2. Consider a firm which is currently worth $400,000. There is a 62% chance that the ex-coupon firm value will increase by 35% and a 38% chance that it will decrease by

26%. Two corporate securities are outstanding: 150 shares of stock, and 100 callable, convertible bonds that mature two year later. Each bond has a face value of $1,000

and pays annual coupon at a rate of 10%. If bondholders decide to convert, they can convert at a ratio of half-a-share per bond and receive no accrued interest. Anytime

before maturity, stockholders can call the bonds for a fixed call price of $1,200 plus the accrued interest. The firm pays no dividends. The risk-free rate of interest is

constant at 8% per year. When the bonds are called, bondholders have the choice to convert the bonds into the stocks.

(a) What is the current market price per unit of the callable, convertible bonds?

(b) What is the option value of the convertibility provision per bond if the bonds are not callable?

(c) What is the option value of the call provision per bond if the the bonds are not convertible?

(d) What can you conclude from parts (a), (b), and (c)?