Question

# Vernon Glass Company has \$20 million in 10 percent, \$1,000 par value convertible bonds outstanding. The...

Vernon Glass Company has \$20 million in 10 percent, \$1,000 par value convertible bonds outstanding. The conversion ratio is 40, the stock price is \$22, and the bond matures in 15 years. The bonds are currently selling at a conversion premium of \$55 over their conversion value.

If the price of the common stock rises to \$28 on this date next year, what would your rate of return be if you bought a convertible bond today and sold it in one year? Assume on this date next year, the conversion premium has shrunk from \$55 to \$20. (Hint: Calculate rate of return as (Future bond price − Current bond price + Interest earnings) / Current bond price))

Coupon payment = 1000 * 10% = \$ 100

Current convertible bond price = ( current Stock price * conversion ratio ) + Conversion premium

=( 22 * 40) + 55

current convertible bond price = \$ 935

After One year, Convertible bond price :-

Bond price = ( current Stock price * conversion ratio ) + Conversion premium

= (28 * 40) + 20

Bond price after one year = \$ 1140.

Rate of return = ( Bond price after one year + Coupon payment - current bond price ) / current bond price

=( 1140 +100 - 935) / 935

Rate of return =32.62%