Straight bond value greater than conversion value

Straight bond value priƓ

less than conversion value

As shown, the minimum, or floor, value of a convertible bond is either its straight bond value or its conversion value, whichever is greater.

convertible is most significantly influenced by the underlying value as straight debt. However, when the value of the firm is very high, the value of a convertible bond is mostly determined by the underlying conversion value. This is also illustrated in Figure 14.3.

Option Value The value of a convertible bond will always exceed the straight bond value and the conversion value unless the firm is in default or the bondholders are forced to convert. The reason is that holders of convertibles do not have to convert immediately. Instead, by waiting, they can take advantage of whichever is greater in the future, the straight bond value or the conversion value.

This option to wait has value, and it raises the value of the convertible bond over its floor value. The total value of the convertible is thus equal to the sum of the floor value and the option value. This is illustrated in Figure 14.4. Notice the similarity between this picture and the representation of the value of a call option in Figure 14.2, referenced in our earlier discussion.

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