Question 7: Dash Incorporated has the following convertible bond outstanding:
Coupon 5%
Principal $1,000
Maturity 12 years
Conversion price $33.34
Conversion ratio 30 shares
Call price 1,000 + one year’s interest
The bond’s credit rating is BB, and comparable BB-rated bonds yield 9 percent. The firm’s stock is selling for $25 and pays a dividend of $0.50 a share. The convertible bond is selling for $1,000.
a) what is the premium paid over the bond’s value as debt? What justifies this premium?
b) Given the bond’s income advantage, how long must the investor hold the bond to overcome the premium over the bond’s value as stock?
c) If the price of the stock were to decline by 50 percent, what is the worst performance that the bond should experience and why?
d) If after four years the price of the stock has risen to $40, what is the minimum percentage increase in the bond’s price?
e) If the company pay a 20 percent stock dividend (i.e., not a cash dividend), what impact will that payment have on the price of the convertible bond?
f) If the bond is not converted, what does the investor receive when the bond matures? What is the annual return on the investment?
g) Is there any reason to expect that the firm will currently call the bond?
h) If the price doubles and if the bond is call and investors do not convert, what do they receive?
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