Investments, tenth edition

 Figure 20.11 

Values of callable bonds compared with straight bonds  

 Should a convertible bond issued at par value have a higher or lower coupon rate 

than a nonconvertible bond issued at par? 

 CONCEPT CHECK 

20.8 

  Figure 20.12  illustrates the optionlike properties of the convertible bond.  Figure 20.12, 

panel A  shows the value of the straight debt as a function of the stock price of the issu-

ing firm. For healthy firms, the straight debt value is almost independent of the value of 

the stock because default risk is small. However, if the firm is close to bankruptcy (stock 

prices are low), default risk increases, and the straight bond value falls. Panel B shows the 

conversion value of the bond. Panel C compares the value of the convertible bond to these 

two lower bounds.  

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  Options Markets: Introduction

703

 When stock prices are low, the straight bond value is the effective lower bound, and the 

conversion option is nearly irrelevant. The convertible will trade like straight debt. When 

stock prices are high, the bond’s price is determined by its conversion value. With conver-

sion all but guaranteed, the bond is essentially equity in disguise. 

 We can illustrate with two examples: 

Straight Debt Value

Stock Price