Question

Your company needs funds for expansion and decides to issue a 5-year convertible bond. The stock price currently is $40 and your banker recommends a 25% conversion premium over the current stock price. Using option models the total option value of the convertible is found to be $89.83 per $1,000 face amount of bond. The company’s current cost of regular 5-year debt is 4%, assuming semi-annual interest payments. The stock does not pay a dividend.

1. How many shares will each $1,000 bond convert?
   1.   25
   2.   40
   3.   20
   4. 100
2. What is the exercise or conversion price of each option of stock embedded in the convertible?
   1. $25
   2. $40
   3. $48  
   4. $50

Answer 1

PART a-

option (c) i.e 20 shares is the correct answer

Shares to be issued for $1000 bond = Bond value ÷ Price per converted share

Shares to be issued = $1,000 ÷ ($40 * 1.25)

Number of shares to be issued = 20 shares

PART b-

option (d) i.e $50 is the correct answer.

Conversion Price of each stock option = Price at which the conversion will be exercised

= Current market price per share *(1+conversion premium)

= $40 * (1 + 0.25)

=$50 per option

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