Floor Value Convertible Bond

A technology company issued 100 million in convertible bonds on 1 january 20x1 with a maturity date of 31 december 20y5.

Floor value convertible bond.

The value of these payments represents a convertible bond s floor or minimum value. While the rewards are not as great the risks are less. The floor value of the convertible bond is the lowest value to which the bond can drop and the point at which the conversion option. To estimate the bond investment value one has to determine the required yield on a non convertible bond.

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 lowest value that convertible bonds can fall to given the present value of the remaining future cash flows and principal repayment. Convertible bonds are safer than preferred or common shares for the investor. 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.

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. Floor value the floor value of a convertible bond is the greater of 1. 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.

It should trade for at least its floor value regardless of how low the stock drops. The value of a straight bond. Issued a convertible bond with a 1 000 face value that pays 4 interest. As an example let s say exxon mobil corp.

It is the lowest market value that the bond can have. Example of a convertible bond. The bond floor is the value at which the. 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.

Convertible bonds have a floor value which makes it very unlikely the investor will lose money on them. It is calculated assuming that the holders take cash on redemption rather than convert. Bond investment value value as a corporate bond without the conversion option based on the convertible bond s cash flow if not converted.