Suppose you find two bonds identical in all respects except that Bond A is convertible to common stock and Bond B is not.Bond A is priced at $1,245 and Bond B is priced at $1,120.Bond A has a promised yield to maturity of 5.6% and Bond B has a promised yield to maturity of 6.7%.The stock of Bond A is trading at $49.80 per share.Which of the following statements is/are correct?
I.The value of the conversion option for Bond A is $125.
II.The lower promised yield to maturity of Bond A indicates that the bond is priced according to its straight debt value rather than its conversion value.
III.Bond A can be converted into 25 shares of stock.
A) II only
B) I and III only
C) III only
D) I, II and III

Question

Quizplus · Accepted Answer

I. The value of the conversion option for Bond A can be calculated by subtracting the market value of the bond from the conversion value of the bond. The conversion value can be calculated by multiplying the conversion ratio (which is 1/25 as stated in III) with the market price of the stock (which is $49.80). Therefore, the value of the conversion option for Bond A is (1/25) x $49.80 - $1,245 = $125.
II. Since Bond A is priced lower than Bond B, it indicates that the market is valuing Bond A according to its conversion value rather than its straight debt value. Therefore, this statement is not correct.
III. Bond A can be converted into 1/($1,245/$1,000) = 1.207 shares of stock, which is rounded down to 1 share of stock. Since the conversion ratio is 25, Bond A can be converted into 25 shares of stock. Therefore, this statement is correct.

Suppose You Find Two Bonds Identical in All Respects Except