CONVERTIBLE

SECURITIES
CONVERSION FEATURE
-An option that is included as part of a bond or a preferred
stock issue and allows its holder to change the security into a
stated number of shares of common stock.

 TYPES OF CONVERTIBLE SECURITIES

1. Convertible Bonds- can be changed into a specified number

of shares of common stock.
2. Convertible Preferred Stock- is preferred stock that can be
changed into a specified number of shares of common stock.

Straight Preferred Stock- preferred stock that is nonconvertible,

having no conversion feature.
 GENERAL FEATURES OF CONVERTIBLES
-Limited number of years: 5 to 10 years

Conversion Ratio- is the ratio at which a convertible

security can be exchanged for common stock

TWO WAYS:
1. Stated in terms of a given number of shares of
common stock.

Conversion Price- is the per-share price that is

effectively paid for common stock as the result of
conversion of a convertible security.
Western Wear Company, a manufacturer of denim products, has
outstanding bond that has a $1,000 par value and is convertible
into 25 shares of common stock. The bond’s conversion ratio is
25. The conversion price for the bond is $40 per share
($1000/25).

2. Instead of the conversion ratio, the conversion price is

given.

Mosher Company, a franchiser of seafood restaurants, has

outstanding a convertible 20-year bond with a par value of
$1000. The bond is convertible at $50 per share into common
stock. The ownership ratio is 20 ($1000/ $50).
Conversion (or stock) Value- the value of the convertible
measured in terms of the market price of the common
stock into which it can be converted.

CONVERSION VALUE= Conversion ratio x current market

price of the firm’s common stock

McNamara Industries, a petroleum processor, has outstanding a

$1,000 bond that is convertible into common stock at $62.50 per
share. The conversion ratio is therefore 16 ($1,000/ $62.50).
Because the current market price of the common stock is $65 per
share, the conversion value is $1,040 (16 x $65). Because the
conversion value is above the bond value of $1000, conversion is
a viable option for the owner of the convertible security.
 EFFECTS ON EARNINGS PER SHARE

Contingent Securities affects the reporting of the firm’s

earnings per share.
 FINANCING WITH CONVERTIBLES

 Motives for Convertible Financing

1. Use as a form of deferred common stock financing

2. Use as a “sweetener” for financing

3. To raise cheap funds temporarily

 DETERMINING THE VALUE OF A CONVERTIBLE BOND

 Three values of Convertible Bond

1. Straight Bond Value- the price at which it would

sell in the market without the conversion feature.
-floor or minimum price at which the
convertible bond would be traded
2. Conversion (or Stock) Value- is the value of the
convertible measured in terms of the market price of
the common stock into which the security can be
converted.
3. Market Value- it is likely to be greater than its straight
value or its conversion value.