ITC Corporation has convertible bonds outstanding with the following features:
- The bonds mature in fifteen years; there are 100,000 bonds outstanding.
- Each bond can be converted into 50 shares of stock any time until expiration.
- The coupon rate on the bond is 5%; straight bonds issued by the company are yielding 10%.
- The current stock price is $15 per share and the standard deviation in ln(stock prices return) is 40%.
- There are 20 million shares outstanding.
a. Value the conversion option.
b. Estimate the value of the straight bond portion.
c. If these bonds were issued at par, who would be gaining? Who would be losing?
d. What impact would forced conversion have on the value of this convertible bond?