www.safeecollege.com1 concept of valuation. 7. convertibles it is a financial security with call...
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Concept of Valuation
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7. Convertibles
It is a financial security with Call Option to buy shares, of the issuer.
Example:
• Compulsory Convertible Preference Share• Foreign Currency Convertible Bonds• Partly Convertible Debentures• Optionally Fully Convertible Debentures
Convertible Bonds
Bonds (Host Contract)
Call option to buy shares of the issuer.
(Embeded Contract)
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Pricing of Convertible Bond
Value of Bond Value of Call Option or a Stock
+
Value of a coupon paying bond.
Straight Value of a Bond
Use either Black Shole Model or Risk Neutral Approach.
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a) Conversion Price and Conversion Ratio :
A Convertible financial security either Conversion Price or Conversion Ratio or Both.
Conversion Price is a price per share at which conversion will take place.
Conversion Ratio is that total number of shares to be received after conversion of one Convertible Bond
Conversion Price = Face Value of Bond
Conversion Ration
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b) Conversion Value : It is a value of a convertible bond if it is converted into
shares.
CV = Current MPS × Conversion Ratio
The minimum Value of a Convertible bond should be Greater of two figures :
a) Conversion Valueb) Straight Value of Convertible Bond
(This is the value of a convertible bond as if there is no conversion feature)
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c) Market Conversion Price :
It is the market price per share if we buy one convertible bond in the market and then we convert into shares.
= MP of one Convertible bond
Conversion Ratio
d) Conversion Premium Per Share :
= Market Conversion Price × Current Market Price
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e) Market Conversion Premium Ratio :
Alternative 1
= Conversion Premium Per Share
Current MPS
Alternative 2
= Market Price of Convertible Bonds - Conversion Value
Conversion Value
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f) Premium Pay Back Period : (Break even time or Period)
= Market Conversion Premium per share
Favourable income differential per share
= Face Value of Bond × Coupon Rate
= Dividend Per Share × Conversion Ratio
Conversion Ratio
Premium pay back period does not consider Time Value.
My Income
Income of person buying only shares
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g) How to calculate Downside risk of a Convertible Bond :
Investor use Straight Value of the bond as a measure of downside risk and it is calculated as % of Premium over Straight Value of Bond.
= Market Price of Straight Value of
Convertible Bond - Bond
Straight Value of Bond