A warrant is attached to a $1,000 par, 10 percent, 10-year bond, paying annual interest and having 20 warrants attached for the purchase of a firm's stock. The bonds were initially sold for $1,200. When issued, similar risk, straight bonds were selling at a 14 percent rate of return. The implied price of the warrant is ________.
A) $10.40
B) $20.40
C) $10.00
D) $20.00

Question

Quizplus · Accepted Answer

First, we need to calculate the straight bond price when issued at a 14% rate of return:
PV = 1000/1.14 + 1000/((1.14)^2) + ... + 1000/((1.14)^10) = $678.92
Next, we need to allocate the bond price between the bond and the warrants:
$1,200 = bond price + warrant price
bond price = $1,200 - warrant price
Now, we can use the warrant formula to solve for the implied warrant price:
warrant price = ($1,200 - $678.92)/(20) = $26.055
Therefore, the implied price of the warrant is $20.40, which is the closest answer choice.

A Warrant Is Attached to a $1,000 Par, 10 Percent