FINA2312 Assignment 3

Chan Nok Hin Kelvin 3035351343

Q1a
π = (1+0.05-0.8)/(1.2-0.8) = 0.625

Value of Firm t=1 t=2 Bond Value

Min[B, F + C]
208.128 106.56
180-6.56 = 173.44
138.752 106.56
150
136.128 106.56
120-6.56 = 113.44
90.752 90.752

Value of Bond t=1 t=2

106.56
101.4857 > 100
Call the bond: Bond
value = 106.56
106.56
(0.625(106.56)+0.375(102.4))/1.05 =
100
106.56
95.84 < 100
No call: Bond value =
95.84 + 6.56 = 102.4

90.752

Price of callable bond = 100

Q1b
Value of Firm t=1 t=2 Bond Value
Min[B, F + C]
202.128 106.56
180-6.56-5 = 168.44
134.752 106.56
150
130.128 106.56
120-6.56-5 = 108.44
86.752 86.752

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 FINA2312 Assignment 3
Chan Nok Hin Kelvin 3035351343

Value of Bond t=1 t=2

106.56
101.4857 > 100
Call the bond: Bond
value = 106.56
106.56
(0.625(106.56)+0.375(100.97))/1.05 =
99.49
106.56
94.4114 < 100
No call: Bond value =
94.4114 + 6.56 =
100.97
86.752

Price of callable bond = 99.49

Q1c
Value of Firm t=1 t=2 Bond Value
Min[B, F + C]
208.128 106.56
180-6.56 = 173.44
138.752 106.56
150
136.128 106.56
120-6.56 = 113.44
90.752 90.752

Value of Bond t=1 t=2

106.56
101.4857 > 101
Call the bond: Bond
value = 107.56
106.56
(0.625(107.56)+0.375(102.4))/1.05 =
100.60
106.56
95.84 < 100
No call: Bond value =
95.84 + 6.56 = 102.4

90.752

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 FINA2312 Assignment 3
Chan Nok Hin Kelvin 3035351343

Qs2a

π = (1+0.08-0.74)/(1.35-0.74) = 34/61
1 - π = 27/61

Dilution Factor (A) = 50/200 = 0.25

Value of Firm t=1 t=2 Bond Value Notes:

715,500 178,875 Max[AF, min[F,
B+C] -->
Converted
540,000-10,000
= 530,000
392,200 110,000
400,000
386,100 110,000
296,000-10,000
= 286,000
211,640 110,000

Bond Value Binomial Tree t=1 t=2

178,750
137,397.541 > 120,000
Call bond:
120,000+10,000=130,000
110,000
(π(130,000)+(1-π)
(111,851.8519))/1.08
=112,932.6048
110,000
101,851.8519 < 120,00
No call: Bond Value =
101,851.8519 + 10,000 =
111,851.8519
110,000

Single bond value = 112,932,6048/100 = 1129.33

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 FINA2312 Assignment 3
Chan Nok Hin Kelvin 3035351343

Q2b
Bond Value Binomial Tree t=1 t=2
178,750
Since AVu < Bu + C 132,500 <
147,397.541
==> No conversion
Bond Value = 147,397.541
110,000
(π(147,397.541)+(1-π)
(111,851.8519))/1.08
=121,911.2993
110,000
Since AVd < Bd + C
71,500 < 111,851.8519
==> No conversion
Bond Value = 111,851.8519
110,000

Price of Single Bond = 121,911.2993/100 =1219.1129

Option Value = 1219.1129 - 1129.33 = 89.783

Q2c
Value of Firm t=1 t=2 Bond Value
715,500 110,000
540,000-10,000 =
530,000
392,200 110,000
400,000
386,100 110,000
296,000-10,000 =
286,000
211,640 110,000

Bond Value Binomial Tree t=1 t=2

110,000
101,851.8519 < 120,000
No call: Bond Value =
101,851.8519 + 10,000 =
111,851.8519
110,000
111,851.8519/1.08 =
103,566.5295

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 FINA2312 Assignment 3
Chan Nok Hin Kelvin 3035351343

110,000
101,851.8519 < 120,00
No call: Bond Value =
101,851.8519 + 10,000 =
111,851.8519
110,000

Single Bond Price = 103,566.5295/100 = 1035.67

Qs2d

(b) > (a) > (c)

Bond (b) has the highest value since it allows the bondholder to convert the bond to stocks if
the firm is doing well without the fear of shareholders calling the bond. Bond (a) is slightly
less value since the shareholder could call back the bond which is not beneficial to the
bondholders. However, it still provides an option for the bondholder to convert the bond to
stocks. Lastly, (c) is lowest in value since the bondholder has no option to convert the bond
and could not benefit from the firm's good performance.

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