Financial Decision Making & Risk Management

1

Name: Manoj Kumar Reddy Koluguri

Westcliff University

Date:03/28/21

Maple Aircraft has issued a 4¾% convertible subordinated debenture due 3 years from now. The conversion price is $47.00 and the debenture is callable at 102.75% of face value. The market price of the convertible is 91% of face value, and the price of the common is $41.50. Assume that the value of the bond in the absence of a conversion feature is about 65% of face value. 

Answers:

d. In the absence of the conversion feature,what is the current yield and yield to maturity ? Current Bond Trading Price ($) = P = 91% = $910

Bond Face Value/Par Value ($) = F= $1000

Years to Maturity = n = 3

Annual Coupon Rate (%) = C = 4.75%

Coupon Payment Frequency: Annually

The current yield is calculated using the equation

Annual Interest Payment= 0.0475 X $1000 = $47.5

Current yield = Annual Coupon / Interest Payment Current market price of the bond = [(0.0475 X $1000)] X (100%) = 5.22%

Yield to Maturity is defined as: “The yield to maturity (YTM) is that discount rate which causes the present value of the promised payment stream to equal the current price of the bond.” ("Yield to Maturity - QS Study", 2021). “Yield to maturity = {Coupon rate + (Face value – Purchase price/years until maturity)} / {Face value + Purchase price/2}.” ("Yield to Maturity - QS Study", 2021).

Yield to Maturity is defined as in the photo below:

So YTM = (C + (F - P) / n) / ((F + P) / 2)

In the same time, the equation of the current yield is “dividing the annual coupon payment by the bond's current market value.” (Bloomenthal, 2021).

Current Bond Trading Price ($) = P = 91% = $910

Bond Face Value/Par Value ($) = F= $1000

Years to Maturity = n = 3

Annual Coupon Rate (%) = C = 4.75%

Applying the calculator, we find that Yield to Maturity x 100 = 8.259%

e. What is the conversion ratio of the debenture?

To solve this, we need to know the conversion ratio. “The conversion ratio is the number of common shares received at the time of conversion for each convertible security.” (Bloomenthal, 2021).

Conversion ratio =

face value of the bond conversion price = 1,000/47 = 21.28

f. If the conversion ratio were 50, what would be the conversion price?

“The conversion price is equal to the face value of the bond divided by the conversion ratio.” (understanding convertible bonds, 2021)

Conversion price =

Face valueconversion ratio = 1,000/50 = $20

g. What is the conversion value?

Conversion value =

conversion ratio market share price =

21.28 X $41.50 = $883.12

h. At what stock price is the conversion value equal to the bond value?

Stock price = bond value conversion ratio = $650/21.28 = $30.55

i. can the market price be less than the conversation value?

No, in the case that the investor can convert as soon as possible.

J. How much is the convertible holder paying for the option to buy one share of common stock

Value of the conversion option for each share equals the difference between the price of the convertible bond and the price of the straight bond to conversion ratio = (910 – 650)/21.28 = $12.22

K. By how much does the common have to rise after three (3) years to justify conversion?

To solve that we use the following equation:

(Conversion price to the price of the common) - 1 = (47/41.50) - 1 = 0.1325 and in percentage 13.25%

The conversion value equals or larger than the face value

21.28 x (41.50 x 1.1325) = 1000

Bibliography

Allianz global investors. (2021). understanding convertible bonds[Ebook]. Retrieved from http://hk.allianzgi.com

BLOOMENTHAL, A. (2021). Current yield vs yield to maturity. Retrieved 28 March 2021, from https://www.investopedia.com/ask/answers/072915/what-relationship-between-current-yield-and-yield-maturity-ytm.asp

Yield to Maturity - QS Study. (2021). Retrieved 28 March 2021, from https://qsstudy.com/business-studies/yield-to-maturity