Your next significant task as financial manager of the Alpha-Beta Group (ABG) is to price several types of bonds considering various market conditions for your Chief Executive Officer. You must utilize your extensive knowledge of finance and make bond decisions for the boss and answer the following scenarios provided for your firm.
Coupon Issue Zero Coupon Perpetual Convertible
Maturity 5 years 5 years Infinity 5 years
Coupon rate 6 percent Zero 6 percent 5 percent
A. If the market yield is 7 percent, what are the values of the three first bonds (assume a face value of $1,000)?
B. Why are the values of the bonds lower than their face value?
C. Why is the coupon rate for the convertible bond lower than that for the non-convertible coupon issue?
D. Given that the convertible bond is trading at $1,040, what is the value of the option to convert?
E. Suppose that the market yield rises to 7.5 percent. What are the bond values at that yield?