Amram Inc. can issue a 20-year bond with a 6% annual coupon. This bond is not co

Question

Amram Inc. can issue a 20-year bond with a 6% annual coupon. This bond is not convertible, is not callable, and has no sinking fund. Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the convertible, callable bond a Exactly equal to 6%. b It could be less than, equal to, or greater than 6%. c Greater than 6%. d Exactly equal to 8%. e Less than 6%

Explanation / Answer

b It could be less than, equal to, or greater than 6% The second bond's convertible feature and sinking fund would tend to lower its required rate of return, but the call feature would raise its rate. Given these opposing forces, the second bond's requiredcoupon rate could be above or below that of the first bond. However, the convertible feature generallydominates in the real world, so convertibles' coupon rates are generally less than comparable non-convertible issues' rates

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