Question #10
Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers
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Question
Suppose that the stock price of a common stock increases by 10%. Which of the following is most accurate for the price of the recently issued convertible bond? The value of the convertible bond will:
Answer Choices:
A. increase by 10%
B. increase by less than 10%
C. remain unchanged. Explanation When the underlying stock price rises, the convertible bond will underperform because of the conversion premium. However, buying convertible bonds in lieu of stocks limits downside risk. The price floor set by the straight bond value causes this downside protection. (Module 27.8, LOS 27.q) V1,U = = 97.38 V 1,L = = 99.98 V0 = = 98.71 ( + 4) 98.07 + 99.95 2 1.057798 ( + 3.8743) 100 + 99.95 2 1.038743 ( + 2) 97.38 + 99.98 2 1.02 V1,U = = 97.38 V 1,L = = 99.98 V0 = = 98.71 ( + 4) 98.07 + 99.95 2 1.057798 ( + 3.8743) 100 + 99.95 2 1.038743 ( + 2) 97.38 + 99.98 2 1.02
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