Series 7 practice questionhardDebt Securities — Corporate Bonds — Convertible Bond Scenario
An investor holds a convertible bond ($1,000 par, 4% coupon) convertible into 20 shares of stock. The stock is trading at $55, and the bond is priced at $1,150. What is the conversion premium in dollars, also called points?
- A15%
- B4.55%
- C50 points✓ Correct answer
- DThere is no conversion premium since the bond is in the money
Explanation
Why C — 50 points
The parity price (conversion value) of the bond is 20 shares x $55 = $1,100. The bond is currently trading at $1,150. The conversion premium is the amount by which the bond price exceeds its parity value: $1,150 - $1,100 = $50 (or 50 points). Expressed as a percentage, the conversion premium is $50 / $1,100 = 4.55%. This premium reflects the additional value investors assign to the bond's fixed-income features.
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