Fgenerates a single cash-flow in one year. This cash-flow depends on the strategy chosen by the management:

• -The safe strategy yields a certain cash-flow of $1,250,
• -The risky strategy yields a high cash-flow of $4,000 with probability 0.2, and a low cash-flow of $500 with probability 0.8.
• Fhas one stock outstanding and one bond with a $1,000 face value, a 5% annual coupon and a one-year maturity. The management chooses the strategy that maximizes the final expected cash-flow for the stockholder (in one year).

(a)If the bond is non-convertible, which strategy does the management choose?

(b)If the bond is convertible until maturity with a conversion ratio 1of 4 (coupon and maturity are unchanged), will the bondholder convert if the final cash-flow is $1,250? Same question if the final cash-flow is $4000, and if it is $500.

(c)If the bond is convertible with a conversion ratio of 4, what is the conversion ratio such that the management feels indifferent to the strategies?