An investment company recently issued convertible bonds with a $1,000 par value.
ID: 2653587 • Letter: A
Question
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?
Explanation / Answer
Conversion price of the bonds=$25.
At the time of issue underlying stock price=$20.
a. Convertible issues conversion ratio=$1000/$25. =40 shares.
Each bond is converted into 40 shares. therefore the ratio is 40:1.
Answer for point b:
The value of the bond will not change as the stock price is still less than the conversion price.
Answer for point c:
The bond holder convered the bondto stock when the price of the underlying sock is $35. It means that the 40 shares that he got after conversion would be valued at $35 per share. Total market value of the new shares=$35* 40 =$1,400.
Answer for point d:
When the bond holders converrt their bonds to common stock, the liabilities of the company reduces and the equity of the shareholders increases to that extent. This is because Bonds are liability to the company as it is debt that needs to be repaid, but when the same gets converted to stock, the equity of the share holderrs increases.
Answer for point e:
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