CHAPTER 24 CASE C-1
CHAPTER 24
S&S AIR’S CONVERTIBLE BOND
1. Chris is suggesting a conversion price of $45 because it means the stock price will have to increase
before the bondholders can benefit from the conversion. Even though the company is not publicly
traded, the conversion price is important. First, the company may go public in the future. The case
does not discuss whether the company has plans to go public, and if so, how soon it might go public.
If the company does goes public, the bondholders will have an active market for the stock if they
convert. Second, even if the company does not go public, the bondholders could potentially have an
2. The floor value is the maximum of the conversion value and the intrinsic value. The conversion
value of the bond is given as $680.56. The intrinsic value of the bond is:
3. The conversion ratio of the bonds is:
4. The conversion premium is the increase in stock price necessary to make the conversion option
possible. Since the stock is currently selling for $30.63, and the conversion price is $45, the
conversion premium of the bond is:
5. The option value of a convertible bond is defined as the difference between the market value of the
bond and the maximum of its straight value and conversion value. Since the bond is sold at par
value, the option value is:
Option value = Market value – Max[Straight value, Conversion value]
CHAPTER 24 CASE C-2
6. Todd’s argument is wrong because it ignores the fact that if the company does well, bondholders will
7. Mark’s argument is incorrect because the company is issuing debt with a lower coupon rate than they
8. Reconciling the two arguments requires that we remember our central goal: to increase the wealth of
the existing shareholders. Thus, with 20–20 hindsight, we see that issuing convertible bonds will turn
In contrast, if a company does poorly, issuing convertible bonds will turn out to be better than
Both of the arguments have a grain of truth; we just need to combine them. Ultimately, which option
is better for the company will only be known in the future and will depend on the performance of the
company. The table below illustrates this point.
If the company does poorly If the company prospers
Low stock price and no
conversion
High stock price and
conversion
Convertible bonds
Cheap financing because
Expensive financing because
Convertible bonds
Expensive financing because
Cheap financing because firm
9. The call provision allows the company to redeem the bonds at the company’s discretion. If the
company’s stock appears to be poised to rise, the company can call the outstanding bonds. It could