Assume a 4 year maturity 5% annual coupon convertible bond is issued at par. It has conversion ratio of 20 shares of common stock for each bond of $1,000 par value. At the time of issue, the common stock trades at $40 per share. Two years after issue, the interest rates didn’t change, but the common stock trades at $60 per share and the bond trades at 125.5% of par value. Answer the following assuming two years after issue.
a) What is the conversion value of the bond?
b) What is the market conversion price per share?
c) What is the value of the conversion option embedded in the bond?
d) Is arbitrage possible? Explain.