Valuation of compulsorily convertible (partly or fully) debentures is the process of determining the fair value of these debentures. The fair value of a compulsorily convertible (partly or fully) debenture is the price that a willing buyer would pay to a willing seller in an arm’s-length transaction.
Valuation methods
There are several methods that can be used to value compulsorily convertible (partly or fully) debentures. Some of the most common methods include:
- Net asset value method: The net asset value method is based on the value of the underlying assets of the company. The debentures are valued as a debt instrument, and the value of the conversion option is ignored.
- Discounted cash flow method: The discounted cash flow method is based on the expected future cash flows from the debentures. The debentures are valued as a debt instrument, and the value of the conversion option is taken into account.
- Option pricing method: The option pricing method is based on the Black-Scholes model or other option pricing models. The debentures are valued as a combination of a debt instrument and an option, and the value of the conversion option is taken into account.
Multiple choice questions:
- Which of the following is a method that can be used to value compulsorily convertible (partly or fully) debentures?
- Net asset value method
- Discounted cash flow method
- Option pricing method
- All of the above
- The answer is All of the above. All of these methods can be used to value compulsorily convertible (partly or fully) debentures.
- The net asset value method is based on the value of the underlying assets of the company. The debentures are valued as a debt instrument, and the value of the conversion option is:
- Included
- Ignored
- Not relevant
- All of the above
- The answer is Ignored. The net asset value method ignores the value of the conversion option.
- The discounted cash flow method is based on the expected future cash flows from the debentures. The debentures are valued as a debt instrument, and the value of the conversion option is:
- Included
- Ignored
- Not relevant
- All of the above
- The answer is Included. The discounted cash flow method includes the value of the conversion option.
Factors affecting value of compulsorily convertible (partly or fully) debentures
The value of a compulsorily convertible (partly or fully) debenture is affected by a number of factors, including:
- The price of the underlying stock
- The exercise price of the debenture
- The time to expiration of the debenture
- The volatility of the underlying stock
- The risk-free interest rate
- The dividends paid by the underlying stock
- The conversion premium
Conversion premium
The conversion premium is the difference between the market price of the debenture and the exercise price of the debenture. The conversion premium is a measure of the value of the conversion option.
Conclusion
The valuation of compulsorily convertible (partly or fully) debentures is a complex process that takes into account a number of factors. The specific method that is used to value these debentures will depend on the specific circumstances.