4. Convertible bonds, warrants, and other exotic bond features As the name suggests, convertible bonds allow the owner the option to convert the bonds into a fixed number of shares of common stock. Jorge bought APJ Inc.'s convertible bond at par ($1,000) with a yield of 3.25%. This bond had a conversion ratio of 25:1 at the price of $40 per share. If APJ Inc.'s shares are currently trading at $48 per share, should Jorge convert his bond into shares? Which of the following best describes the difference between a convertible bond and a warrant? Convertible bonds give the investor the option to exchange bonds for shares at a certain price, whereas warrants give the investor the option to buy shares at a certain price. Convertible bonds give the investor the option to buy shares at a certain price, whereas warrants give the investor the option to exchange bonds for shares at a certain price. Consider the case of an investor, Nazim: Nazim wants to include bonds in his investment portfolio, but he wants the option to sell the bond to the issuer at a specified price at a certain date before the maturity of the bond. Which of the following bond redemption features should he pick? Convertible bond Putable bond Nazim also recently bought bonds with a clause stating that interest will be paid based on the inflation rate. When the inflation rate increases, the interest on the bonds will also increase. Nazim has invested in 3. More on the characteristics of bonds Based on the descriptions given in the following table, identify the type of bond that best matches each description: Type of Bond Description Bonds that are offered at a price lower than their par value at the time of issue Bonds that pay coupons in the form of additional bonds Suppose you invested in company A's bonds and the company used a large amount of that debt to acquire another firm. (Such a deal is called a leveraged buyout.) This deal led to significant losses for bondholders and had a negative impact on the firm's credit risk. the yield to maturity will and the value of its outstanding In such a situation, the company's bond rating is likely to bonds will Due to the impact that sudden events could have in the value of bonds, event risk covenants, or provisions, are included in the issuance of some corporate bonds. This covenant allows the bondholder to turn in, or put, a bond back to the issuer of the bond at par if a takeover, merger, or a major change in the company's capital structure were to occur. Such a bond is called a 5. The valuation of bonds Seattle Seafood Company (SSC) has an issue of 8-year, 11% annual coupon bonds outstanding. The bonds, which were originally issued 12 years ago, have a face value (FV) of $1,000, a yield to maturity (YTM) of 7%, and are noncallable. What is the current market price of SSC's bonds? (Note: Do not round your intermediate calculations.) $1,053.02 $1,238.85 $1,362.74 $1,548.56 Are the bonds of Seattle Seafood Company selling at a discount, at par, or at a premium? Premium Par Discount What is the current yield on Seattle Seafood Company's outstanding bonds? 10.45% 8.07% 8.88% 7.10% Seattle Seafood Company (SSC) has an issue of 8-year, 11% annual coupon bonds outstanding. The bonds, which were originally issued 12 years ago, have a face value (FV) of $1,000, a yield to maturity (YTM) of 7%, and are noncallable. What is the current market price of SSC's bonds? (Note: Do not round your intermediate calculations.) $1,053.02 $1,238.85 $1,362.74 $1,548.56 Are the bonds of Seattle Seafood Company selling at a discount, at par, or at a premium? Premium Par Discount What is the current yield on Seattle Seafood Company's outstanding bonds? 10.45% 8.07% 8.88% 7.10% What is the expected one-year capital gain yield on the bonds of Seattle Seafood Company? -1.88% -1.71% -1.50% 1200 A 1100 B 1000 900 800 700 600 10 8 6 4 2 0 YEARS TO MATURITY Johnson Based Irwin eding information, which of the following statements are true? Check all that apply. Smith ected capital gains yield for Irwin's bonds is greater than 12%. Smith's bonds have the highest expected total return. The expected capital gains yield for Irwin's bonds is negative. The bonds have the same expected total return. Smith just registered and issued its bonds, which will be sold in the bond market for the first time. Smith's bonds would be referred to as A bond investor is analyzing the following annual coupon bonds: Issuing Company Annual Coupon Rate Smith Enterprises 6% Irwin Incorporated 12% Johnson Metalworks 9% Each bond has 10 years until maturity and has the same risk. Their yield to maturity (YTM) is 9%. Interest rates are assumed to remain constant over the next 10 years. Identify the curves on the following graph to indicate the path that each bond's price, or value, is expected to follow. BOND VALUE IS1 1200 1100 B 1000 900 800 700 600 10 8 4 2 0 YEARS TO MATURITY 