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Chapter 6 Bonds

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CHAPTER 6

Solutions to Self-Test Problems

ST6-1 a. Conversion price = $1,000/50 = $20 b. If the bond is converted, investors would be able to sell the stock for $20.50 per share, which would yield a total of $1,025. Thus, it would be better to redeem the bond for $1,100.
ST6-2 a. Pennington’s bonds were sold at par; therefore, the original YTM equaled the coupon rate of 12%.

b.

Alternatively, with a financial calculator, input the following: N = 50, I = 5, PMT = 60, FV = 1000, and PV = ? PV = $1,182.56. c. Current yield = Annual coupon payment/Price = $120/$1,182.56 = 0.1015 = 10.15%. Capital gains yield = Total yield – Current yield = 10% – 10.15% = –0.15%.

d.

Using a financial calculator, input the following: N = 19, PV = – 891.64, PMT = 60, FV = 1,000, and rd/2 = I = ? Calculator solution = rd/2 = 7.05%; therefore, rd = 14.1%. e. Current yield = $120/$891.64 = 13.46%. Capital gains yield = 14.1% – 13.46% = 0.64%

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PROBLEMS

6-1 a. Number of zeros = Amount needed/Price per bond = $4,500,000/$567.44 ≈ 7,931 bonds.

b. In five years, Filkins will have to repay $4.5 million when the bond matures. But, because the debt is a zero-coupon bond, there will no interest payments in the meantime. Thus, the annual debt service costs are $0.

c. Calculator solution: N = 5, PV = -567.44, PMT = 0, and FV = 1,000; I = 12.0%

6-2 a. The conversion price simply is the face (par) value of the bond divided by the conversion ratio--the conversion price for this issue is $1,000/25 = $40. Therefore, it would be beneficial for investors to convert their bonds into common stock when the price of the stock is greater than $40 per

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