Tulsa Drilling Company has $1 million in 11 percent convertible bonds outstanding. Each bond has a $1,000

Question:

Tulsa Drilling Company has $1 million in 11 percent convertible bonds outstanding. Each bond has a $1,000 par value. The conversion ratio is 40, the stock price is $32, and the bonds mature in 10 years. The bonds are currently selling at a conversion premium of $70 over the conversion value.

a. If the price of Tulsa Drilling Company common stock rises to $42 on this date next year, what would your rate of return be if you bought a convertible bond today and sold it in one year? Assume that on this date next year, the conversion premium has shrunk from $70 to $20.

b. Assume the yield on similar nonconvertible bonds has fallen to 8 percent at the time of sale. What would the pure bond value be at that point? (Use semiannual analysis.) Would the pure bond value have a significant effect on valuation then?

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on...