Question: Rajiv Singh, a bond analyst, is analyzing a convertible bond. The characteristics of the bond and the underlying common stock follow: CONVERTIBLE BOND AND UNDERLYING

Rajiv Singh, a bond analyst, is analyzing a convertible bond. The characteristics of the bond and the underlying common stock follow:

CONVERTIBLE BOND AND UNDERLYING STOCK CHARACTERISTICS

Convertible Bond Characteristics

Par value ..................$1,000

Annual coupon rate (annual pay) ..........6.5%

Conversion ratio ...............22

Market price .................105% of par value

Straight value ................99% of par share

Underlying Stock Characteristics

Current market price .............$40 per share

Annual cash dividend .............$1.20 per share

a. Compute the bond’s

(1) Conversion value

(2) Market conversion price

(3) Premium payback period

b. Determine whether the value of a callable convertible bond will increase, decrease, or remain unchanged in response to each of the following changes, and justify each of your responses with one reason:

(1) An increase in stock price volatility

(2) An increase in interest rate volatility

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