Problem
Tulsa Drilling Company has $1.6 million in 13 percent convertible bonds outstanding. Each bond has a $1,000 par value. The conversion ratio is 30, the stock price is $30, and the bonds mature in 10 years. The bonds are currently selling at a conversion premium of $60 over the conversion value. Use Appendix B and Appendix D as an approximate answer, but calculate your final answer using the formula and financial calculator methods.
I. Today, one year later, the price of Tulsa Drilling Company common stock has risen to $40. What would your rate of return be if you had purchased the convertible bond one year ago and sold it today? Assume that on the date of sale, the conversion premium has shrunk from $60 to $10.
II. Assume the yield on similar nonconvertible bonds has fallen to 10 percent at the time of sale. What would the pure bond value be at that point?