A firm issues the convertible debt shown above.The price of stock in this company on July 1,2008 is $6.58.What is the minimum call price that would make a bondholder prefer to accept the call rather than convert?

Question

Quizplus · Accepted Answer

To determine the minimum call price that would make a bondholder prefer to accept the call rather than convert, we need to compare the value of the bond and the conversion value. The conversion value is 10 shares x $6.58 = $65.80. The value of the bond is the present value of the annuity of $3.00 for 5 years plus the present value of the principal of $1,000, both discounted at the 8% yield rate. Using a financial calculator, we get a bond value of $858.05. 
Therefore, the bondholder would prefer to convert as long as the call price is less than $858.05 + $65.80 = $923.85. 
Par value is $1,000, so choice C is the best option as it is the only option that is greater than this amount.

A Firm Issues the Convertible Debt Shown Above