Conversion valuation refers to determining the value of a convertible bond or preferred stock by considering the conversion feature, which allows the holder to convert the security into common stock.
Which of the following factors is NOT directly related to the conversion valuation of a convertible security?
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Select an option above to see an explanation here.
A) The conversion ratio determines the common shares obtained by converting one convertible security. B) The conversion price is when a convertible security can be converted into common stock. C) The conversion premium is the difference between the convertible security's market price and its conversion value. D) Duration is a measure of a bond's sensitivity to changes in interest rates and is not directly related to conversion valuation.
What is the conversion value of a convertible bond with a conversion ratio of 25 and a current stock price of $40?
A) The conversion value is calculated by multiplying the conversion ratio (25) by the current stock price ($40), which equals $1,000. B) $1,500 is not the correct conversion value. C) $2,000 is not the correct conversion value. D) $2,500 is not the correct conversion value.
In the late 1990s, many technology companies issued convertible bonds to raise capital. As the tech bubble burst in the early 2000s, the value of these convertible bonds plummeted, and many investors were left with securities that had little or no conversion value.
At what point is a convertible security considered to be at parity?
A) Parity is not reached when the conversion value exceeds the market price. B) Parity is not reached when the conversion value is less than the market price. C) Parity is reached when the conversion value equals the market price, meaning the investor is indifferent between holding the security as a fixed-income investment or converting it into common stock. D) Parity is not reached when the conversion value equals the conversion price.
A company issues a convertible bond with a face value of $1,000 and a conversion ratio of 20. This means the bondholder can convert the bond into 20 shares of the company's common stock. For example, if the stock's current market price is $50, the bond's conversion value is $1,000 (20 shares x $50). If the bond's market price is $1,100, the conversion premium is $100 ($1,100 - $1,000).
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Example Series 65 Example Practice Question
Parity = (Convertible Bond Price / Conversion Ratio) / Common Stock Price
Suppose we have a convertible bond with a market price of $1,200, a conversion ratio of 20, and the underlying common stock has a market price of $60. Parity = ($1,200 / 20) / $60 Parity = $60 / $60 Parity = 1