Hello,
convertible bond price = conversion price * conversion ratio.
Does this mean that as the conversion price (stock price paid) goes up, you have to pay more for the convertible bond?
So if the stock is $40 right now, we have to pay more for a $50 call instead of a $45 call?
This seems backwards to me…
Somebody save me from myself?
Convertable bonds are in how they behave a mixture of bonds and stocks. Conversion price is the price you pay for the stock, when you buy the bond and convert. It is usually above the normal market price of the stock, thus you can compute the corresponding premium. Your convertible bond has nice features such as the regular straight value of the bond that works as a (moving) floor and reduces your exposure to price decreases of the stock which justifies the premium.
But why would you pay a higher premium for a higher call price?
Not quite sure about what are you asking, but if the market conversion price (stock price paid via conversion) is more than the actual stock price, it’s a busted convertible and the convertible bond trades more like a fixed income security. Once the actual stock price increases, the bond will trade more like equity since it’ll be more attractive to convert.
Exactly, so wouldn’t the convertible bond price decrease to the straight value as the conversion price of the stock increases?
Yes, if the call option is way out-of-the-money, the straight value will serve as a floor on the bond’s price.