Valuation - convertible bond You purchased one of AAA Corp.\'s 9%, 15-year conve
ID: 2636799 • Letter: V
Question
Valuation - convertible bondYou purchased one of AAA Corp.'s 9%, 15-year convertible bonds at its $1,000 par value a year ago when the company's common stock was selling for $25. Similar bonds without a conversion feature returned 10% at the time. The bond is convertible into stock at a price of $35. The stock is now selling for $40.
Assume no dividends.
a) You exercise the conversion feature today and immediately sold the stock you received. Calculate the total return on your investment.
b) What would your return have been if you had invested $1,000 in AAA's stock instead of the bond?
Please show all work. Thank you.
Valuation - convertible bond
You purchased one of AAA Corp.'s 9%, 15-year convertible bonds at its $1,000 par value a year ago when the company's common stock was selling for $25. Similar bonds without a conversion feature returned 10% at the time. The bond is convertible into stock at a price of $35. The stock is now selling for $40.
Assume no dividends.
a) You exercise the conversion feature today and immediately sold the stock you received. Calculate the total return on your investment.
b) What would your return have been if you had invested $1,000 in AAA's stock instead of the bond?
Please show all work. Thank you.
Please show all work. Thank you.
Explanation / Answer
a. Interest received for 1 Year of holding = 1,000 x 9% = $90
Add: Gain on conversion of bond into Stock and selling = 40 - 35 = $5
Total Gain = $95
But if the same amount would have been invested in non convetible bond than Interest income would have been for 1 year = 1,000 x 10% = $100
So, total return on convertible bond = -5
b. If Investment is made in stock than Total Share received = 1,000 / 25 = 40 Shares
Current Market Price = $40, Gain of $15 Per Share (40 - 25)
Total Return = 40 x 15 = $600
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