2.2 Analytics of convertibles and structured convertibles Conversion premium and break-even calculations Decomposition of convertible value into different components bond plus warrant plus default risk put plus stock plus yield advantage Interest rate sensitivities - duration Lattice tree calculations: incorporation of default risk, call and conversion rights Structured convertibles Mandatory convertibles (performance based conversion premium, parallel debts Exchangeables convertible stock notes Debt exchangeable for common stock
1 2.2 Analytics of convertibles and structured convertibles • Conversion premium and break-even calculations • Decomposition of convertible value into different components - bond plus warrant plus default risk - put plus stock plus yield advantage • Interest rate sensitivities – duration • Lattice tree calculations: incorporation of default risk, call and conversion rights • Structured convertibles - Mandatory convertibles (performance based conversion premium, parallel debts) - Exchangeables - convertible stock notes - Debt exchangeable for common stock
Premium for conversion right An investor who purchases a convertible bond rather than the underlying stock typically pays a premium over the current market price of the stock Why would someone be willing to pay a premium to buy this stock? The market conversion premium per share is related to the price of a call option limit the downside risk of the convertible bond
2 Premium for conversion right • An investor who purchases a convertible bond rather than the underlying stock typically pays a premium over the current market price of the stock. • Why would someone be willing to pay a premium to buy this stock? The market conversion premium per share is related to the price of a call option – limit the downside risk of the convertible bond
Analytics of convertible bonds stock price $30.00 per share stock dividend $0. 50 per share convertible market price $1000 coupon rate 7.00 maturity 20 years conversion price $36.37 Stock dividend yield= annual dividend rate current stock price =$0.50/$30.00=1.67%
3 Analytics of convertible bonds stock price $30.00 per share stock dividend $0.50 per share convertible market price $1,000 coupon rate 7.00% maturity 20 years conversion price $36.37 Stock dividend yield = annual dividend rate / current stock price = $0.50 / $30.00 = 1.67%
Conversion ratio number of shares for which one bond may be exchanged par/ conversion price =$1,000/$3637=27.50 shares Conversion value equity value or stock value of the convertible stock price x conversion ratio =$30.00x27.50=$82500
4 Conversion ratio = number of shares for which one bond may be exchanged = par / conversion price = $1,000 / $36.37 = 27.50 shares Conversion value = equity value or stock value of the convertible = stock price x conversion ratio = $30.00 x 27.50 = $825.00
Conversion premium (convertible price-conversion value) conversion value ($13000-$825)/$825.00=21.21% Dollar premium convertible price-conversion value(expressed in points) ($12000-$825)/$1,000×100% 17.50 points
5 Conversion premium = (convertible price – conversion value) / conversion value = ($1,000 – $825) / $825.00 = 21.21% Dollar premium = convertible price – conversion value (expressed in points) = ($1,000 – $825) / $1,000 x 100% = 17.50 points