Mr. Smith intends to purchase a convertible bond with a face value of $1000. The bond is convertible to 40 common shares and its maturity is in 12 years (2012). The coupon rate is 8% and the required return on the bond is 10%, compounded semi-annually. The coupons are also paid semi-annually.

The company just paid a dividend of $3 to the shareholders. The dividends on common shares are paid annually. We anticipate that the dividends will grow at 7% (effective annual) every year in the future. The required return on the common shares is 20%, effective annual.

a) Calculate the strictly debt value, the conversion value and the minimum price of the bond.

b) In exactly 4 years (July 2004), the required return on the bond decreases by 1.5% and the required return on common shares decreases value and the minimum price (market value) of the bond in July 2004.