Investments, tenth edition

  Convertible Bonds   

   Convertible  bonds    give bondholders an option to exchange 

each bond for a specified number of shares of common stock of the firm. The  conversion 

ratio  is the number of shares for which each bond may be exchanged. Suppose a convert-

ible bond is issued at par value of $1,000 and is convertible into 40 shares of a firm’s 

 Suppose that Verizon issues two bonds with 

identical coupon rates and maturity dates. One 

bond is callable, however, whereas the other is 

not. Which bond will sell at a higher price? 

 CONCEPT CHECK 

14.1 

YIELD %

0.5662

4.5187

2.2590

0.4663

1.1635

1.1569

ISSUER NAME

WACHOVIA CORP

GLOBAL MTN

GOLDMAN SACHS

GROUP INC

ANHEUSER BUSCH

INBEV WORLDWIDE

JPMORGAN CHASE

& CO

HOUSEHOLD FIN

CORP

ANHEUSER BUSCH

INBEV WORLDWIDE

SYMBOL

WFC.PO

GD.AEH

BUD3876843

JPM.KPG

HBC.IGQ

BUD3876840

COUPON

5.500%

5.750%

2.500%

4.750%

4.750%

1.375%

MATURITY

May 2013

Jan  2022

Jul  2022

May  2013

Jul  2013

Jul 2017

MOODY'S/S&P/

FITCH

A2 /A+ /AA–

A3 /A– /A

A3 /A /A

A2 /A /A+

Baa1 /A /AA–

A3 /A /A

HIGH

103.7060

111.8040

104.1200

103.1790

105.3220

101.3000

LOW

103.4240

100.3290

101.8410

102.6250

103.0760

100.9150

LAST

103.6590

109.4040

102.1360

103.1790

103.3780

101.0460

1.3090

0.2034

0.4110

0.2720

0.2280

–0.0820

CHANGE

 Figure 14.2 

Listing of corporate bonds 

  Source: FINRA (Financial Industry Regulatory Authority), August 1, 2012.  

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  C H A P T E R  

1 4

  Bond Prices and Yields 

449

stock. The current stock price is $20 per share, so the option to convert is not profitable 

now. Should the stock price later rise to $30, however, each bond may be converted prof-

itably into $1,200 worth of stock. The  market conversion value  is the current value of 

the shares for which the bonds may be exchanged. At the $20 stock price, for example, 

the bond’s conversion value is $800. The  conversion premium  is the excess of the bond 

value over its conversion value. If the bond were selling currently for $950, its premium 

would be $150. 

 

Convertible bondholders benefit from price appreciation of the company’s stock. 

Again, this benefit comes at a price: Convertible bonds offer lower coupon rates and stated 

or promised yields to maturity than do nonconvertible bonds. However, the actual return 

on the convertible bond may exceed the stated yield to maturity if the option to convert 

becomes profitable. 

 We discuss convertible and callable bonds further in Chapter 20.