Problem 1) Find the conversion (or stock) value for each of the $1,000-par-value convertible bonds described in the following table.
Convertible Conversion Ratio Current Market Price of Stock
A 25 $42.25
B 16 $50.00
C 20 $44.00
D 5 $19.50
Problem 2) Common stock versus warrant investment Tom Baldwin can invest $6,300 in the common stock or the warrants of Lexington Life Insurance. The common stock is currently selling for $30 per share. Its warrants, which provide for the purchase of two shares of common stock at $28 per share, are currently selling for $7. The stock is expected to rise to a market price of $32 within the next year, so the expected theoretical value of a warrant over the next year is $8. The expiration date of the warrant is 1 year from the present.
a. If Mr. Baldwin purchases the stock, holds it for 1 year, and then sells it for $32, what is his total gain? (Ignore brokerage fees and taxes.)
b. If Mr. Baldwin purchases the warrants and converts them to common stock in 1 year, what is his total gain if the market price of common shares is actu¬ally $32? (Ignore brokerage fees and taxes.)
c. Repeat parts a and b, assuming that the market price of the stock in I year is (1) $30 and (2) $28.
d. Discuss the two alternatives and the tradeoffs associated with them.
Problem 3) Carol Krebs is considering buying 100 shares of Sooner Products, Inc., at $62 per share. Because she has read that the firm will probably soon receive certain large orders from abroad, she expects the price of Sooner to increase to $70 per share. As an alternative, Carol is considering purchase of a call option for 100 shares of Sooner at a striking price of $60. The 90-day option will cost $600. Ignore any brokerage fees or dividends.
a. What will Carol's profit be on the stock transaction if its price does rise to $70 and she sells?
b. How much will Carol earn on the option transaction if the underlying stock price rises to $70?
c. How high must the stock price rise for Carol to break even on the option transaction?
Problem 4) Ed Martin, the pension fund manager for Stark Corporation, is considering purchase of a put option in anticipation of a price decline in the stock of Carlisle, Inc. The option to sell 100 shares of Carlisle, Inc., at any time during the next 90 days at a striking price of $45 can be purchased for $380. The stock of Carlisle is currently selling for $46 per share.
a. Ignoring any brokerage fees or dividends, what profit or loss will Ed make if he buys the option and the lowest price of Carlisle stock during the 90 days is $46, $44, $40, and $35?
b. What effect would the fact that the price of Carlisle stock slowly rose from its initial $46 level to $55 at the end of 90 days have on Ed's purchase?