1 You have been hired to value a new 10-year callable, convertible bond. The bond has a 5.6 per cent coupon rate, payable annually. The conversion price is £150, and the equity currently sells for £44.75. The share price is expected to grow at 8 per cent per year. The bond is callable at £1,100 but based on prior experience it will not be called unless the conversion value is £1,200. The required return on this bond is 6 per cent. What value would you assign to this bond? (30 marks)
2 Your firm has 3 million shares of equity and 100,000 warrants. Each warrant gives its owner the right to purchase one share of newly issued equity for an exercise price of €15. The warrants are European and will expire one year from today. The market value of the company’s assets is €60 million, and the annual standard deviation of the returns on the firm’s assets is 24 per cent. Treasury bills that mature in one year yield a continuously compounded interest rate of 2 per cent. The company does not pay a dividend. Use the Black–Scholes model to determine the value of a single warrant. (30 marks)
3 Review the reasons given for why firms issue convertible bonds. Which one do you think is the most valid? Explain. (40 marks)