What is the straight value of the convertible bond, Risk Management

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The current stock price of IOU is $250 and has a standard deviation of 35% per year. The risk-free interest rate is 5% per year compounded continuously. Find the prices of a call and a put which have an exercise price of $270 and expire in four months.

Banana Computer has a perpetual, convertible 7% annual coupon bond outstanding. The bond has a face value of $1,000 and has a conversion price of $40. The required return on an otherwise identical nonconvertible bond is 8%. Banana will never pay dividends and its current stock price is $20.

a. What is the straight value of the convertible bond?

b. What is its conversion value?

c. If Banana's stock price were to grow at 10% per year forever, how long would it take for the bond's conversion value to exceed the bond price?

d. When should the bondholder convert? Why?


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