Question
The Blanco River Company plans to sell a 12% coupon, twenty-year convertible bond for $1,014 (par value $1,000). The bond is callable at $1,080 in
The Blanco River Company plans to sell a 12% coupon, twenty-year convertible bond for $1,014 (par value $1,000). The bond is callable at $1,080 in the first year, and the call price declines by $4 each year thereafter. The bond may be converted into twenty shares of stock that currently sell for $40 per share. The stock price is expected to increase at a rate of 7% each year. Nonconvertible bonds with the same degree of risk would yield 13%. Investors expect the firm to call the convertibles if and when the conversion value exceeds the par value by about 20%.
What rate of return can investors expect to receive if they purchase the bonds for $1,014?
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