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101 Concepts for the Level I Exam

Essential Concept 69: Components of a Convertible Bond’s Value

There are a number of investment metrics and ratios that help analyze and value convertible bonds.

The conversion value indicates the value of the bond if it is converted at the market price of the shares.

The minimum value of a convertible bond is the greater of

  • The conversion value and
  • The value of the underlying option-free bond

The market conversion premium represents the price investors effectively pay for the underlying shares if they buy the convertible bond and then convert it into shares. Scaled by the market price of the shares, it represents the premium payable when buying the convertible bond rather than the underlying common stock.

Market conversion premium per share = market conversion price – underlying share price

Market conversion premium ratio = Market conversion premium per share / Underlying share price

Premium over straight value = (convertible bond price / straight value) – 1

Valuation of a Convertible Bond

Value of convertible bond = Value of straight bond + Value of call option on the issuer’s stock

Value of callable convertible bond = Value of straight bond + Value of call option on the issuer’s stock –Value of issuer call option

Value of callable putable convertible bond = Value of straight bond + Value of call option on the issuer’s stock – Value of issuer call option + Value of investor put option

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