4. Convertible bonds, warrants, and other exotic bond features As the name suggests, convertible bonds allow the owner the option to convert the bonds into a fixed number of shares of common stock. Jorge bought APJ Inc.'s convertible bond at par ($1,000) with a yield of 3.25%. This bond had a conversion ratio of 25:1 at the price of $40 per share. If APJ Inc.'s shares are currently trading at $48 per share, should Jorge convert his bond into shares? Which of the following best describes the difference between a convertible bond and a warrant? Convertible bonds give the investor the option to exchange bonds for shares at a certain price, whereas warrants give the investor the option to buy shares at a certain price. Convertible bonds give the investor the option to buy shares at a certain price, whereas warrants give the investor the option to exchange bonds for shares at a certain price. Consider the case of an investor, Nazim: Nazim wants to include bonds in his investment portfolio, but he wants the option to sell the bond to the issuer at a specified price at a certain date before the maturity of the bond. Which of the following bond redemption features should he pick? Convertible bond Putable bond Nazim also recently bought bonds with a clause stating that interest will be paid based on the inflation rate. When the inflation rate increases, the interest on the bonds will also increase. Nazim has invested in 3. More on the characteristics of bonds Based on the descriptions given in the following table, identify the type of bond that best matches each description: Type of Bond Description Bonds that are offered at a price lower than their par value at the time of issue Bonds that pay coupons in the form of additional bonds Suppose you invested in company A's bonds and the company used a large amount of that debt to acquire another firm. (Such a deal is called a leveraged buyout.) This deal led to significant losses for bondholders and had a negative impact on the firm's credit risk. the yield to maturity will and the value of its outstanding In such a situation, the company's bond rating is likely to bonds will Due to the impact that sudden events could have in the value of bonds, event risk covenants, or provisions, are included in the issuance of some corporate bonds. This covenant allows the bondholder to turn in, or put, a bond back to the issuer of the bond at par if a takeover, merger, or a major change in the company's capital structure were to occur. Such a bond is called a 5. The valuation of bonds Seattle Seafood Company (SSC) has an issue of 8-year, 11% annual coupon bonds outstanding. The bonds, which were originally issued 12 years ago, have a face value (FV) of $1,000, a yield to maturity (YTM) of 7%, and are noncallable. What is the current market price of SSC's bonds? (Note: Do not round your intermediate calculations.) $1,053.02 $1,238.85 $1,362.74 $1,548.56 Are the bonds of Seattle Seafood Company selling at a discount, at par, or at a premium? Premium Par Discount What is the current yield on Seattle Seafood Company's outstanding bonds? 10.45% 8.07% 8.88% 7.10% Seattle Seafood Company (SSC) has an issue of 8-year, 11% annual coupon bonds outstanding. The bonds, which were originally issued 12 years ago, have a face value (FV) of $1,000, a yield to maturity (YTM) of 7%, and are noncallable. What is the current market price of SSC's bonds? (Note: Do not round your intermediate calculations.) $1,053.02 $1,238.85 $1,362.74 $1,548.56 Are the bonds of Seattle Seafood Company selling at a discount, at par, or at a premium? Premium Par Discount What is the current yield on Seattle Seafood Company's outstanding bonds? 10.45% 8.07% 8.88% 7.10% What is the expected one-year capital gain yield on the bonds of Seattle Seafood Company? -1.88% -1.71% -1.50% 1200 A 1100 B 1000 900 800 700 600 10 8 6 4 2 0 YEARS TO MATURITY Johnson Based Irwin eding information, which of the following statements are true? Check all that apply. Smith ected capital gains yield for Irwin's bonds is greater than 12%. Smith's bonds have the highest expected total return. The expected capital gains yield for Irwin's bonds is negative. The bonds have the same expected total return. Smith just registered and issued its bonds, which will be sold in the bond market for the first time. Smith's bonds would be referred to as A bond investor is analyzing the following annual coupon bonds: Issuing Company Annual Coupon Rate Smith Enterprises 6% Irwin Incorporated 12% Johnson Metalworks 9% Each bond has 10 years until maturity and has the same risk. Their yield to maturity (YTM) is 9%. Interest rates are assumed to remain constant over the next 10 years. Identify the curves on the following graph to indicate the path that each bond's price, or value, is expected to follow. BOND VALUE IS1 1200 1100 B 1000 900 800 700 600 10 8 4 2 0 YEARS TO MATURITY