How to Calculate a Floor Value of Convertible Bonds
A convertible bond represents a mix between a regular corporate bond and a stock option. It pays interest like a regular bond but also gives you the right to exchange it for a fixed number of shares of the company’s stock. When a company’s stock price is high, its convertible bonds are worth more because of the conversion feature. But if the stock price falls, its bonds still pay interest and repay their principal. The value of these payments represents a convertible bond’s floor, or minimum, value. It should trade for at least its floor value regardless of how low the stock drops.
Sign in to your broker’s trading software and search for your desired convertible bond. Click on the bond or a nearby information button to view its details.Step 2
Find the bond’s coupon rate, maturity length, face value, credit rating and interest payment frequency. For example, assume a convertible bond has a 3 percent coupon rate, 15-year maturity length, BB credit rating and $1,000 face value. Assume it pays interest semiannually.Step 3
Pull up the details for a non-convertible corporate bond with the same credit rating and characteristics as the convertible bond. Identify the non-convertible bond’s yield to maturity, or YTM. In this example, assume a non-convertible corporate bond with a BB credit rating and 15 year maturity has a 4.5 percent YTM.Step 4
Divide the non-convertible bond’s YTM by the number of times the convertible bond pays interest annually, and add 1. In this example, divide 4.5 percent, or 0.045, by 2 to get 0.0225. Add 1 to get 1.0225.Step 5
Multiply the number of payments per year by the convertible bond’s maturity length. Raise your Step 4 result to the power of this result. In this example, multiply 15 by 2 to get 30. Raise 1.0225 to the 30th power to get 1.9494.Step 6
Divide 1 by your Step 5 result and subtract this result from 1. In this example, divide 1 by 1.9494 to get 0.513. Subtract 0.513 from 1 to get 0.487.Step 7
Multiply the convertible bond’s coupon rate by its face value and divide your result by the non-convertible bond’s YTM. In this example, multiply 0.03 by $1,000 to get $30. Divide $30 by 0.045 to get $666.67.Step 8
Multiply your Step 7 result by your Step 6 result. In this example, multiply $666.67 by 0.487 to get $324.67.Step 9
Divide the convertible bond’s face value by your Step 5 result and add this calculation’s result to your Step 8 result to figure the bond’s floor value. Concluding the example, divide $1,000 by 1.9494 to get $512.98. Add $512.98 to $324.67 to get a floor value of $837.65. This means that, even if the company’s stock price falls, the convertible bond should trade for a minimum of $837.65.
- Like the value of a regular, non-convertible bond, a convertible bond’s floor value fluctuates with market interest rates and various other factors.