this is Q-Bank 9720 For a convertible bond, which of the following is least accurate? A) The issuer can decide when to convert the bonds to stock. B) A convertible bond may be putable. C) A convertible bond may be callable. D) The conversion ratio times the price per share of common stock is a lower limit on the bond’s price. ---- A is obviously incorrect, but what about D? I thought the lower bound of a CB is the underlying straight value of the bond? Am I missing somthing?
D’s correct. if the bond broke the conversion ratio. there would be an arbitrage opportunity. buy the bond then convert to stock. i could be blowing smoke. am I?
the lower bound is the higher between the conversion value and the straight value of the bond
I think, but I am not certain, that the lower limit is the higher of the two. If the conversion value is 900, but the straight value is 850, the lower limit is 900 because it can be converted at that price. edit: florinpop too fast . . .
Min value of the convertible bond must be greater of it;s CONVERSION value or it’s STRAIGHT value, where CONVERSION value = P0*conversion Ratio. So D is 100% correct and ! is 100% false. The conversion option lies with the holder edit: florinpop too fast . . .
yeah pretty straight forward concept - I think the confusion for me lies around the “is a” lower limit - not “the” lower limit
Hmmm I thought with a convertable bond it was the bond holder who had the option.
^^^ it is the bondholder who has the option…hence A is the “least accurate”
i think A too… i think the conversion value is the lowest limit. curious as to straight value being another lowest limit. but for sure conversion value shouldn’t be breached.
there is such a thing as a forced conversion, but I think for this question’s purpose, A is the best answer.
I think “forced conversion” is a misnomer. To my knowledge, there aren’t convertibles out there that give the issuer the right to force bondholders to convert to equity when the equity is below the conversion price. That would be worse than owning convertible preferred because if the company started having problems, you would end up with equity and a busted convert would be just icky equity. “forced conversion” usually means the bond is callable and the issuer calls it when the equity is above the conversion price. You don’t have to convert, but every rational investor would.
not sure about forced conversion… but can’t some bonds call/redeem in stock… of course, probably no relevence for question.
I agree with dinesh… interest rate rise then the STRAIGHT value will drop meaning the conversion option becomes more valuable. Be careful of the perfect storm where the interest rates are falling AND the stock price is falling. In this case the conversion value and straight price do not protect the bond holder against downside risk.
So is D correct. It looks like we’ve decided A is incorrect as well.
So is D the right answer? It looks like we’ve decided A is incorrect as well.