How to Calculate Convertible Bonds

The market determines whether you should exercise a stock option.

The market determines whether you should exercise a stock option.

Like all bonds, convertible bonds pay their face value at maturity and periodically pay interest until then. Unlike most bonds, convertible bonds also include the option to convert your investment to equity in the issuer's company. Each convertible bond can be exchanged for a fixed number of company shares. The stock option may initially be worth less than the bond's investment value, but the option can become more attractive as the stock's price rises.

Add 1 to the bond's coupon rate. For example, if the bond offers a coupon of 5 percent, add 1 to 0.05 to get 1.05.

Raise this sum to the power of the number of years until the bond matures. For example, if the bond matures in six years, raise 1.05 to the power of 6 to get 1.34.

Multiply this value by the bond's face value. For example, if the convertible bond offers a face value of $1,000, multiply $1,000 by 1.34 to get $1,340.

Divide this value by the bond's conversion ratio, which is declared at issue. For example, if the bond offers a conversion ratio of 20, divide $1,340 by 20 to get $67. This is the stock price above which it becomes profitable — and generally advisable — to convert the bond into stock.

Photo Credits

  • Creatas/Creatas/Getty Images