Convertible bonds This question illustrates that when there is scope for the firm to vary its risk, lenders may be more prepared to lend if they are offered a piece of the action through the issue of a convertible bond. Ms. Blavatsky is proposing to form a new start-up firm with initial assets of $10 million. She can invest this money in one of two projects. Each has the same expected payoff, but one has more risk than the other. The relatively safe project offers a 40% chance of a $12.5 million payoff and a 60% chance of an $8 million payoff. The risky project offers a 40% chance of a $20 million payoff and a 60% chance of a $5 million payoff.
Ms. Blavatsky initially proposes to finance the firm by an issue of straight debt with a promised payoff of $7 million. Ms. Blavatsky will receive any remaining payoff. Show the possible payoffs to the lender and to Ms. Blavatsky if (a) she chooses the safe project and (b) she chooses the risky project. Which project is Ms. Blavatsky likely to choose? Which will the lender want her to choose?
Suppose now that Ms. Blavatsky offers to make the debt convertible into 50% of the value of the firm. Show that in this case the lender receives the same expected payoff from the two projects.
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PRIN.OF CORPORATE FINANCE
- You are an analyst at a local bank and one of your corporate customers is interested in fixed rate USD funding. Your bank desires TTD funding. The following borrowing costs are available: BORROWING COSTS Local FIRM Local BANK FIXED USD 6% 4.5% FLOATING USD LIBOR + 1% LIBOR FIXED TTD 4% 3.5% A Can a swap be structured that benefits both parties? Illustrate how a swap can be structured to benefit both partied and calculate the effective rates assuming gains are divided equally?arrow_forwardabout SOFR and LIBOR a SOFR represents the interest rate of the unsecured funds LIBOR is a good proxy of the risk-free rate SOFRS include triparty repo data from the Bank of New York Mellon (BNYM) and the Depository Trust & Clearing Corporation (DTCC). LIBOR now in 2020 is still the most influential interest rate in the international market.arrow_forwardOption 1: Merit could approach JPMorgan Chas, a bank that had served Merit well for many years with seasonal credit lines as well as medium-te loans. Lehn believed that JPMorgan was unlikely to make a $4 billion loan to Merit on its own, but it could probably gather a group of banks together to make a loan of this magnitude. However, the banks would undoubtedly demand that Merit limit further borrowing and provide JPMorgan with periodic financial disclosures so that they could monitor Merit's financial condition as it expanded its operations. Option 2: Merit could convert to pubic ownership, issuin stock to the public in the primary market. With Merit's excellent financial performance in recent years, Sara thought that its stock could command a high price in the market and that many investors would want to participate in any stock offering that Merit conducted. Required: •Pros and cons of option 1 and 2 •Which option do you think Sara should recommend to the board and why?arrow_forward
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- Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning