Question

A convertible debenture is convertible into common at $40 per share. if the market price of the bond rises to a 10 point premium over par, which statements are true? i the conversion ratio is 20:1 ii the conversion ratio is 25:1 iii the parity price of the stock is $44 iv the parity price of the stock is $50
a.i and iii
b.i and iv
c.ii and iii
d.ii and iv

Answer 1

Ans is c.ii and iii  
The conversion ratio is established when the bond is issued, and is: par value divided by the conversion price. In this case, the conversion price is set at $40 per share, so the conversion ratio is $1,000 par / $40 conversion price = 25:1 (25 shares per bond). If the bond moves to a 10 point premium over par, its new price will be 110, or $1,100 per bond. For the common stock to be valued at parity to the bond, the price per share must be $1,100 / 25 shares per bond = $44 per share parity price.