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ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions

Each $100 convertible bond of Linden Co converts into 20 shares. The current share price is $4. The straight-debt value of the bond is $82. A call option on one share with the conversion terms is worth $0.75. What is the theoretical value of one convertible bond?

The theoretical value is $97. A convertible equals its straight-debt value of $82 plus the call option on the 20 conversion shares, which is 20 × $0.75 = $15. Adding the option to the conversion value would double count the share value.

  1. A$97Correct
  2. B$82
  3. C$95
  4. D$80

Explanation

A convertible is valued as straight debt plus a call option on the shares. The option is on 20 shares: 20 × 0.75 = $15. Value = 82 + 15 = $97. Adding the option to the conversion value (80 + 15 = 95) double counts the share value, and $82 alone is only the floor.

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