Question 5

1. a) What are some of the motivations for issuers to issue convertible bonds? Define the

   breakeven for convertible bonds and explain what it measures.

   (13 marks)

2. b) Fraser Inc. is considering investing in a 3-year project that has a 14% discount rate and requires an initial investment of $1000. Suppose that there is a 50% probability that the yearly cash flows will be $200 and a 50% probability that they will be $600. In addition, at the end of the first year we will know whether the project is a success (cash flow is $600) or a failure ($200), and we have the option to abandon the project at the end of the first year and receive the salvage value of $650. First determine the optimal

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abandonment strategy. Then calculate the project's NPV and the value of the abandonment option using that strategy.