Faversham Fish Farm has outstanding a 7.75 percent, 20 year convertible debenture issue. Each $1,000 debenture is convertible into 25 shares of common stock. The company also has a straight debt issue outstanding of the same approximate maturity, so it is an easy matter to determine the straight bond value of the convertible issue. The market price of Faversham common stock is volatile. Over the last year, the following was observed:
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OBSERVATION |
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1 |
2 |
3 |
4 |
5 |
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Market price per share |
$ 40 |
$ 45 |
$ 32 |
$ 23 |
$ 18 |
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Straight bond value |
690 |
700 |
650 |
600 |
550 |
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Market price of convertible debenture |
1,065 |
1,140 |
890 |
740 |
640 |
a. Compute the premium over conversion value (in dollars) and the premium over straight bond value for each of the observations.
b. Compare the two premiums either visually or by graph. What do the relationships tell you with respect to the valuation of the convertible debenture?