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Goonland plc has in issue 8% convertible bonds. In 5 years’ time investors have the choice of either converting the bonds into 25 ordinary shares per £100 bond, or having them redeemed at a 10% premium to par. The current ordinary share price of Wonderland plc is £3.53 and this is expected to grow by 7% per year. If investors in the bonds require a return of 9% plc, what is the expected current market value of the bond?
A.
£111.56B.
£102.61C.
£91.23D.
£96.45E.
£114.54Please do not simply type out a full question and expect to be provided with a full answer. You must have an answer in the same book in which you found the question, so ask about whatever it is in the answer that you are not clear about and then I will explain 🙂
For each $100 bond, in 5 years time they will have the choice of taking cash of $110, or taking shares which will be worth 25 x $3.53 x 1.07^5 = $124.
They will therefore have the expectation that they will take the shares and that the value in 5 years time will be $124.
The current market value of the bond is (as always) the present value of the future receipts which are $8 per year for 5 years and $124 in 5 years time, all discounted at they required rate of return of 9%.
(Because this is revision from Paper FM, you will find a lecture working through a very similar example in the Paper FM free lectures 🙂 )
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