Kurt owns a convertible bond that matures in three years.The bond has an 8 percent coupon and pays interest semi-annually.The face value of the bond is $1,000 and the conversion price is $25.Similar bonds have a market return of 9.25 percent.The current price of the stock is $26.50 per share.What is the straight bond value?

Question

Quizplus · Accepted Answer

The straight bond value can be calculated using the present value of the bond's future cash flows, which include the semi-annual interest payments and the principal repayment at maturity. Given an 8 percent annual coupon rate on a $1,000 face value bond, the semi-annual interest payment is $40 ($1,000 * 8% / 2). The bond matures in three years, so there are 6 periods. The market return for similar bonds is 9.25 percent annually, or 4.625 percent semi-annually. The present value of the interest payments (an annuity) can be calculated using the formula PV = PMT * [(1 - (1 + r)^-n) / r], where PMT is the payment per period, r is the discount rate per period, and n is the number of periods. The present value of the principal repayment can be calculated using the formula PV = F / (1 + r)^n, where F is the face value. Adding these two present values together gives the straight bond value.PV of interest payments = $40 * [(1 - (1 + 0.04625)^-6) / 0.04625] = $214.89PV of principal = $1,000 / (1 + 0.04625)^6 = $752.99Straight bond value = $214.89 + $752.99 = $967.88, which rounds to $967.89, so the correct answer is B.

Kurt Owns a Convertible Bond That Matures in Three Years