(This question is from CFA Examination III, June 1, 1991, Afternoon Session, Question 13.) Simon Evans, CFA, is researching SOC Corporation, a company that has issued both convertible and straight bonds. A major broker/dealer makes an over-the-counter market in options on SOC's common stock. Evans is consid- ering two possible portfolios: Portfolio X: five SOC convertible bonds (total par value $5,000) with a con- version ratio of 20 Portfolio Y: five SOC straight bonds (total par value $5,000) and a call option for 100 SOC shares Evans believes that portfolios X and Y are similar in some ways, because each portfolio holds SOC bonds and rights to own SOC stock. In preparing to make a portfolio decision, Evans obtained the current information presented in the following table: SOC Bonds Data Coupon Convertible 5.5% Straight 10.5% Maturity 5 years 5 years Conversion ratio 20.0 - 93.75 100.00 7.0% 10.5% Market price Yield to maturity SOC call/option data (American style): strike price expiration date $50.00 5 years call premium = $7.50

a. Certain steps are required to change each portfolio from SOC bonds to SOC common stock. Using only the information provided here, compare portfolios X and Y with respect to each of the following: Transactions required to change holdings from bonds to stocks Parties involved in the transactions Potential risks or costs associated with the changes

b. Complete the following table. (Use 8.5302 as the present value of an ordinary annuity of $1 paid semiannually for five years discounted at a 6% risk-free an- nual discount rate.)

Straight SOC Bonds Convertible SOC Bonds Difference Cost of five bonds Dollar amount of semiannual coupon for five bonds Present value of cash flow differences

c. Recommend and justify the purchase of either portfolio X or portfolio Y, using your analysis in parts a and b.AppendixLO1