Fifteen years ago, Roop Industries sold $400 million of convertible bonds. The bonds had a 40-year maturity, a 5.75% coupon rate, and paid interest annually. They were sold at their $1,000 par value. The conversion price was set at $62.75, and the common stock price was $55 per share. The bonds were subordinated debentures and were given an A rating; straight nonconvertible debentures of the same quality yielded about 8.75% at the time Roop’s bonds were issued.
1. The bonds originally sold for $1,000. If interest rates on A-rated bonds had remained constant at 8.75% and if the stock price had fallen to$32.75, then what do you think would have happened to the price of the convertible bonds? (Assume no change in the standard deviation of stock returns.)
2. Now suppose that the price of Roop’s common stock had fallen from $55 on the day the bonds were issued to$32.75 at present, 15 years after the issue. Suppose also that the interest rate on similar straight debt had fallen from 8.75% to5.75%.
Under these conditions, what is the current price of the straight-bond portion of the convertible bond?
What is the current value if a bond holder converts a bond?
What do you think would have happened to the price of the bonds?