Convertible Bond

The holder of a convertible bond may:

1. A.Vote as a shareholder while holding the bondUntil conversion actually happens the holder remains a creditor. Voting rights attach to the common shares and arrive only once the bond has been exchanged for them.
2. B.Force the company to be acquiredNo security in the capital structure gives its holder that power. A convertible grants a right to receive the issuer's shares, not any control over corporate transactions.
3. C.Demand double the par valueA bond entitles its holder to par at maturity, and the conversion feature offers shares in place of that par, not a multiple of it. Doubling face value is a payoff no indenture provides.
4. D.Exchange it for a fixed number of common sharesCorrect - conversion into equity.

Why: A convertible bond can be exchanged for a fixed number of the issuer's common shares.

A convertible bond's conversion ratio equals:

1. A.Par value divided by the conversion priceCorrect - shares per bond at conversion.
2. B.Coupon divided by priceThis is the current yield formula imported from a different topic. How much interest the bond pays says nothing about how many shares it turns into on conversion.
3. C.Price divided by parThis flips the fraction. Dividing a per-share conversion price into par is what yields a share count; running it the other way produces a fraction well below one, which cannot be a number of shares.
4. D.Market price times sharesMultiplying a share price by a share count produces a dollar amount, which is the conversion value of the bond rather than the ratio. The ratio is a count of shares and has to be known before that value can be computed.

Why: Conversion ratio = par value divided by the conversion price.

A convertible bond is convertible at $40 per share. The bond currently trades at $1,150. The parity price of the underlying stock is:

1. A.$25.00That is the conversion RATIO (number of shares), not a stock price.
2. B.$46.00Correct. 25-share ratio; $1,150 / 25 = $46 makes stock and bond values equivalent.
3. C.$28.75This divides 1,150 by the $40 conversion price, mixing up price and ratio.
4. D.$40.00That is the conversion price - parity only equals it when the bond trades exactly at par.

Why: Conversion ratio = $1,000 par / $40 = 25 shares. Parity stock price = bond market price / ratio = $1,150 / 25 = $46. Parity is the stock price at which conversion value equals the bond's market price. The clue: always derive the ratio from PAR, then divide the market price by it. Review: Equity and Debt Securities.

A convertible bond with a 1,000-dollar par and a 25-dollar conversion price converts into:

1. A.25 sharesThis lifts the conversion price out of the stem and reports it as a share count. The 25 is dollars per share and belongs in the denominator, not in the answer.
2. B.100 sharesThis would be the conversion ratio at a 10-dollar conversion price. At 25 dollars per share, 1,000 of par purchases 40 shares.
3. C.40 sharesCorrect - par / conversion price.
4. D.10 sharesThis implies a 100-dollar conversion price rather than the 25 given. Dividing par of 1,000 by 25 produces 40 shares, four times this figure.

Why: 1,000 / 25 = 40 shares.