At maturity in seven years if the value of the shares

at maturity in seven years
•
If the value of the shares exceeds $100 million on or
anytime before maturity, investors may elect to
convert the bond and receive shares

Convertible Bond Component
Parts
Convertible Bond Component Parts
-3%
0%
3%
6%
20 22 24 26 28
-3%
0%
3%
6%
20 22 24 26 28
-3%
0%
3%
6%
20 22 24 26 28
Bond with 6% coupon
Call option on
$20 stock with $24
Call strike price
Convertible = +
Breakeven
price
Future share price
E conom icV a lue

Convertible Bond Example
• A company issues a $100 million convertible with a seven-year
maturity and a 3% annual coupon. Investors are given the right to
receive either $100 million repayment at maturity or, at their option,
give up receipt of this cash amount in exchange for receiving a
predetermined number of shares of the issuer’s common stock
• On the date of convertible issuance, the company’s stock price is
trading at $25, and the company agrees to a “conversion price” for the
convertible of $31.25, which is 25% above $25. This percentage is
called the “conversion premium,” because the conversion price is set at
a premium (in this case, a 25% premium) to the company’s share price
on the date of convertible issuance
•
The conversion price determines the number of shares that the investor
has the right to convert into. This determination is made by dividing
the total proceeds of the offering by the conversion price
•
The result, in this example, is $100 million / $31.25 = 3.2 million
shares

Convertible Example (cont.)
 Convertible investors, therefore, have a choice to make:
either take $100 million in cash at maturity or give up the
cash right in exchange for receiving 3.2 million shares
anytime at or before maturity
 If, for example, the issuer’s share price increases to $45 at
maturity in seven years, convertible investors might elect
to give up the right to receive $100 million in cash in
exchange for 3.2 million shares because the value of these
shares would be 3.2 million x $45 = $144 million
 In practice, most investors wait until maturity to make the
conversion decision due to the value of the options
embedded in the convertible, but they have the right to
convert earlier.

Zero Coupon Convertibles
 A Zero Coupon Convertible (ZCC) is similar to a coupon-paying convertible
except, instead of paying interest coupons each year, the issuer increases the
principal amount of the convertible by an amount equal to the unpaid coupon,
creating an “accretion” of the bond
 Although there are approximately the same number of underlying shares for a
ZCC and a coupon-paying convertible, and ZCCs’ unpaid coupons are “paid”
by increasing the principal amount of the convertible, a ZCC offers additional
benefits
 An issuer is able to receive tax deductions in relation to the annual accretion of
the convertible, creating a positive cash flow bond financing (no cash payments
for coupons, but tax deductions equal to the deductions the issuer would
receive if a coupon paying convertible had been issued)
 Also, there is a lower probability of conversion on the portion of the