Concept of Valuation
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)
Pricing of Convertible Bond Value of BondValue 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.
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
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 Value b)Straight Value of Convertible Bond (This is the value of a convertible bond as if there is no conversion feature)
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
e) Market Conversion Premium Ratio : Alternative 1 = Conversion Premium Per Share Current MPS Alternative 2 = Market Price of Convertible Bonds - Conversion Value Conversion Value
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
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