You purchased one of AAA Corp.’s 9%, 15-year convertible bonds at its $1,000 par
ID: 2710123 • Letter: Y
Question
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?
Explanation / Answer
A)
Total return on investment:
= (Profit on sale of stocks +Coupon payment received)÷$1,000
= (($40-$35)×28+$20+$1,000×9%)÷$1,000
= 25%
(Assumed $1,000 bond is converted into 28 shares and $20)
B)
Total return on investment:
= Profit on sale of stocks÷$1,000
= ($40-$25)×40÷$1,000
= 60%
(With $1,000 we can buy 40, $25 stocks)
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