Valuation – convertible bond. You purchased one of Big Corp.’s 8%, 10-year conve
ID: 2726115 • 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?
Explanation / Answer
Calculating total return
Conversion ratio =1000/30=33.33
Conversion value = 33.33*35 =1167
Interest paid on the bond at 8% =80
Rate of return =(1167+80-1000)/1000 = 24.70%
b) What would your return have been if you had invested $1,000 in Big’s stock instead of the bond?
Rate of return if invested in stock=
Value of stock =1000*20= 20,000
Current value =1000*35 =35000
Rate of return =(35000-20000)/20000 =75%
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