Question

"A corporation has issued $1,000 par, 8% convertible bonds, callable at par. The bonds are convertible into 20 shares of common stock. Currently, the bond is trading at 100 1/2 while the common stock is trading at $51. The corporation calls the bonds at par plus accrued interest of $10 per bond. A customer holds 100 bonds, purchased at par. The customer wishes to liquidate the position at the greatest profit. The BEST recommendation is to (ignoring commissions):"

Answer 1

Answer:

Convert the bonds into 20 common stocks.

Explanation:

the investor has 3 options:

1. sell the bond at $1,000 x 1.005 = $1,005
2. sell the bond to the corporation at $1,000 + $10 = $1,010
3. convert the bond into 20 common stocks = 20 x $51 = $1,020

the option that yields the highest return is to convert the bonds into common stocks.