What value would you assign

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Reference no: EM133065245

Pricing convertibles

Question 1: You have been hired to value a new 30-year redeemable, convertible note. The note has a 6 per cent coupon, payable annually. The conversion price is $10, and the share currently sells for $6.562. The share price is expected to grow at 7.07 per cent per year. The note is redeemable at $110 but, based on prior experience, it will not be called unless the conversion value is $130. The required return on this note is 8 per cent. What value would you assign?

Question 2: Option value and interest rates
Suppose the interest rate on government securities suddenly and unexpectedly rises. All other things being the same, what is the impact on call option values? On put option values?

Question 3: Calculating intrinsic risk
Government securities currently yield 5 per cent. Shares in the Rain Corporation Ltd are currently selling for $4.40 per share. There is no possibility that the share will be worth less than $3.00 in one year.
a What is the value of a call option with a $3_00 exercise price?
b What is the value of a call option with a $2.00 exercise price?
C What is the value of a put option with a $3.00 exercise price?

Question 4: Calculating option values
The prices of Ney Horse supplies Co Ltd shares will be either $4 or $6 at the end of the year Call options are available with 1 year to expiration. Government securities currently yield 5 per cent.
Suppose the current price of Ney shares is $4.50. What is the value of the call option if the exercise price is $3.60 per share?
b Suppose the exercise price is $4.50 in part (a) above. What would the value of the call option be?

Question 5: Calculating yields
The following one-year 'forward' rates exist for each of the years 2008-2012
1 /1 /08-31 /12/08 7.00%
1/1/09-31/12/09 8.00%
1/1/10-31/12/10 9.00%
1/1/11-31/12/11 8.00%
1/1/12-31/12/12 10.00%
What are the 1-, 2-, 3-, 4- and 5-year yields?

Question 6: Equity as an option and the OPM
Lifebeinit Co Ltd has debt that matures in one year and requires the firm to pay $10m. The current market value of the firm's assets is $12m. The annual variance for the firm's return on assets is 0.30, and the annual risk-free interest rate is 6 per cent. Based on the Black-Scholes model, what is the market value of the firm's debt and equity?

Question 7: Changes in variance and equity value

From the previous problem, Lifelike is considering two mutually exclusive investments. Project A has an NPV of $1m, and Project B has an NPV of $1.5m. As a result of taking Project A, the variance of the firm's return on assets will increase to 0.40. If Project B is taken, the variance will fall to 0.25.

What is the value of the firm's debt and equity if Project A is undertaken? If Project B is undertaken? Which project do the shareholders prefer? Can you reconcile your answer with the NPV rule?

Suppose the shareholders and debtholders are in fact the same group of investors. Would this affect the answer to part (b)? o What does this problem suggest about shareholder incentives?

Reference no: EM133065245

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