Convertible bonds are a hybrid debt instrument issued by a corporation that can be converted to common stock at the discretion of the bondholder or the corporation once certain price thresholds are achieved. The floor value of the convertible bond is the lowest value to which the bond can drop and the point at which the conversion option becomes worthless. It's important to know how to calculate this value so that you can sell or convert the bonds while they still retain value.
Determine the face value of the bond. When a bond reaches maturity the holder receives a principal payment, or face value payment, from the bond issuer. Bonds are typically issued in common denominations of $1,000 or $10,000 and upon maturation of the bond you'll receive a payment equal to the purchase price of the bond. If you purchase a basic convertible bond for $1,000 and receive a $1,000 principal payment at maturity you will receive the face, or par, value. If you purchase the bond on the secondary market at a discount or a slight premium the face value of the security to you will adjust accordingly.
Video of the Day
Identify the yield of the bond. Convertible bond issuers attach a coupon or interest payment to each bond issue. This provides incentive for investors to purchase the debt as they will receive a scheduled interest payment over the life of the bond. Investors refer to this interest payment as the bond yield. The bond prospectus lists the rate at which the bonds bear interest, as well as the frequency at which the yield will be paid and the longevity of payments.
Combine face value and bond yield. Add the face value of the bond to the expected remaining yield left to be paid on the convertible bond. For example, if the face value of the bond is $1,000 and it will pay a quarterly interest dividend of 2.5 percent -- $25 -- for one year until it reaches maturity the combined value would be $1,100. The combined value is essentially the bond floor, or the value that the stock conversion value cannot drop below before the conversion option becomes worthless. This is the number you will compare against the conversion value --or stock value-- to determine whether it's dropped below the the bond floor value.
Compare floor value against stock value. Look up the underlying stock value. Assuming that the bond debt will convert to common stock in the debt-issuing company, look up the value of the issuer's common stock. Online finance sites provide easy to use listings for all commonly traded stock on U.S. stock exchanges. Multiply the stock price by the number of shares a bond conversion would produce. For example, if the common stock trades for $10 per share and each bond converts to 100 shares, the stock value -- or conversion value -- would be $10 x 100 shares, or $1,000. If the total worth of the stock value is less than that of the combined bond face value and yield, the security's value has fallen below the floor value.