The bonds of VDM, Inc. are convertible into shares of the firm's common stock at $50 per share. The current price of the common stock is $45 per share. The bonds have a $1,000 par value and currently sell for $950 apiece. When the bonds were issued, the market price of the common stock was $40. Thus, what was the conversion premium at issuance?

Question

Quizplus · Accepted Answer

The conversion premium at issuance can be calculated as the extra amount over the stock's market value that investors are willing to pay for the bond, due to its convertibility into stock. At issuance, the stock price was $40, and the conversion price is $50, meaning each bond converts into $1,000/$50 = 20 shares. The value of these shares at the stock's market price at issuance would be 20 shares * $40 = $800. Since the bond sold for $1,000, the conversion premium is ($1,000 - $800) / $800 = $200 / $800 = 0.25 or 25%.

The Bonds of VDM, Inc