Many of your clients own small to medium-sized private businesses. One of your clients, Maurice Roussel, is planning to finance the education of his two children, ages 10 and 12. Currently, neither child has any assets, so Roussel is considering investing a modest amount in convertible bonds in their names with his wife, Lili, as custodian. Lili Roussel has doubts because she does not believe that it is wise to risk their hard-earned money on risky investments. Mr. Roussel believes that the money to be transferred is small enough to risk. Besides, he is fascinated with the convertible bonds issued by UT&T, a large company with a good, if not superior, credit rating.
1. If the bonds were not convertible, what would they be worth?
2. Since the bonds are convertible, what is their stock value?
3. If the value of the stock rose to $15, what would happen to the value of the bonds?
4. If the price of the stock declined to $5, what would happen to the value of the bonds?
5. If the money were invested in the nonconvertible bonds and the price of the stock changed, what would happen to the value of the bonds?
6. If the price of the stock rose, would the Roussels have to exchange the bonds for the stock?
7. If Mrs. Roussel changed her mind, could she get the principal back?
8. If the company were to fail, what would happen to the bonds?
9. Would buying the bonds be preferable to putting the money in the firm's stock?
10. Would buying the bonds be preferable to putting the money in a certificate of deposit in a federally insured commercial bank?
11. What are the federal income tax implications of owning convertible bonds? Would putting the bonds in the children's names result in any tax savings? Given the nature of Mrs. Roussel's questions, do you believe that the money should be invested in convertible bonds?