Vernon Glass Company has $20 million in 10 percent convertible bonds outstanding

Question

Vernon Glass Company has $20 million in 10 percent 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

Rate of return

Explanation / Answer

Conversion value = 40*22 = 880

Current price = 880 + 55 = 935

Next year

Conversion value = 40*28 = 1120

Price = 1120 + 20 = 1140

Return = (1140 - 935) / 935 = 21.93%

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