Dinoo Mathur wishes to determine whether the $1,000 price asked for Stanco Manufacturings bond is fair in
Question:
Dinoo Mathur wishes to determine whether the $1,000 price asked for Stanco Manufacturing’s bond is fair in light of the theoretical value of the attached warrants. The $1,000parvalue, 30year, 11.5%couponinterestrate bond pays annual interest and has 10 warrants attached for purchase of common stock. The theoretical value of each warrant is $12.50. The interest rate on an equalrisk straight bond is currently 13%.
a. Find the straight value of Stanco Manufacturing’s bond.
b. Calculate the implied price of all warrants attached to Stanco’s bond.
c. Calculate the implied price of each warrant attached to Stanco’s bond.
d. Compare the implied price for each warrant calculated in part c to its theoretical value. On the basis of this comparison, what assessment would you give Dinoo with respect to the fairness of Stanco’s bond price? Explain.
Step by Step Answer:
a Straight bond value Years Payments Discount Rate ...View the full answer
Principles Of Managerial Finance
ISBN: 9780136119463
13th Edition
Authors: Lawrence J. Gitman, Chad J. Zutter
Related Video
Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.
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