Question #52 - Reading 27 Valuation and Analysis of Bonds With Embedded Options

Reading: Reading 27 Valuation and Analysis of Bonds With Embedded Options - Anwers

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Shared Context

- Assuming the common stock of MediSoft underwent a one-for-two reverse split, how would the features of the company's bonds be adjusted? The: A) conversion value of the convertible bond would be reduced by half. B) market conversion price of the convertible bond would be reduced by half. C) conversion ratio of the convertible bond would be reduced by 50%. Explanation A stock split would affect the market price of the common stock and the conversion ratio of a convertible bond. Since the split is a one-for-two split, the number of shares outstanding in the marketplace will be reduced by one half. Therefore, the stock price will double, keeping the total market value of the stock the same. Upon a stock split (or a reverse stock split), the conversion ratio is adjusted to reflect the split. In this case, the conversion ratio would be reduced by half. The market conversion price would double (the price of the bond is unchanged, but the conversion ratio decreases by 50%). (Module 27.8, LOS 27.o)

Question

Subsequent to purchasing one of the putable bonds for his portfolio, one of the managers at Brown & Associates realized that the bond contained a soft put. Which of the following securities cannot be used to redeem the bond in the event the bond becomes putable?

Answer Choices:

A. Thirty-year Treasury notes with a coupon of 4.5%

B. MediSoft’s 9.0% subordinated notes with a maturity of 10 years

C. Shares of MediSoft’s common stock. Explanation A bond with an embedded soft put is redeemable through the issuance of cash, subordinated notes, common stock, or any combination of these three securities. In contrast, a bond with a hard put is only redeemable using cash. (Module 27.1, LOS 27.a)

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