15. Assume that at settlement the stock is at $45, the conversion ratio for the bond is 32. Then the intrinsic value of the bond is 45 × 32 = $1,440. Under the net share settlement, the investor receives $1,000 cash toward the par value and 440/45 = 9.7778 shares.

16. A brief note regarding the bifurcation principle: Under the debt method, a $1,000 par convertible would be viewed as, say, $850 of discounted debt that will accrete to $1,000 at maturity, and the $150 equity component to be accounted as equity. The interest expense would be increasing over time to maturity and is computed as the accreted bond liability times the straight, nonconvertible debt rate applicable to the bond at the time of issuance of the convertible security. Note that under the old method the debt expense would have been par times the cash coupon of the convertible which would have been lower that the nonconvertible bond rate. The increased interest expense flows through to the earnings calculation. Upon conversion, the eps is the more dilutive of (a) the debt method above, or (b) the fully diluted “equity method” in which all the shares underlying the bond are included in the denominator, not just the shares paid out in the net share settlement method.

17. Lately, following the financial turmoil of 2007/2008, the term “CoCo bonds” has been applied in a totally different context. These CoCo bonds, issued by banks and financial institutions, may be converted into equity at the option of the issuer banks if/when their business losses cause their core capital ratios to decline below regulator-mandated levels. The bond investors, in effect, have sold an embedded credit put to the issuing financial institutions and, therefore, have no say if and when this variety of CoCo bonds will be converted into equity to the detriment of the investor. Very unlike the CoCo bonds discussed here it is more like a reverse convertible, wherein, once again, there is an embedded put sold by the investor to the issuer. Not surprisingly, neither of these issuer putable securities is traded on the convertible desk.