An investor purchases a 5.00% corporate convertible debenture with a par value of 1,000. T… — FINRA SIE (Securities Industry Essentials)

An investor purchases a 5.00% corporate convertible debenture with a par value of $1,000. The debenture has a specified conversion price of$ 40 per share. The underlying common stock of the issuing corporation is currently trading in the secondary market at $46 per share. If the convertible bond is trading in the market at a 5% premium to its parity value, what is the current market price of the bond in dollars?

Answer: 1207.5 $

Answer

The current market price of the bond is $1,207.50.

To find the bond's market price, first compute the conversion ratio:

1,000 par value divided by the

40 conversion price equals 25 shares. Next, find the bond's parity value by multiplying the 25 shares by the common stock's market price of

46, resulting in

1,150. Finally, apply the 5% premium to parity (

1,150 × 1.05), which yields the final bond market price of

1,207.50.

Step-by-Step Solution

Determine the conversion ratio

Conversion Ratio =

1,000 Par Value /

40 Conversion Price = 25 shares per bond

The conversion ratio establishes how many shares of common stock the bondholder receives upon converting one bond.

Calculate the parity value of the bond

Parity Value = 25 shares ×

46 Stock Price =

1,150

Parity occurs when the market value of the convertible security equals the total market value of the common stock into which it can be converted.

Apply the market premium over parity

Market Price =

1,150 × (1 + 0.05) =

1,207.50

Convertible bonds often trade at a premium to parity because investors pay extra for downside protection provided by the bond's senior claim and coupon payments.

Key Concept

Convertible Bond Parity Value and Market Premium Calculation

Question

Answer

Step-by-Step Solution

Key Concept

Common Mistakes

Topics

More questions from this topic