A company issues $500 million of 2.5% convertible senior notes due in 2031 with a conversion price of $150 per share (current stock price is $120). What is the conversion premium?
- A15%
- B20%
- C25%✓ Correct answer
- D30%
Why C — 25%
The conversion premium is calculated as the difference between the conversion price and the current stock price, divided by the current stock price. In this case: ($150 - $120) / $120 = $30 / $120 = 25%. This means the stock must appreciate by 25% before conversion becomes economically attractive. The conversion premium compensates bondholders for receiving a lower coupon rate than a comparable non-convertible bond. Typical conversion premiums range from 20-40% for investment-grade convertibles, balancing the interests of both bondholders and existing equity holders concerned about dilution.
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