premium payback period = market conversion premium / favourable income difference per share fav income per share = [coupon interest - (conv ratio * dividend per share)] / conv ratio I’m having some trouble interpreting this. The way I think of this is- Suppose a bondholder exercises his conversion option [stocks are more valuable than the principle on the day] and converts the bond into common stock of the issuer. Bondholder will pay a price premium to the current stock price. And this premium would have been repaid back within “premium payback period” in years, if the bondholder chose not to exercise the conversion option and earn the coupon interest on bonds instead of dividend income on stock. Is this correct or I have messed this up ?
you got it right. You pay a premium for the conversion to Stock. you would have received coupon payments from Bond, now you get dividends from stock. in how much time do you recover the extra premium you paid…
So you had this convertible bond and were getting nice semi-annual PMT’s, but now you decide to convert them to stocks of the issuer. The no of stocks you get is decided by the conversion ratio stated. You would have to pay a premium to get the bond converted to stock and you forewent the goody-goody PMT’s you were getting for mere dividends (It’s almost always true that the PMT > DIV). So this favourable income difference per share is helping you in recouping the premium you paid. Then in how much time (in yrs) you will breakeven is what is called PPBP.
speaking of all of this stuff, there are a lot of formulas in SS14 where they bang them out one after another about this stuff- but the LOS never says calculate. i get the concepts behind all of this stuff, but i’m going to be the first to admit to you that i might not memorize all 7 or 8 of those formulas. i’ll file them in the “would be nice” if i had endless time and braincells category- along with the TB formula, black scholes formula, etc. but reality- i’m not going to know them all. deal with it people.
thanks CP and Swaption on confirming my understanding… now lets analyze it from the way CFAI may like to test it… 
lower the premium payback period …higher the incentive for bondholder to convert to stock ? YES … NO
Compare PPBP = 8yrs vs PPBP = 1 yr. I would prefer 1 yr recoup period. Hence YES
Which reading is this? Banni is correct we had many many formula’s but no calculate los last year. Are they asking to do the calculations now?
^ agree with SG- better to get paid back sooner than later YES
SS14, just read it this weekend- still no CALCULATE in the LOS. Maybe an interpret or evaluate.
both schweser and stalla do a lot of calculation intensive stuff there, so does the cfai book.
the LOS has the evaluate keyword… Evaluate To determine or fix the value of; to determine the significance or worth of, usually by careful appraisal and study. from the LOS Command words so I can see why both groups would go with calculating the numbers to make a decision…
you’re a buzzkill CPK. i thought the keyword was IGNORE the formulas. : ) a lot of them are pretty intuitive anyways. just for you, i’ll make notecards tonight for those formulas then. i hate how you don’t cut any corners. you are guilting me into learning.
you are way ahead of me bannis… I am still on my first pass thro stuff I hate - Derivatives and with PM left… after that rinse and repeat - which is going to be the death of me.
You guys are going to kill it man! I am just done with Econ, Corp Fin & AI … Doing Quant now. Taking it slow and easy this time, unlike last time where I sprinted for 3 months straight and fell on the face 10 mts before the finish line.