Question
Vernon Glass Company has $20 million in 10 percent, $1,000 par value convertible bonds outstanding. The conversion ratio is 40, the stock price is $22,
Vernon Glass Company has $20 million in 10 percent, $1,000 par value convertible bonds outstanding. The conversion ratio is 40, the stock price is $22, and the bond matures in 15 years. The bonds are currently selling at a conversion premium of $55 over their conversion value.
If the price of the common stock rises to $28 on this date next year, what would your rate of return be if you bought a convertible bond today and sold it in one year? Assume on this date next year, the conversion premium has shrunk from $55 to $20. (Hint: Calculate rate of return as (Future bond price Current bond price + Interest earnings) / Current bond price))
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