4.3 - Convertible Products

What is a convertible bond?

A corporate bond that can be converted into common stock of the same issuer.

Why do convertible bonds typically have lower yields than non-convertible bonds?

Because they offer an added benefit: the option to convert into stock. (equity upside)

Why must issuers get shareholder approval before issuing convertible bonds?

Because conversion dilutes existing shareholders

Conversion Math

What is the conversion ratio formula?

Conversion Ratio = Par ÷ Conversion Price

What does the conversion ratio represent?

Number of shares received if the bond is converted.

Conversion Ratio Example:

$1,000, Conversion Price = $40 → Conversion Ratio?

25 shares (1,000 ÷ 40)

Conversion Price

What is the conversion price formula?

Conversion Price = Par ÷ Conversion Ratio

Conversion Price Example:

Conversion Ratio = 20 → Conversion Price?

$50 (1,000 ÷ 20)

Conversion Value & Profit

What is conversion value?

Value of shares received after conversion
= Conversion Ratio × Stock Price

What is the profit formula from conversion?

Profit = Conversion Value − Bond Purchase Price

Example:

• Bond price = $900

• Conversion ratio = 10

• Stock price = $120
  Profit?

• Conversion value = 10 × 120 = $1,200

• Profit = 1,200 − 900 = $300

Conversion Cost Per Share

What is conversion cost per share?

Bond price ÷ Conversion ratio

Why is conversion cost per share important?

It tells you the “effective price” you're paying per share when converting

When does conversion make sense?

When stock price > conversion cost per share.

(greater-than)

Parity Pricing

Stock Parity Pricing

What is stock parity price?

The effective stock price per share from buying and converting a bond.

Stock parity price formula?

Stock PP = Bond market price ÷ Conversion ratio

Bond Parity Price

What is bond parity price?

The equivalent bond value based on stock price.

Bond parity price formula?

Bond PP = Stock price × Conversion ratio

Bond Parity Price Example:

Stock = $90, Ratio = 10 → Bond PP?

$900

When is arbitrage possible with parity pricing?

When bond price < (less-than) bond parity price → buy bond, convert, sell stock.

Mezzanine Debt

What is mezzanine debt?

Long-term corporate debt that sits between senior debt and equity in liquidation.

Where does mezzanine debt rank in liquidation?

• Senior debt

• Mezzanine debt

• Equity

Why is mezzanine debt considered a hybrid security?

It combines debt features with equity-like features (e.g., warrants, conversion)

Who typically issues mezzanine debt?

Smaller companies or startups seeking alternative financing.

Mezzanine Features

What features may be included in mezzanine debt?

• PIK interest

• Warrants

• Conversion features

PIK (Payment-in-Kind) Interest

What is PIK interest?

Interest added to principal instead of paid in cash.

When is PIK interest paid?

At maturity (or redemption)

What happens to the bond’s principal with PIK interest?

It increases over time.

Warrants (Quick Hit)

What is a warrant?

A right to buy stock at a fixed price.

Why are warrants attractive?

They provide additional upside if stock price rises.

🧠 Keep in Mind

• Memorize formulas cold (this is where points come from)

• Focus on:

  • Conversion ratio vs price (they flip)

  • Profit math

  • Parity logic (cheap vs expensive)

• Mezzanine + PIK = more conceptual, fewer calculations.