Characteristics, Uses and Taxation of Investments - Convertible Bond Mathematics
- Analysis and valuation of convertible bonds could fill volumes and actually do [Much has been written about convertible securities. Two volumes, in particular, explore both the basics and the arcana of these instruments. They come from the portfolio managers at Calamos Investments, an investment management firm with a focus on convertible bonds. Calamos, John P. CONVERTIBLE SECURITIES The Latest Instruments, Portfolio Strategies, and Valuation Analysis Revised Edition McGraw-Hill ,1998 and Calamos, Nick P. Convertible Arbitrage: Insights and Techniques for Successful Hedging John Wiley & Sons, Inc. 2003]. For the purpose of the Certified Financial Planner ™ examination, a working knowledge of the basic traits, the mathematics of conversion and their suitability in a client portfolio is sufficient. Evaluation considers several factors, to wit:
- Price appreciation required of the underlying common stock of the issuer for conversion to be attractive. The conversion premium ration measures this.
- The growth prospects of the underlying common stock.
- The bond's downside potential should the underlying common stock's price be so low as to render the conversion privilege worthless.
- The yield sacrifice required to purchase the convertible.
- The income advantage to acquiring the convertible bond rather than the quantity of shares of the underlying common stock that would be obtained upon conversion.
- The quality of the bond and the underlying stock, both of which are, in turn, a function of the quality of the issuer.
- The breakeven time which is the number of years over which the premium paid to acquire the convertible will be recovered through what the bondholder expects to be the favorable income differential offered by the convertible bond relative to the underlying common stock.
- Formulae: better than committing them to memory alone is an understanding of how and where they figure in the analytical and valuation process. Therefore, a detailed example is provided to bring these concepts together and reinforce them.
Information on the Globotron Meganet (GMN) 5 ¾ % Convertible Bond Due in 9+ Years and Common Stock
|Coupon rate||5 ¾ %|
|Current market price||$106.5|
|Conversion Ratio||25.320 shares of ADC/$1,000 par value|
|Non-callable for||three years|
|Maturity Date||9+ Years|
|Call Price Schedule|
|In Year 4||103.59|
|In Year 5||102.88|
|In Year 6||102.16|
|In Year 7||101.44|
|In Year 8||100.72|
|In Year 9||100.00|
|In Year 10||100.00|
|ADC Common Stock|
|Current dividend yield||2.727%|
|Dividend Per Share||$0.90|
Conversion Ratio: the number of shares of common stock that the investor receives from exercising the call option. The ratio may be valid for all or a portion of the bond's life and the ratio itself may change. It is adjusted proportionately for stock splits and stock dividends. ADC Conversion ratio: 25.32 shares
(Stated) Conversion Price: par value/conversion ratio. ADC's conversion price: $1,000/25.32 shares = $39.49
Conversion (parity) Value: conversion value = market price of common stock x conversion ratio. This formula determines the value of the security if immediately converted. Callable and Foreign Bonds and Promissory Notes
InvestingWhile stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
RetirementWe discuss the advantages of seeking professional help when it comes to managing our retirement account.
Personal FinanceWhile there’s still potential for some “tweaking” around your Social Security retirement benefits, I’d like to share some insight on what we know now.
Chart AdvisorThere has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
EntrepreneurshipLearn how a complete risk management plan can minimize or eliminate your financial exposure through insurance and prevention solutions.
Investing BasicsA diversified portfolio will protect you in a tough market. Get some solid tips here!
EntrepreneurshipThere are a lot of risks associated with running a business, but there are an equal number of ways to prepare for and manage them.
Active TradingIt's impossible to avoid disaster without trading rules - make sure you know how to devise them for yourself.
Trading StrategiesReduce position size by 50% to 75% in a flat market.
Credit & LoansIf you are seeking a personal loan, be aware of these pitfalls before you proceed.
The excess return that investing in the stock market provides ...
The amount of risk that an insurance company retains after subtracting ...
Coverage that provides financial protection to investors, financial ...
The maximum loss from a peak to a trough of a portfolio, before ...
The absolute level of a fund's investments.
A technique used by insurance companies to calculate loss reserves.
Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
Like all securities, mutual funds are subject to market, or systematic, risk. This is because there is no way to predict ... Read Full Answer >>
Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic ... Read Full Answer >>
While your auto insurance company cannot pull your full motor vehicle report, or MVR, it does pull a record summary that ... Read Full Answer >>
While the majority of financial advisors work for financial institutions such as banks, a large proportion of them are self-employed ... Read Full Answer >>