Rich McDonald, CFA, is evaluating his investment alternatives in Ytel Incorporated by analyzing a Ytel convertible bond and Ytel common equity. Characteristics of the two securities are given in the following exhibit:

a. Calculate, based on the exhibit, the:
i. Current market conversion price for the Ytel convertible bond.
ii. Expected 1-year rate of return for the Ytel convertible bond.
iii. Expected 1-year rate of return for the Ytel common equity.
One year has passed and Ytel’s common equity price has increased to $51 per share. Also, over the year, the interest rate on Ytel’s nonconvertible bonds of the same maturity increased, while credit spreads remained unchanged.
b. Name the two components of the convertible bond’s value. Indicate whether the value of each component should decrease, stay the same, or increase in response to the:
i. Increase in Ytel’s common equity price.
ii. Increase in interestrates.

Transcribed Image Text:

Characteristics Convertible Bond Common Equity Par value Coupon (annual payment) Current market price Straight bond value Conversion ratio Conversion option Dividend Expected market price in 1 year 1,000 4% $980 $925 25 At any time $35 per share $0 $45 per share 1,125