Defense Systems Inc. has convertible bonds outstanding that are callable at $1,0

Question

Defense Systems Inc. has convertible bonds outstanding that are callable at $1,020. The bonds are convertible into 20 shares of common stock. The stock is currently selling for $61.50 per share.

a. If the firm announces it is going to call the bonds at $1,020, what action are bondholders likely to take?
  

b. Assume that instead of the call feature, the firm has the right to drop the conversion ratio from 20 down to 18.00 after 5 years and down to 16.00 after 10 years. If the bonds have been outstanding for four years and 11.00 months, what will the price of the bonds be if the stock price is $64.90? Assume the bonds carry no conversion premium. (Do not round intermediate calculations and round your answer to 2 decimal places.)
  

c. Further assume that you anticipate that the common stock price will be up to $68.80 in two months. Considering the conversion feature, should you convert now or continue to hold the bond for at least two more months?

Bondholders will most likely convert their bonds to shares of common stock. Bondholders will most likely allow their bonds to be called.

Explanation / Answer

Bonds Callable at 1020 $ Conversion Ratio 20 shares of common stock Current Selling Price 61.5 $ Value of 20 Shares =20*61.5 Value of 20 Shares 1230 $ Now if Bond holders convert the same into equity at conversion rate they shall get a value of 1230$ If they allow the call the firm is liable to pay only 1020$ Under curent market price and converison ratio it is better to go for conversion Bondholders will most likely conver their bonds to shares of common stock

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