Floor Value Convertible Bond

Convertible bonds can be an option for those who want to invest in the stock market but are worried about losing money.

Floor value convertible bond.

The value of a straight bond. However in reality if stock price falls too much the credit spread will increase and the price of the bond will go below the bond floor. It is calculated assuming that the holders take cash on redemption rather than convert. Example of a convertible bond.

A technology company issued 100 million in convertible bonds on 1 january 20x1 with a maturity date of 31 december 20y5. Convertible bonds have a floor value which makes it very unlikely the investor will lose money on them. The bond floor is the value at which the. Usually bond holders will be expecting to convert because they are expecting that the shares will be worth more than the cash alternative and so you would usually expect the actual market value to be higher than the floor value.

The bond has a maturity of 10 years and a. Floor value the floor value of a convertible bond is the greater of 1. The convertible bond will outperform the company s stock when the stock declines in value because the convertible has a price floor equal to the straight bond value. The lowest value that convertible bonds can fall to given the present value of the remaining future cash flows and principal repayment.

They provide asset protection because the value of the convertible bond will only fall to the value of the bond floor. As an example let s say exxon mobil corp. To estimate the bond investment value one has to determine the required yield on a non convertible bond. It is the lowest market value that the bond can have.

The value of these payments represents a convertible bond s floor or minimum value. Conversion premium current bond price max cv bv where cv stands for conversion value and bv stands for bond value without the conversion feature i e. Bond investment value value as a corporate bond without the conversion option based on the convertible bond s cash flow if not converted. Issued a convertible bond with a 1 000 face value that pays 4 interest.

The convertible bond will underperform the company s stock when the stock appreciates significantly because the investor paid a conversion premium on the convertible bond. Convertible bonds are a hybrid debt instrument issued by a corporation that can be converted to common stock at the discretion of the bondholder or the corporation once certain price thresholds are achieved. While the rewards are not as great the risks are less.