Assessing Convertible Bond Cheapness Against Straight Bonds and Options

Summary

The discussion offers two rough ways to assess whether a convertible bond may be inexpensive. One is to compare its market price with the value of a comparable straight bond, which isolates the premium paid for the embedded conversion feature. The premium is expressed as the convertible’s price divided by straight value, less one.

A second approach estimates the embedded option’s value and compares it with a traded option on the underlying shares, adjusting the comparison so both options represent the same share quantity. A gap between the observed and implied option values may indicate relative mispricing. These are screening comparisons rather than a full valuation framework: the answers provide no detailed assumptions for valuing the bond or option, and differences in terms, credit risk, and market liquidity can affect comparability.

Key ideas

• The premium over straight value compares a convertible bond’s price with a bond stripped of conversion rights.
• The embedded conversion option can be compared with an exchange-traded option on the same shares.
• Option comparisons require scaling the contracts to a common share quantity.
• These rough indicators do not account for every valuation input or instrument difference.

Tags

# Cheapness indicator for Convertibles Bonds


# Cheapness indicator for Convertibles Bonds












What indicator (or combination of those) could be used to roughly estimate the cheapness of a convertible bonds ?

Like the price/earning ratio for equities.

Thanks, Max.

## Answer by Bikenfly (score 1)

https://quant.stackexchange.com/a/16402

The above gives you the value of the option in the convertible bond. Next step, look at the price of an exchange-traded option to see what the embedded convertible bond option is worth. That can tell you if the convertible bond is over or under priced - compare the market value of the option to the implied price of the option (scaling prices to the same number of shares).

## Answer by Bob Jansen (score 0)

https://quant.stackexchange.com/a/16394

For a rough estimate you can compare the value against a straight bond (one without options).

$$\textrm{Premium over straight value} = \frac{\textrm{Convertible bond price}}{\textrm{Straight value}} - 1.$$

Taken from the CFA Level II curriculum Volume 5.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.