Two firms have common stock and convertible bonds outstanding. Information concerning these securities is as follows: a)
Question:
Two firms have common stock and convertible bonds outstanding. Information concerning these securities is as follows:
a) What is the value of each bond in terms of stock?
b) What is the premium paid over each bond's value as stock?
c) What is each bond's income advantage over the stock into which the bond may be converted?
d) How long will it take for the income advantage to offset the premium determined in part (b)?
e) If after four years firm A's stock sells for $65 and the firm calls the bond, what is the holding period return and the annual rate of return earned on an investment in the stock or in thebond?
Firm A Flrm B Common stock Price of common stock Cash dividend Convertible bond Principal Conversion price $46 $30 $1 none $1,000 $50 20 shares 10 years 75% $1,100 $1,000 $33% Maturity Coupon Market price 10 years 75% $1,100
Step by Step Answer:
a The value of each bond in terms of stock Firm A 20 shares x 46 920 Firm B 30 shares x 30 900 b The premium paid over each bonds value as stock Firm ...View the full answer
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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