Corporation RTY has the following convertible bond outstanding:

Coupon ........7%

Principal ........$1,000

Maturity ........10 years

Conversion price ....$64.516

Call price ........$1,000 + one year’s interest

The bond’s credit rating is A. Other bonds issued by the company have a AA rating. Comparable AA-rated bonds yield 9 percent, and A-rated bonds yield 10 percent. The firm’s stock is selling for $60 and pays a dividend of $2 a share. The convertible bond is selling for par ($1,000).

a) What is the value of the bond in terms of stock?

b) What is the premium paid over the bond’s value as stock?

c) What is the bond’s income advantage?

d) Given the bond’s income advantage, how long must the investor hold the bond to overcome the premium over the bond’s value as stock?

e) What is the probability that the firm will currently call the bond?

f) If after three years the price of the stock has risen annually by 10 percent to $80, what must have happened to the price of the bond?

g) If the price of the bond rises to $1,240 at the end of three years, what is the total percentage return (i.e., the holding period return) the investor earns on the stock and on the bond?

h) Why is the holding period return misleading?

i) If the price of the bond rises to $1,240 at the end of three years, what is the annualized return the investor earns? Does this return exceed the return earned on the stock?

j) If the stock is split 2 for 1, what impact will that have on the price of a convertible bond?

k) If the convertible bond is held to maturity, what does the investor receive? What is the annualized return?

l) If the price of the stock rises to $90 a share while interest rates on A-rated bonds rise to 12 percent, what impact does the increase in interest rates have on this convertible bond?