how to value a convertible?

L

loufah

IMA is going to buy MATR, paying $6.50 in cash and $32.50 in convertible preferred stock (paying 3%, convertible at $69.32). The IMA common stock is currently at $48.

How do you put a value on convertible stock that's underwater? Do you treat it like a long-dated option and use something like Black-Scholes to estimate its value?
 
Since only companies with suspect credit ratings issue convertibles...
(Because instead of just issuing bonds... they are potentially giving away equity)...
A simple convertible can be viewed as a junk bond + long-term call option.

Of course you can value the "call" using Black-Scholes...
But this kind of ubiquitous valuation will not give you an edge...
Since anyone can do it.
 
Convertible bonds are priced according to the underlying share price.

So you have to "forecast" future movements in share price (directional trades).

Unless you plan to do some market neutral strategy, going long bond/shorting stock (or viceversa).
 
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