Reference no: EM132999258

Falcon Company is planning to issue convertible bonds to finance planned expansion operations that will cost $1 billion. Company plans to issue bonds at par value of $1000 each with an option to convert bonds into stocks at maturity to make issuance attractive for investors. Current share price of Falcon is $60 and bond A will be issued with a 25% conversion premium, 4 years term and $400 million total value ; and Bond B will be issued with a 35% conversion premium, 5 years term and $600 million total value. Both bonds will pay semi-annual coupon. Falcon has stock options available in the market and on the closing of 08/16/2021, option prices are listed below;

08/13/2021 Market Data (Share Price: $55)
Option Type Exercise Price Last Trade Maturity
Call $55 $2.00 09/30/2021
Call $58 $1.55 11/15/2021
Call $60 $1.97 02/15/2022

Management asked your help to determine coupon rate for the convertible bond issuance.

a. Calculate implied volatilities of the options listed above and use the average volatility in your option valuation.

b. Get the yield of 5 years US Treasure Note and use it as your risk-free rate. (You may use finance.yahoo.com or other online sources)

c. Calculate the option price with the 25% and 35% conversion premium and the value of the conversion options seperately.

d. Find the appropriate coupon rate that reflects the value of the conversion option and bond issued at par value. Yield estimate for the bond is 6%.