Convertible Bonds: Options Pricing Model Harvard Case Solution & Analysis

Convertible Bonds: Options Pricing Model Case  Solution  

Convertible Bonds

A convertible bond is a special type of bond that allows the holder option to convert the bonds to a pre-determined number of shares in the company before the maturity of the bonds. These bonds allow the issuing company to issue debt while easily maintaining the cash flow position of the company by performing well and persuading bond holders to convert their bonds to shares.

By using convertible bonds a company has the option to reduce negative interpretations by the investors regarding the company’s actions and financial position. An example of this could be that ifa company whose shares are already traded in public and it is listed in stock exchange, then it may want to issue stocks, which is seen by the market as an indication of overvalued share price of the company and therefore, it may act to bring it to a reasonable level. The management can avoid these negative interpretations by issuing convertible bonds, which will allow the investors to invest in the company without the risk that the company’s share may under perform as the bondholders will at least receive a minimum face value of the bond. Also, the company will be able to issue equity without giving negative impressions to the market. For an investor, more value is added to their wealth because if the company performs well, then the share price is expected to increase and the investor will convert to share to earn more capital gains. As the bonds are more secured and have potential for large capital gains, therefore they usually carry a very low or no coupon rate.

The value of the convertible bond has been calculated using the total value of firm and total proceeds from bonds.A convertible bond consists of two components which are; a regular non-convertible bond and an option to buy a fixed number shares or stocks of the company at a future date. Therefore, in order to calculate the value of convertible bond, we can add the value of a non-convertible bond to the value received by investor as conversion privilege over other investors.Hence,it should be used for calculating the price of the bonds.......................

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