In the second quarter of 2013, Tesla Motors, Inc. (symbol: TSLA) raised $600 million in debt markets by issuing senior convertible bonds. Tesla used a large portion of this capital to repay a loan provided by the Department of Energy in 2013. 

 

a) Assume that each convertible bond is priced at $1,000, has a face value of $1,000 and a 5-year maturity, and pays a coupon of 1.5 percent of the face value every year. Assume that if Tesla were to issue straight debt, the straight debt would have an expected return (discount rate) of 4.5 percent per year. What is the value of the conversion option for each convertible bond? 

 

b) Suppose that it is June 1, 2015 and you own one Tesla convertible bond. This convertible bond was originally issued on June 1, 2013 and has a maturity date of June 1, 2018. You are considering two choices: convert the bond into eight shares right now, or never convert the bond and receive the two remaining coupon payments and the face value payment at maturity. Assume that the Tesla closing stock price on June 1, 2015 is $250.00 per share.

 Explain whether or not you would convert the bond. You will need to compare the value of the shares you would receive if you did convert to the present value of the remaining bond payments you would receive if you did not convert (from the point of view of June 1, 2015