Question 3 (20%) ABC company just issued US$200 million 10 year bond at PAR with an annual coupon of 2% attached with a 3 year warrants on ABC company shares. Each bond has a US$10,000 denomination and has 500 detachable warrants. 1 warrant allows bondholder to purchase one ABC company share at an exercise price of US 52. Currently the ABC companyshare is quoted at US$40 and the Yield to Maturity (YTM) of a similar fixed coupon bond issued by ABC company is 4%.

(a) If the market has a standard that if a warrant has a premium greater than 20%, the warrant is then expensive. Given the issuance terms, would you recommend investors to buy this issue? Hint: Calculate the $ value per warrant to evaluation the warrant premium in %. (8 Marks)

(b) At the same time as (a), ABC company also issued a Convertible Bond (CB) with a zero coupon with a Conversion Price that gives the Conversion Premium the same Warrant Premium as Bond cum Warrant in (a). If investors have an extremely bullish view on ABC company over the next 10 years, what would you recommend to investors between this CB and the Bond with Warrants described in (a). Explain the rationale between your recommendation. (2 Marks)

(c) ABC company is considered issuing a callable fixed coupon bond. The issuing terms are 6 year maturity with 8% annual coupon callable at year 3 and every year thereafter at a Call Price of $110. The issue price is at PAR with the yield to maturity (YTM) is 7%. A similar 6 year government bond yields 4%. If the call option part of this Callable Bond is valued at 7. The market has a comparable non callable fixed coupon bond by another issuer (EAF) that has a 3% YTM. Can you review the attractiveness of ABC company callable bonds credit (or yield) spread comparing with the EAF bond? Hint: Analyse the Call Adjusted Yield spread (CAS) to assess. (5 Marks)

(d) An investor is assessing the Callable Bond in (c) with the market is expected the YTM to fall significantly. The investor wants to estimate the rough YTM level that ABC company will call the bonds. Explain how the investor would work it out?