Emerson Electrical Engineering Inc.is issuing new 20-year bonds that have warrants attached.If not for the attached warrants,the bonds would carry an 11% interest rate.However,with the warrants attached the bonds will pay a 9% annual coupon.There are 25 warrants attached to each bond,which have a par value of $1,000.The exercise price of the warrants is $25.00 and the expected stock price 10 years from now (when the warrants may be exercised)is $50.77.What is the investor's expected overall pre-tax rate of return for this bond-with-warrants issue?

Question

Quizplus · Accepted Answer

The investor's expected overall pre-tax rate of return is calculated by considering both the lower coupon rate due to the warrants and the potential gain from exercising the warrants. The warrants allow the investor to buy stock at a lower price than the expected future price, providing additional return. The combination of the 9% coupon and the value of the warrants results in an expected return of 11.79%.