34.2 TERMINOLOGY
Convertible bonds give holders the right to exchange the bonds for common shares of the issuer at a stated ratio during a particular period. They are complex securities that blend the characteristics found in equity, debt, and option securities. As a result, traders and arbitrageurs have developed specialized terminology to describe various aspects of the marketplace. For the sake of simplicity, assume it is now January 1, 2012, and that a hypothetical convertible bond is denoted as XYZ convertible 2% 2016. Exhibit 34.1 describes the various parameters that characterize this convertible bond.
EXHIBIT 34.1 Summary of the Terms Offered by the XYZ Convertible 2% 2016 Bond
| Fixed-Income Features | |
| Issuer | XYZ Company Inc. |
| Rating | BBB |
| Coupon | C = 2% (annual) |
| Issue date | January 1, 2012 (today) |
| First coupon date | December 31, 2012 (in one year) |
| Accrued interest | 0 |
| Maturity | December 31, 2016 (in T = 5 years) |
| Nominal value | $1,000 |
| Risk-free rate | Rf = 4% per year |
| Issuer credit spread | CS = 400 basis points (bps) above the risk-free rate |
| Equity Features | |
| Issuer | XYZ Company Inc. |
| Stock price | S0 = $100 per share |
| Stock price change volatility | σ = 30% per year |
| Stock dividend | None |
| Conversion Features | |
| Conversion ratio | CR = 8 |
| Conversion price | $125.00 |
| Call protection | None |
| Market Valuation | |
| Convertible market price | 90 (i.e., 90% of face value) |
| Parity | 80 (i.e., 80% of face value) |
| Conversion premium | 12.50% |
The fixed-income features of the convertible ...
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