A firm issues the convertible debt shown above.The price of stock in this company on July 1,2008 is $28.20.What is the minimum conversion ratio that would make a bondholder prefer to convert rather than accept the call price?

Question

Quizplus · Accepted Answer

To determine the minimum conversion ratio that would make a bondholder prefer to convert rather than accept the call price, we need to compare the conversion value to the call price. 
Conversion Value = Conversion Ratio x Stock Price = CR x $28.20 
Call Price = $1,000

The bondholder will prefer to convert if the conversion value is greater than the call price. Therefore, we can set up the following inequality: 
CR x $28.20 > $1,000 
CR > $1,000 / $28.20 
CR > 35.460 
Since the conversion ratio must be a whole number, the minimum conversion ratio that would make a bondholder prefer to convert rather than accept the call price is 37 shares per $1,000 principal amount (choice C).

A Firm Issues the Convertible Debt Shown Above