Problem: Consider a Convertible Bond with Par value of $1,000, Coupon rate of 9.5%. The Market price of the convertible bond is $1,000, the Conversion ratio is 37.383, the estimated straight value of bond is $510 and the Yield to maturity of straight bond is 18.7%. Assume that the price of the common stock is $23 and that the dividend per share is $0.75 per year.
(a) Calculate each of the following:
(i) Conversion value, (ii) Market conversion price, (iii), Conversion premium per share, (iv) Conversion premium ratio, (v) Premium over straight value, (vi) Favorable income differential per share, and (vii) Premium payback period.
(b) Suppose that the price of the common stock increases from $23 to $46. Answer the following:
(i) What will be the approximate return realized from investing in the convertible bond?
(ii) What would be the return realized if $23 had been invested in the common stock?
(iii) Why would the return on investing in the common stock directly be higher than investing in the convertible bond?
(c) Suppose that the price of the common stock declines from $23 to $8. Answer the following questions:
(i) What will be the approximate return realized from investing in the convertible bond?
(ii) What would be the return realized if $23 had been invested in the common stock?
(iii) Why would the return on investing in the convertible bond be higher than investing in the common stock directly?