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Consider a corporate bond with an embedded conversion option. If both the share prices of the...

Consider a corporate bond with an embedded conversion option. If both the share prices of the company and interest rates are falling, would it be a good or bad idea to exercise the conversion option? Discuss the reason(s).

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Answer #1

If both the share price and the interest rates are falling, since I am a conservative investor, I would not be converting my bonds because of following reasons -

A. Conversion will lead to having lower value of my overall shares.

B. Conversion will also lead to getting stuck with the falling shares and there is probability that they can fall More

C. Bonds are more safer in nature and at least I will have the security of repayment of my capital

D. Bonds are having a fixed rate of payments even though the interest rates are falling, so it would in fact make my bonds more attractive

In these scenarios, because of these conditions I would not be exercising my conversion option as they will lead to reduction in the overall value of my holdings, so I would be rather sticking with my bond holdings then going for share conversion

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