10. A 10-year convertible bond has a face value of $1,000 and pays an annual cou

Question

10. A 10-year convertible bond has a face value of $1,000 and pays an annual coupon of $50. The bond's conversion price is $40. The issuing company's stock currently trades at $30 a share. The company can issue straight (non-convertible) debt with an 8% yield. Which of the following statements is CORRECT?

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I need to know how to get this answer please.

a. The bond's conversion ratio is 20.

b. The bond's conversion value is currently $750.

c. The bond's straight-debt value is $750.

d. The bond's straight-debt value is $1,000.

e. The convertible bond should sell for less than $750.

Explanation / Answer

Statement b is correct; the other statements are incorrect. The bond’s conversion ratio is 25 ($1,000/Conversion Price). The bond’s conversion value is $750. (The conversion ratio multiplied by the current stock price.) The bond’s straight-debt value is $798.70. (N = 10; I = 8; PMT = 50; FV = 1,000), so both statements c and d are incorrect. Clearly, the bond should also sell for more than its straight-debt value, so statement e is incorrect.

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