Corporation HBM has a convertible bond with the following terms:
   Coupon                       5%
   Principal                   $1,000
   Maturity                    10 years
   Conversion price             $50 (20 shares)
   Call price               $1,000 + one year's interest

The bond's credit rating is BBB, and comparable BBB rated bonds yield 9 percent.

The firm's stock is selling for $45 and pays a dividend of $1.50 a share. The convertible bond is selling for $1,000.

a. What is the premium paid over the bond's value as stock?

b. Given the bond's income advantage, how long must the investor hold the bond to overcome the premium over the bond's value as stock?

c. If the price of the bond stock to $65, is there any reason to expect the firm to call the bond?

d. If the convertible bond is held to maturity, what is the annualized return on an investment in the bond?

e. If the price of the stock declines to $25 a share while interest rates on BBB rated bonds rise to 12 percent, what impact does the increase in interest rates have on this convertible bond?

Question

Corporation HBM has a convertible bond with the following terms: 
      Coupon                       5% 
      Principal                   $1,000 
      Maturity                    10 years 
      Conversion price             $50 (20 shares)
      Call price               $1,000 + one year's interest 
 ​ 
 The bond's credit rating is BBB, and comparable BBB rated bonds yield 9 percent. 
 ​ 
 The firm's stock is selling for $45 and pays a dividend of $1.50 a share. The convertible bond is selling for $1,000. 
 ​ 
 a. What is the premium paid over the bond's value as stock? 
 ​ 
 b. Given the bond's income advantage, how long must the investor hold the bond to overcome the premium over the bond's value as stock? 
 ​ 
 c. If the price of the bond stock to $65, is there any reason to expect the firm to call the bond? 
 ​ 
 d. If the convertible bond is held to maturity, what is the annualized return on an investment in the bond? 
 ​ 
 e. If the price of the stock declines to $25 a share while interest rates on BBB rated bonds rise to 12 percent, what impact does the increase in interest rates have on this convertible bond?

Quizplus · Accepted Answer

The Answer of Corporation HBM has a convertible bond with the following terms: 
      Coupon                       5% 
      Principal                   $1,000 
      Maturity                    10 years 
      Conversion price             $50 (20 shares)
      Call price               $1,000 + one year's interest 
 ​ 
 The bond's credit rating is BBB, and comparable BBB rated bonds yield 9 percent. 
 ​ 
 The firm's stock is selling for $45 and pays a dividend of $1.50 a share. The convertible bond is selling for $1,000. 
 ​ 
 a. What is the premium paid over the bond's value as stock? 
 ​ 
 b. Given the bond's income advantage, how long must the investor hold the bond to overcome the premium over the bond's value as stock? 
 ​ 
 c. If the price of the bond stock to $65, is there any reason to expect the firm to call the bond? 
 ​ 
 d. If the convertible bond is held to maturity, what is the annualized return on an investment in the bond? 
 ​ 
 e. If the price of the stock declines to $25 a share while interest rates on BBB rated bonds rise to 12 percent, what impact does the increase in interest rates have on this convertible bond?

Corporation HBM Has a Convertible Bond with the Following Terms