Floor Value Convertible Bond

It is calculated assuming that the holders take cash on redemption rather than convert.

Floor value convertible bond.

While the rewards are not as great the risks are less. Convertible bonds are a hybrid debt instrument issued by a corporation that can be converted to common stock at the discretion of the bondholder or the corporation once certain price thresholds are achieved. It is the lowest market value that the bond can have. The lowest value that convertible bonds can fall to given the present value of the remaining future cash flows and principal repayment.

Convertible bonds are safer than preferred or common shares for the investor. They provide asset protection because the value of the convertible bond will only fall to the value of the bond floor. The floor value of the convertible bond is the lowest value to which the bond can drop and the point at which the conversion option. The convertible bond will outperform the company s stock when the stock declines in value because the convertible has a price floor equal to the straight bond value.

Issued a convertible bond with a 1 000 face value that pays 4 interest. To estimate the bond investment value one has to determine the required yield on a non convertible bond. A technology company issued 100 million in convertible bonds on 1 january 20x1 with a maturity date of 31 december 20y5. Bond investment value value as a corporate bond without the conversion option based on the convertible bond s cash flow if not converted.

Convertible bonds have a floor value which makes it very unlikely the investor will lose money on them. The value of these payments represents a convertible bond s floor or minimum value. However in reality if stock price falls too much the credit spread will increase and the price of the bond will go below the bond floor. Usually bond holders will be expecting to convert because they are expecting that the shares will be worth more than the cash alternative and so you would usually expect the actual market value to be higher than the floor value.

The bond has a maturity of 10 years and a. The bond floor is the value at which the. It should trade for at least its floor value regardless of how low the stock drops. The convertible bond will underperform the company s stock when the stock appreciates significantly because the investor paid a conversion premium on the convertible bond.

Conversion premium current bond price max cv bv where cv stands for conversion value and bv stands for bond value without the conversion feature i e. Example of a convertible bond. As an example let s say exxon mobil corp.