Heavy equipment industry-what is the fair value of the bond

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Reference no: EM132006143

Pentos International (PI) is in heavy equipment industry. The debt rating for PI is AA and the yield spread on AA rated bonds for five year maturity is 3% per year. The yield on a five-year treasury is 4% per year. The company recently announced that it would issue convertible bonds. The bonds will have no coupons and will have a maturity of five years and will pay $1000 at the end of five years. The bond can be converted to 20 shares of PI stock at the end of two years. The price of PI stock is $35. A call option on PI stock with an exercise price of $50 and maturity of five years is priced at $18. What is the fair value of the bond? Use simple compounding and ignore any dilution effects. Hint: Convertible bond price = (bond Price without options) + (Convertible Option). Show all work.

Reference no: EM132006143

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