Question

. Masco is issuing new 15-year convertible bonds that can be exchanged for 40 shares of stock. The current stock price is 23. If not for the convertibility feature, the bonds would carry a 9% interest rate. However, with the convertibility feature attached the bonds will pay a 7% annual coupon and can still be issued at the par value of $1,000. What is the value of the conversion premium?

a) $20             b) $80              c) $160            d) $210       

Answer 1

K = N

Bond Price =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =15

Bond Price =∑ [(7*1000/100)/(1 + 9/100)^k]     +   1000/(1 + 9/100)^15

k=1

Bond Price = 838.79

Value of share upon exercise of convertible option=

40*23 = 920

Value of convertibility feature = Value of share upon exercise of convertible option-bond price

=920-838.79 =~ 80