Nick Andrews, a fixed-income investment analyst, has been asked by his supervisor to prepare an analysis of
Question:
Nick Andrews, a fixed-income investment analyst, has been asked by his supervisor to prepare an analysis of the convertible bond issued by Heavy Element Inc., a chemical industry company, for presentation to the investment committee. Andrews has gathered the following data from the convertible bond’s prospectus and market information:
Issuer: Heavy Element Inc.
Issue Date: 15 September 2020
Maturity Date: 15 September 2025
Interest: 3.75% payable annually
Issue Size: $100,000,000
Issue Price: $1,000 at par
Conversion Ratio: 23.26
Convertible Bond Price on 16 September 2022: $1,230
Share Price on 16 September 2022: $52
Suppose that on 16 September 2022 the convertible bond is available in the secondary market at a price of $1,050. An arbitrageur can make a risk-free profit by:
A. Buying the underlying common stock and shorting the convertible bond.
B. Buying the convertible bond, exercising the conversion option, and selling the shares resulting from the conversion.
C. Shorting the convertible bond and buying a call option on the underlying common stock exercisable at the conversion price on the conversion date.
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