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Chapter 5: Q3DQ (page 621)

Why is it said that convertible securities have a floor price?

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Answer

The floor value of the convertible securities is the lowest value to which the bond can reduce and the point at which the conversion option becomes useless.

Step by step solution

01

Introduction to convertible security-

Convertible security is a security generally a bond or a preferred stock that can be converted into an alternate security normally equity shares or common stock.

02

Convertible securities have a floor price

The floor price of a convertible securities depends on the pure bond value related with the interest payments on the bond. Notwithstanding of how low the related common stock could go; the semi-yearly interest payments will set a floor price for the bond. It's vital to know how to compute the value so that can be convert the bonds while they still hold value.

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Most popular questions from this chapter

Question: The Bowman Corporation has a \(18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 10 years remaining. The new issue would be for 10 years. There is a 9 percent call premium on the old issue. The underwriting cost on the new \)18,000,000 issue is \(530,000, and the underwriting cost on the old issue was \)380,000. The company is in a 35 percent tax bracket, and it will use an 8 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision.

a. Calculate the present value of total outflows.

Midland Corporation has a net income of \(19 million and 4 million shares outstanding. Its common stock is currently selling for \)48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of \(21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for \)44 per share with a spread of 4 percent.

c. What are the earnings per share (EPS) and the price-earnings ratio before the issue (based on a stock price of $48)? What will be the price per share immediately after the sale of stock if the P/E stays constant?

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