Question
Peter has recently received a large grant from Waitangi Tribunal settlement with the Singapore Government. Anna Carolina, Peters newly appointed financial controller, has been considering
Peter has recently received a large grant from Waitangi Tribunal settlement with the Singapore Government. Anna Carolina, Peters newly appointed financial controller, has been considering investing a portion of the funds in the bonds of Blackburn Industries until the finance committee has decided on a long-term investment of the monies. The bonds (which are actively traded in the bond markets) were issued five years ago at their $1,000 par value and have exactly 20 years remaining until they mature. They have an 8% coupon interest rate, are convertible into 50 shares and can be called any time at $1,080. The bond is rated Aa by the rating agency Moodys. Blackburn Industries, a manufacturer of sporting goods, recently acquired a clothing company that was in financial distress. Because of the acquisition, Moodys and other rating agencies are considering a rating change for Blackburn bonds. Recent economic data suggest that inflation, currently at 3% annually, is likely to increase to a 4% annual rate.
Anna remains interested in the Blackburn bond but is concerned about inflation, a potential rating change and maturity risk. To get a feel for the potential impact of these factors on the bond value, she decided to apply the valuation techniques she learned back in the university.
REQUIRED:
- If the price of the shares into which the bond is convertible rises to $25 per share after five years and the issuer calls the bonds at $1,080, should Anna let the bond be called away from her or should she convert it into shares?
- For each of the following required returns, calculate the bonds value, assuming annual interest. Indicate whether the bond will sell at a discount, at a premium or at par value. (i). The required return is 6%, (ii). The required return is 8% and (iii). The required return is 10%.
- If Anna strongly believes that inflation will rise by 1% during the next six months, what is the most she should pay for the bond, assuming the annual interest?
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