Question

Tulsa Drilling Company has $1.6 million in 12 percent convertible bonds outstanding. Each bond has a $1,000 par value. The conversion ratio is 50, the stock price is $34, and the bonds mature in 10 years. The bonds are currently selling at a conversion premium of $70 over the conversion value. Use Appendix B and Appendix D as an approximate answer, but calculate your final answer using the formula and financial calculator methods.

a. Today, one year later, the price of Tulsa Drilling Company common stock has risen to $44. What would your rate of return be if you had purchased the convertible bond one year ago and sold it today? Assume that on the date of sale, the conversion premium has shrunk from $70 to $20. (Hint: Don’t forget to include the interest payment for the first year) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Rate of Return?

b-1. Assume the yield on similar nonconvertible bonds has fallen to 8 percent at the time of sale. What would the pure bond value be at that point? (Use semiannual analysis.) (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

Pure Bond Value?

Answer 1

Rate of Return

1	Bond Purchase Value	[conversion Value + conversion Premium]
		1700	70	1770
	Bond Sale Value	[conversion Value + conversion Premium]
		2200	20	2220
	Interest received during the year	$ 1000	@ 12 %	$ 120

Rate of return [[Sale Value - Purchase Value]+Interest or Dividend Received]/ Purchase Value

i.e [[2220 - 1770]+ 120]/ 1770,

ROR = 32%

2. Bond yield Formula : Bond Yield= [ Face Value of Bond x Interest Rate]/ Market Value of Bond

So Market value of Bond =  [ Face Value of Bond x Interest Rate]/ Bond Yield

So Market value of Bond = [1000*12%]/8%

i.e $ 1500 is Pure Bond Value