Question: Your client, the Notsoblue Chip Corp., wants to issue $50 million of 10 year debt at par with an 8% annual coupon (50,000 bonds of $1,000 par value each, with principal to be repaid in year 10). Your client is willing to attach warrants to the bonds in order to raise the effective yield to 14%, the yield required by the market for this type of issue. Your problem is designing the bond-warrant package that will permit your client to implement its financing plan. For this calculation you will ignore underwriting fees and other expenses. So far, you have determined that:
The warrants will expire in 7 years.
Yield on a seven year government note is 9.0% per annum.
The current stock price of Notsoblue Chip Corp. is $14 a share.
The volatility (standard deviation) of the rate of return of Notsoblue Chip Corp. is 65% per annum.
Common shares outstanding: 5 million.
- Each warrant will entitle the holder to buy one share of Notsoblue Chip Corp. stock for a cash exercise price of $20.
- The company has no other warrants or convertibles outstanding.
1. How many warrants do you need to attach to each bond?
2. What is the value of each warrant?