Question: Prospect Corporation is a venture capital company.It was incorporated and listed on the GrowthEnterprise Market (GEM) four years ago.Since incorporation, the company has been rather successful and its shares are currently trading at $4.5 per share.
Apart from ordinary shares, Prospect has issued 8% convertible bond, redeemable in 2020.The face value of the convertible bond is $1,000, with coupons payable semi-annually and a conversion price of $5.Conversion may take place at any time over the next two years. Current market price of Prospect's convertible bond is $950.Yield to maturity of coupon bonds of a similar risk profile is 10%.
Assume now is the end of 2010 and bond interest has already been paid.The board of directors expect Prospect's share price to rise at 12% per year.No dividend is anticipated for coming two years.
(a) As a holder of Prospect's convertible bond, which of the following actions would you choose to maximize the value of your investment? Explain your decision with a comparison of payoff from each action.
(i) Hold the bond until maturity
(ii) Sell the bond immediately
(iii) Convert the bond to shares now
(iv) Convert the bond at the end of second year.
(b) Explain the differences in payoffs from actions (i), (ii) and (iii).
(c) What are the factors to be considered when using convertible bond as a way of raising finance?