You buy a convertible bond for a company that makes razor wire, because that’s something that people want for Christmas, for some reason..
You give it to your wife. Eh...the bond, that is. This bond is worth $1,000, and it's convertible for 50 shares of stock in the razor wire company.
Let's say the stock is trading at $15 per share. You wouldn't want your wife to convert that bond to stock, since it would only give her 50 shares worth $750 in total. At the minimum, she should want to sell the bond when the stock is trading at $20. That’s because she would get 50 shares worth $20 each at the price of the bond = $1,000.
That threshold, where the price of the bond is equal to the price of shares times the redeemable number of shares...is called the conversion parity price.
Related or Semi-related Video
Finance: What are Convertible Bonds?9 Views
Finance a la shmoop what are convertible bonds? okay there's a joke about the
Inquisition in here somewhere or maybe something about Cossacks and 17th
century Russia what do you think animated musical or maybe a King Henry [King Henry VIII appears]
thing but yeah all that's different kind of conversion way more pedantically a
company might be having a hard time selling or issuing its bonds to Wall [Man with company briefcase for head meets man with Wall Street briefcase for a head]
Street in order for them to close the deal with their stock trading today at
25 bucks a share they might say well these bonds are convertible into 20 [Man with company for a head discussing bonds]
shares of our stock that is they would have a single thousand dollar unit of
that bond and it would convert into 20 shares which would then value the shares
at 50 bucks either thousand divided by 20 there's 50 it's an advanced calculus
sorry if you didn't have it which would sort of be you know the over/under price
at which bondholders would start to seriously look at converting their nice
safe bonds into those risky pesky equities well why would a company offer
convertible bonds instead of you know just vanilla bonds well if they were [Man discussing convertible bonds]
stuck paying 6% interest on just bonds but really could only afford to pay 4%
well they might get the interest rate discount by throwing in that equity
kicker in the bonds having that convertibility feature yes they would
suffer dilution at 50 bucks a share but that price is double and change where
the stocks out here so the company is probably thinking that it wouldn't mind
some dilution from these bonds being converted up there in stock price right [Arrow points to stock value mark on graph]
and remember the bonds pay the 4% interest along the way until they are
converted the moment those bonds are converted into equity well then the debt
on the balance sheet of the company and its obligation to pay that 4% yearly [Company balance sheet and interest highlighted]
interest goes mercifully away they print 20 more shares for each bond converted
and yes those shares may pay a dividend but as far as the convertible bonds go
they are thereafter converted and saved and remember Jesus Saves but Moses
invests
Up Next
What is convertible debt? Convertible debt is a type of bond that’s issued by a corporation. Ownership of these bonds means that the holder has t...
What is a Busted Convertible? A busted convertible is a convertible bond that will never be converted to stock because the underlying stock price i...