Valuation - convertible bond You purchased one of big corp\'s 8%, 10-year conver
ID: 2648713 • Letter: V
Question
Valuation - convertible bond You purchased one of big corp's 8%, 10-year convertible bonds at its $1,000 par value a year ago when the company's common stock was selling for $20. Similar bonds without a conversion feature returned 12% at the time. The bond is convertible into stock at a price of $30. The stock is now selling for $35. 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 big's stock instead of the bond? show work
Explanation / Answer
Number of stocks after conversion are $1,000/ $30 = 33.3333 stocks
These stocks are to sold in the open market at $35,
Profit on sale of stock is 33.333333x $35 - $1,000 = $166.67
Interest on holding bond is $ 1,000x 8/100= $80
Total return after a year is $166.67+ $80 = $246.67
Total number of stock purchased are $1,000/ $20 = 50 Stocks
Sold out after a year at $35 In an open market
Total return if Stock is purchased in place of Convertible bond= 50x $35 -$1,000
= $1750 - $1000= $ 750
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