On 1st January 2010, Exchequers Insurance issued a 15% convertible bond quoted at GH₵123. The nominal value for each bond is GH₵100 and the conversion date for the bond is 31st December 2015 after interest have been paid. The bond is convertible at 20 ordinary shares per GH₵100 bond. The current price per share is GH₵6.
Required:
i. Determine the conversion rate. (2 marks)
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𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑒=𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜 𝑥 𝑚𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜; ₵100=20 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒𝑠 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒= ₵6
∴𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑟𝑎𝑡𝑒=20𝑥6=₵120
ii. Determine the conversion premium. (2 marks)
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𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑝𝑟𝑒𝑚𝑖𝑢𝑚; 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑐𝑜𝑢𝑝𝑜𝑛−𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒
𝑚𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑐𝑜𝑢𝑝𝑜𝑛= ₵123
𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒= ₵120
∴𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑝𝑟𝑒𝑚𝑖𝑢𝑚=123−120=₵3
iii. Comment on the possibility of bond holders converting for shares. (2 marks)
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The share price is less than the bond market value. This will not be attractive to the bondholders. The share price have to increase by at least 2.5% [(3/120) x100] for it to be attractive to bond holders.
c. State TWO (2) key assumptions of the random walk theory. (3 marks)
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The random walk theory is based on the fact that share prices will reflect every available information such that prices will alter when new information becomes available. The assumptions include the following:
- All information about a company is available to all potential shareholders;
- The intrinsic value of shares will change to reflect new information available;
- All investors will act rationally;
- There will be no insider dealings.