a Question 1 (25 points) Consider a firm that pays no dividends on the stock at time 1. The firm has an opportunity to invest an asset that yield 25% or -25% per period with equal probability. If any cash payout, coupon and/or dividend, is made at time 1, then the ex-payout firm value will change by either +25% or -25% over the second period. Suppose the risk-free interest rate is 8% per period effectively. (a) The firm issued a callable bond at time 0 and now the firm has 150 in cash and will invest all the cash into the asset. The callable bond has a coupon rate of 12% and matures at the end of 2 periods. The face value is 100. The call price on an ex-coupon basis is 100. What is the market price of this callable bond? in (b) Suppose instead of a callable bond, the firm issued a convertible bond and now the firm has 150 in cash and invest all the cash into the asset. The convertible bond has a coupon rate of 12% and matures at the end of 2 periods. The face value is 100. The dilution ratio is 60%. What is the market price of this convertible bond? (c) Compare a straight bond, a callable bond and a convertible bond with same coupon rate, face value and time to maturity, which one is the most expensive? Which one is the cheapest? Explain. (There is no need to calculate the price of the straight bond.) met a Question 1 (25 points) Consider a firm that pays no dividends on the stock at time 1. The firm has an opportunity to invest an asset that yield 25% or -25% per period with equal probability. If any cash payout, coupon and/or dividend, is made at time 1, then the ex-payout firm value will change by either +25% or -25% over the second period. Suppose the risk-free interest rate is 8% per period effectively. (a) The firm issued a callable bond at time 0 and now the firm has 150 in cash and will invest all the cash into the asset. The callable bond has a coupon rate of 12% and matures at the end of 2 periods. The face value is 100. The call price on an ex-coupon basis is 100. What is the market price of this callable bond? in (b) Suppose instead of a callable bond, the firm issued a convertible bond and now the firm has 150 in cash and invest all the cash into the asset. The convertible bond has a coupon rate of 12% and matures at the end of 2 periods. The face value is 100. The dilution ratio is 60%. What is the market price of this convertible bond? (c) Compare a straight bond, a callable bond and a convertible bond with same coupon rate, face value and time to maturity, which one is the most expensive? Which one is the cheapest? Explain. (There is no need to calculate the price of the straight bond.) met
