In 2006, Merrill Lynch became the lead book runner for a $5 billion convertible bond issue for MoGen, Inc., which was the single-largest convertible bond issuance in history. Merrill Lynch's Equity Derivatives Group needed to convince MoGen's management of the best coupon rate and conversion premium for MoGen and the potential investors in the issue. This pricing decision requires students understand the concept of valuing a convertible as the sum of a straight bond plus the conversion option. Valuing the conversion option as a call option requires the estimation of the Black-Scholes model, with the volatility being a particularly challenging input. The case is designed for students who already have a basic knowledge of bond valuation and option-pricing principles and works well with undergraduate, MBA, and executive education audiences. The instructor may choose to teach the case in one class period or two.
To understand the investment banker's choice of conversion premium and coupon rate in properly pricing a convertible bond. To see that the convertible is a fairly straightforward application of the Black-Scholes option pricing model. To understand the concept of valuing a convertible as the sum of a straight bond plus the conversion option. To introduce students to the concept of matching a company's business risk with the type of financing: equity, debt, or convertible debt. To show the compatibility of a convertible bond as a source of funds for a company's share repurchase plan.