Q12BP The Olsen Mining Company has bee... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 5: Q12BP (page 625)

The Olsen Mining Company has been very successful in the last five years. Its $1,000 par value convertible bonds have a conversion ratio of 32. The bonds have a quoted interest rate of 7 percent a year. The firm鈥檚 common stock is currently selling for $41.30 per share. The current bond price has a conversion premium of $10 over the conversion value.
What is the current price of the bond?
What is the current yield on the bond (annual interest divided by the bond鈥檚 market price)?
If the common stock price goes down to $23.40 and the conversion premium goes up to $100, what will be the new current yield on the bond?

Short Answer

Expert verified

The current price of the bond is $1,332
The current yield is 5.26%
The current yield of the bond is 8.24%

Step by step solution

Meaning of Convertible Bonds

Bonds that have the alternative of being changed into common stocks are converted into convertible bonds. Investors are concerned with two characteristics of convertible bonds: the conversion ratio and the conversion price.

(a) Computing the current price of the bond

$\begin{array}{rcl} C u r r e n t p r i c e o f t h e b o n d & = & (C o n v e r s i o n r a t i o 脳 C o m m o n s t o c k) + C o n v e r s i o n p r e m i u m \\ = & (32 脳 $ 41.30) + 10 \\ = & $ 1, 322 + $ 10 \\ = & $ 1, 332 \end{array}$

(b) Computing current yield on the bond

$\begin{array}{rcl} C u r r e n t y i e l d & = & P a r v a l u e 脳 \frac{I n t e r e s t r a t e}{C u r r e n t p r i c e} \\ = & 1, 000 脳 \frac{7 %}{1, 332} \\ = & 5.26 % \end{array}$

(c) Calculating new current year yield

With the changes, we first compute the current price of the bond

$\begin{array}{rcl} N e w p r i c e o f t h e b o n d & = & (C o n v e r s i o n r a t i o 脳 C o m m o n s t o c k) + C o n v e r s i o n p r e m i u m \\ = & (32 脳 $ 23.40) + 100 \\ = & $ 749 + $ 100 \\ = & $ 849 \end{array}$

Then the current yield of the bond is:

$\begin{array}{rcl} C u r r e n t y i e l d o f t h e b o n d & = & P a r v a l u e 脳 \frac{I n t e r e s t r a t e}{C u r r e n t p r i c e} \\ = & 1, 000 脳 \frac{7 %}{849} \\ = & 8.24 % \end{array}$

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Short Answer

Step by step solution

Meaning of Convertible Bonds

(a) Computing the current price of the bond

(b) Computing current yield on the bond

(c) Calculating new current year yield

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