
Vanilla convertible bonds
Convertible bonds of this type are the most prevalent. At the maturity date, investors are given the option to convert their bonds into a specific number of shares at a predetermined conversion price and rate. Vanilla bonds may pay coupon payments throughout the bond’s existence and have a predetermined maturity date at which investors are entitled to the bond’s nominal value.
Mandatory convertibles
Investors who buy mandatory convertibles are obligated to convert their bonds to shares when they reach maturity. In most cases, the bonds have two conversion prices. The first price would be the price at which an investor would receive the par value in shares in exchange for their money. The second price establishes a ceiling on the amount an investor can get in excess of the par value.
Reverse convertibles
Reverse convertible bonds allow the issuer the option of buying the bond back in cash or converting it to equity at a predetermined conversion price and rate at maturity.
Advantages of Convertible Bonds
Convertible bonds are a flexible financing option that has several benefits over traditional debt or equity financing. The following are some of the advantages:
Lower interest payments
Convertible bonds attract investors who are willing to accept lower interest payments than ordinary bonds. As a result, issuing corporations can reduce their interest payments.
Tax advantages
Convertible bonds allow the issuing company to benefit from interest tax savings that are not attainable with equity financing because interest payments are tax deductible.
Deferral of stock dilution
Convertible bond financing is preferable to equity financing if a company does not want to dilute its stock shares in the short or medium term but is prepared to do so in the long run. The current company’s shareholders keep their voting rights, and they may benefit from future capital gains in the stock price.
On a convertible bond, how do you calculate the premium?
The difference between the current stock price and the conversion price is known as the convertible bond premium, or conversion premium. The conversion premium is $5 if a convertible bond may be exchanged for stock at $50 per share and the current stock price is $45.
How can you figure out how much a convertible bond’s floor is worth?
Add 1 to the YTM of the non-convertible bond and divide by the number of times the convertible bond pays interest yearly. Divide 4.5 percent (0.045) by 2 to get 0.0225 in this example. To get 1.0225, multiply 1 by 1. Multiply the number of installments per year by the maturity period of the convertible bond.
What is the definition of a convertible bond fund?
Convertible bond portfolios are designed to provide some of the capital appreciation possibilities of stocks while also providing some of the safety and return of bonds. Convertible bonds allow investors to convert their bonds into stock at a predetermined price.
Identify the par value
Begin by calculating the convertible item’s par value. The face value of a stock or bond is represented by this number. The agreement for the majority of things specifies this.
Determine the conversion price
Determine the conversion cost. This is the cost of a single common share. This information should be included in the bond indenture for convertible bonds conversions. This information should be included in the securities prospectus for convertible preferred stock conversions.
Calculate the conversion ratio
You can compute the conversion ratio once you have the par value of your convertible item and the conversion price. Divide the convertible’s par value by the conversion price to get the conversion ratio. The number of shares the holder will receive is the result.
What’s the deal with convertible bonds?
- Convertible bonds are corporate bonds that can be exchanged for the issuing company’s common stock.
- Convertible bonds are issued by companies to cut debt coupon rates and defer dilution.
- The conversion ratio of a bond decides how many shares an investor will receive in exchange for it.
- Companies can force bond conversion if the stock price is higher than the bond’s redemption price.
What is the formula for EPS?
Divide the company’s total earnings by the total number of shares outstanding to get earnings per share.
On the income statement, total earnings equals net income. Profit is another name for it. On a company’s income statement, you can see net income and outstanding shares.
Apple, for example, reported earnings of $19.965 billion in the most recent quarter, with 4.773 billion shares outstanding. The quarterly EPS is calculated as follows: 19.965/4.773 = $4.18.
How do you determine the bond floor?
Calculate the present value (PV) of the coupon and principal payments discounted at the straight bond interest rate to find the bond floor. Even if the stock price of the company decreases, the convertible bond should sell for at least $884.18.
What is the formula for diluted EPS?
(net income preferred dividends)/(weighted average number of shares outstanding + conversion of any in-the-money options, warrants, and other dilutive securities) = diluted earnings per share