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Unformatted text preview: hat inflation, currently at 5% annually, is likely to increase to a 6%
Annie remains interested in the Atilier bond but is concerned about inflation, a potential rating change, and maturity risk. In order to get a feel for the
potential impact of these factors on the bond value, she decided to apply the valuation techniques she learned in her finance course. Required
a. If price of the the common stock into which the bond is convertible rises to
$30 per share after 5 years and the issuer calls the bonds at $1,080, should
Annie let the bond be called away from her or should she convert it into common stock?
b. For each of the following required returns, calculate the bond’s value, assuming annual interest. Indicate whether the bond will sell at a discount, at a premium, or at par value.
(1) Required return is 6%.
(2) Required return is 8%.
(3) Required return is 10%.
c. Repeat the calculations in part b, assuming that interest is paid semiannually
and that the semiannual required returns are one-half of those shown. Compare and discuss differences between the bond values for each required return
calculated here and in part b under the annual versus semiannual payment
d. If Annie strongly believes that inflation will rise by 1% during the next 6
months, what is the most she should pay for the bond, assuming annual
e. If the Atilier bonds are downrated by Moody’s from Aa to A, and if such a
rating change will result in an increase in the required return from 8% to
8.75%, what impact will this have on the bond value, assuming annual
f. If Annie buys the bond today at its $1,000 par value and holds it for exactly
3 years, at which time the required return is 7%, how much of a gain or loss
will she experience in the value of the bond (ignoring interest already received
and assuming annual interest)?
g. Rework part f, assuming that Annie holds the bond for 10 years and sells it
when the required return is 7%. Compare your finding to that i...
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