An investment company recently issued convertible bonds with a $1,000 par value.

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

1) Calculate the convertible issue's conversion ratio = 1000/25 = 40

2) No change. as the price of the stock is below the conversion price, making the call option in the bond unexerciseable.

3) 40 shares * 35 per share = 1400.00

4) liability goes down by 1000. equity increases by 1000.

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