Samuel & Sons is a fixed-income specialty firm that offers advisory services to investment management companies. On

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Samuel & Sons is a fixed-income specialty firm that offers advisory services to investment management companies. On 1 October 20X0, Steele Ferguson, a senior analyst at Samuel, is reviewing three fixed-rate bonds issued by a local firm, Pro Star, Inc. The three bonds, whose characteristics are given in Exhibit 1, carry the highest credit rating.EXHIBIT 1 Fixed-Rate Bonds Issued by Pro Star, Inc. Coupon 4.40% annual 4.40% annual Bond Bond #1 Bond #2

The one-year, two-year, and three-year par rates are 2.250%, 2.750%, and 3.100%, respectively. Based on an estimated interest rate volatility of 10%, Ferguson constructs the binomial interest rate tree shown in Exhibit 2.EXHIBIT 2 Binomial Interest Rate Tree Year 0 2.2500% Year 1 3.5930% 2.9417% Year 2 4.6470% 3.8046% 3.1150%


On 19 October 20X0, Ferguson analyzes the convertible bond issued by Pro Star given in Exhibit 3. That day, the option-free value of Pro Star’s convertible bond is $1,060 and its stock price $37.50.EXHIBIT 3 Convertible Bond Issued by Pro Star, Inc. 6 December 20X0 6 December 20X4 Issue Date: Maturity

The bond that would most likely protect investors against a significant increase in interest
rates is:
A. Bond #1.
B. Bond #2.
C. Bond #3.

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Fixed Income Analysis

ISBN: 9781119850540

5th Edition

Authors: Barbara S. Petitt

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