PART FIVE Risk and Return

14.2 Because each bond can be exchanged for 100 shares, the conversion ratio is 100. The conversion price is the face value of the bond ($1,000) divided by the conversion ratio, or $1,000/100 = $10. The conversion premium is the percentage difference between the current price and the conversion price, or ($10 - 7)/7 = 43%.

The floor value of the bond is the greater of its straight bond value or its conversion value. Its conversion value is what the bond is worth if it is immediately converted: 100 X $7 = $700. The straight bond value is what the bond would be worth if it were not convertible. The annual coupon is $70, and the bond matures in 10 years. At a 12 percent required return, the straight bond value is:

Straight bond value = $70 X (1 - 1/1.1210)/.12 + 1,000/1.1210

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