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Fundamentals of Investment Management

10th Edition
by Geoffrey Hirt and Stanley Block
541 Solutions 22 Chapters 3428 Studied ISBN: 9780078034626 Finance 5 (1)

Chapters 13: Comparative_analysis 1

8. Assume you bought a convertible bond two years ago for $900. The bond has a conversion ratio of 32. When the bond was purchased, the stock was selling for $25 per share. The bond pays $75 in annual interest. The stock pays no cash dividend. Assume after two years the stock price rises to $35 and the firm forces investors to convert to common stock by calling the bond (there is no conversion premium at this time).

Would you have been better of off you (a) had bought the stock directly or (b) bought the convertible bond and eventually converted it to common stock? Assume you would have invested $900 in either case. Disregard taxes, commissions, and so forth. (Hint: Consider appreciation in value plus any annual income received. See Table 3 on page 346 for an example.)

13-1

Step-By-Step Solution

8.

 

Amount Invested

Shares

Ending Stock Price

Ending Value

Total Interest

Total Value

Stock

$900

36*

$35

$1,260

-0-

$1,260

Convertible Bond

$900

32

$35

1,120

$150

$1,270

*36 = $900 invested $25 original common stock price

You would have been slightly better off buying the convertible.

13-1

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