Question

(a) HSU has announced a rights offer to issue 2,000,000 new shares at a $11 subscription price. There are 5,000,000 shares outstanding trading at $12 each. Calculate the ex-rights price and the value of a right. (Show your calculations).

(b) HSU issued an annual coupon convertible bond with a coupon rate of 10% and a face value of $1,000. The bond will mature 2 years from today. The annual market interest rate is 10%. The conversion ratio is 40 shares. The current stock price is $35 per share.

(i) Calculate the option value of the bond if each convertible bond is trading at $1,520. (Show your calculations).

(ii) Explain the meaning of your answer in part (i) above.

Answer 1

The Formula for Theoretical Ex rights price = [New shares* Issue price + Old shares* Market price]/ New shares + Old shares

= [11*2000000+ 12*5000000] / 2000000+ 5000000

= 11.714

Rights Value = Price before rights issue - Price of Subscription / Total shares after issue

= 12- 11/ 2+5

= 0.142

Part B.

Now we have the Bond that is trading at $ 1520

Total number of shares = 40

Price of Shares = 35

Total Option Value of a bond = 40*35

= 1400

The interpretaion is that the Bond though trading at the market price of $ 1520 is not worth the price because of the fact that the option value conversion of the bond gives us the value of 1400 only which is at discount 7.89 %