How does the dividend valuation model estimate a convertible's value?

The dividend valuation model estimates a convertible's value by focusing on the potential benefits that can be derived from conversion into equity, particularly through the conversion ratio and the underlying share price.

In this model, the conversion ratio indicates how many shares of common stock a bondholder would receive upon converting their convertible bond. By multiplying this conversion ratio by the current share price, one can gauge the value of the common equity that the bondholder would obtain through conversion. Additionally, considering the growth rate of dividends reflects the future income potential of owning those equity shares. This approach enables investors to assess the present value of the shares they would acquire, which is essential for determining the overall value of the convertible bond.

In contrast, other options do not align with the dividend valuation model. Current market interest rates pertain more to traditional bond valuation rather than the unique characteristics of convertibles. Calculating future dividends alone disregards the equity aspect of convertibles, as it neglects the potential conversion into shares. Estimating coupon payments refers to the traditional fixed-income component of the convertible bond, which does not account for the value derived from conversion into stock. Hence, using the dividend valuation model combined with conversion parameters provides a comprehensive approach to understanding a convertible's value.