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Understanding Warrants and Convertibles

The document provides calculations and solutions related to warrants and convertible bonds, including the calculation of straight bond value, conversion ratios, and profits or losses from exercising warrants. It covers scenarios involving stock prices, exercise prices, and the impact on retained earnings from stock conversions. Key examples include the theoretical value of warrants and the financial implications of converting preferred stock to common stock.

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a7madelmasry1999
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25 views2 pages

Understanding Warrants and Convertibles

The document provides calculations and solutions related to warrants and convertible bonds, including the calculation of straight bond value, conversion ratios, and profits or losses from exercising warrants. It covers scenarios involving stock prices, exercise prices, and the impact on retained earnings from stock conversions. Key examples include the theoretical value of warrants and the financial implications of converting preferred stock to common stock.

Uploaded by

a7madelmasry1999
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Tutorial 10 – Warrants and Convertibles

Question 1
Calculate the straight bond value and the conversion ratio of a convertible if the current price of
the stock is $60, its conversion price is $70, and it matures 5 years from now. A straight bond with
similar features has a yield to maturity of 10%, compared to an 8% coupon for the convertible.
The par value is $1,000.
Solution
Conversion ratio = 1,000 / 70 = 14.29 shares
1
1− (1+0.10)𝑝𝑜𝑤𝑒𝑟 5 1,000
Straight bond value = (1,000 * 8%) *( ) + (1+0.10)𝑝𝑜𝑤𝑒𝑟 = $ 924
0.10 5

Question 2
The price paid to buy a warrant is $5, the price of the stock is $50, and the exercise price is $40.
How much profit or loss would the holder of a warrant make by exercising the warrant if one
warrant entitles the owner to buy one share of stock?
Solution
Theoretical value of warrant = 1 * (50 - 40) = 10
The profit = 10 – 5 (what you paid for the warrant) = $5
Question 3
Calculate the theoretical value of a warrant when the current price of the stock is $50, and the
exercise price is $45. The exchange ratio is 3 shares for each warrant.
Solution
Theoretical value of warrant = 3 * (50 - 45) = $15
Question 4
A convertible bond has a call price of $1,100. Its underlying stock is selling at $60 per share, and
the conversion price is $50. If owners of the convertible bond convert and sell the stock, how much
profit or loss will they make on each bond if the convertible is called by the company, given the
above conditions?
Solution
Loss to owners on each bond of $100
Question 5
Host Enterprises issued 1,000 shares of common stock (par value $2) upon conversion of 1,000
shares of preferred stock (par value $1) that was originally issued for a $200 premium. What is the
effect, if any, on retained earnings?
Solution
Conversion ratio = 1,000 * 1 = 1,000 shares of common stocks
Preferred stocks (decrease) 1,000 * 1 = $1,000
Common stock (increase) 1,000 * 2 = $2,000
Common stock (decrease) = 200
Retained earnings (decrease) = 8,00

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