Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN: 9781337395083
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
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Chapter 20, Problem 7Q
Summary Introduction
To discuss: Risk and cost of capital of convertible bonds and straight bonds
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Suppose a company simultaneously issues $50 million of convertible bonds with a couponrate of 9% and $50 million of nonconvertible bonds with a coupon rate of 12%. Bothbonds have the same maturity. Because the convertible issue has the lower coupon rate, isit less risky than the nonconvertible bond? Would you regard the cost of capital as beinglower on the convertible than on the nonconvertible bond? Explain. (Hint: Althoughit might appear at first glance that the convertible’s cost of capital is lower, this is notnecessarily the case, because the interest rate on the convertible understates its true cost.Think about this.)
Suppose a company simultaneously issues $50 million of convertiblebonds with a coupon rate of 10% and $50 million of straight bonds with acoupon rate of 14%. Both bonds have the same maturity. Does the convertible issue’s lower coupon rate suggest that it is less risky than the straightbond? Is the cost of capital lower on the convertible than on the straightbond? Explain.
Suppose a company simultaneously issues $50 million of convertible bonds with a coupon rate of10% and $50 million of straight bonds with a coupon rate of 14%. Both bonds have the same maturity. Does the convertible issue’s lower coupon rate suggest that it is less risky than the straight bond? Is the cost of capital lower on the convertible than on the straight bond? Explain. If the project's cost of capital is 12%, should the machine be purchased?
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- You are an investment manager evaluating two corporate bonds, each with a maturity value of $100,000. Each bond matures in exactly 10 years and each bond has a yield-to-maturity (YTM) of 5%. Bond 1 pays a coupon of 8% and Bond 2 pays a coupon of 3%. Without doing any math, which bond trades at a higher price? Which bond is more sensitive to changes in interest rates? If both bonds have the identical maturity date and YTM, then why do they trade at different prices? Is this a violation of The Law of One Price ? If you buy Bond 1, what is the NPV of the cash flows?arrow_forwardConsider a convertible bond as follows: par value = $1,000, coupon rate = 8.00%, market price of convertible bond = $1,100, conversion ratio = 18, straight value of bond = $600, yield to maturity of straight bond = 10%, current price of common stock = $45, dividend per share = $3.00/year. A. What is the favorable income differential per bond (not per share)? B. At what stock price, the realized return from investing in the convertible bond becomes zero? In other words, what is the break-even stock price?arrow_forwardThe following data apply to Saunders Corporation's convertible bonds: Maturity: 10 Stock Price: $30.00 Par value: $1,000.00 Conversion price: $35.00 Annual coupon: 5.00% Straight-debt yield: 8.00% What is the bond's straight-debt value? Based on your answers to the three preceding questions, what is the minimum price (or "floor" price) at which the Saunders' bonds should sell? Please solve the problem by using algebra and formulas instead of excel.arrow_forward
- The following table summarizes the yields to maturity on several one-year, zero-coupon securities: a. What is the price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a AAA rating? b. What is the credit spread on AAA-rated corporate bonds? c. What is the credit spread on B-rated corporate bonds? d. How does the credit spread change with the bond rating? Why?arrow_forwardAssume you make the following investments: A $10,000 investment in a 10-year T-bond that yields 6.00%, and a $20,000 investment in a 10-year corporate bond with an BBB rating and a yield of 8.30%. Based on this information, and the knowledge that the difference in liquidity risk premiums between the two bonds is 0.50%, what is your estimate of the corporate bond's default risk premium? A.) 2.30%? B.) 3.06%? C.) 1.80%? D.) 2.52%?arrow_forwardFielding Systems issued a 10-year corporate bond last year with a coupon rate of 4% p.a. It now trades at a yield to maturity (YTM) of 5% p.a. If the YTM on a comparable government bond is 3% p.a., which of the following statements based on this data is almost certainly true? i) The corporate bond is trading at a premium.ii) The corporate bond is trading at a discount.iii) The corporate bond is probably riskier than the government bond.iv) The corporate bond is a better investment than the government bond.arrow_forward
- General Matter’s outstanding bond issue has a coupon rate of 9.2%, and it sells at a yield to maturity of 7.60%. The firm wishes to issue additional bonds to the public. What coupon rate must the new bonds offer in order to sell at face value?arrow_forwardBig Red Corp's outstanding bond issue has a coupon rate of 11.4%, and it sells at a yield to maturity of 9.20%. The firm wishes to issue additional bonds to the public. What coupon rate must the new bonds offer in order to sell at face value? (Enter your answer as a percent rounded to 2 decimal places.)arrow_forwarda. What is the price (expressed as a percentage of the face value) of a 1-year, zero-coupon corporate bond with a AAA rating and a face value of $1,000? b. What is the credit spread on AAA-rated corporate bonds? c. What is the credit spread on B-rated corporate bonds? d. How does the credit spread change with the bond rating? Why? Note: Assume annual compounding.arrow_forward
- Lackson PLC and Hardy Corp. both have 8 percent coupon bonds outstanding, withsemiannual interest payments, and both are priced at par value. The Lackson PLC bondhas 2 years to maturity, whereas the Hardy Corp. bond has 15 years to maturity.(i) If interest rates suddenly rise by 2 percent, what is the percentage change in the priceof these bonds? (ii) If interest rates were to suddenly fall by 2 percent instead, what would the percentagechange in the price of these bonds be then? (iii) What does this problem tell you about the interest rate risk of longer-term bonds?arrow_forwardWhich of these five statement is the most correct and why ? a. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond. b. Other things held constant, a corporation would rather issue noncallable bonds than callable bonds. c. Reinvestment rate risk is worse from a typical investor's standpoint than interest rate risk. d. If a 10-year, R1 000 par, zero coupon bond were issued at a price which gave investors a 10 percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium over its R1 000 par value. e. If a 10-year, R1 000 par, zero coupon bond were issued at a price which gave investors a 10 percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a discount below its R1 000 par value.arrow_forwardplease dont put in excel i dont understand that yet Given the following information concerning a convertible bond: Principle: $1,000 Coupons: 5 percent Maturity: 15 years Call Price: $1,050 Conversion price: $37 (i.e., 27 shares) Market Price of the Bond: $1040 Common stock: $30 D.What is the premium in terms of stock that the investor pays when he or she purchases the convertible bond instead of the stock? (I already have an answer for D) E.Nonconvertible bonds are selling with a yield to maturity of 7 percent If this bond lacked the conversion feature, what would the approximate price of the bond be? F.What is the premium in terms of debt that the investor pays when he or she purchases the convertible bond instead of a nonconvertible bond? G.What is the probability that the corporation will call this bond? H.Why are investors willing to pay the premiums mentioned in questions d and f?arrow_forward
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