Why would the return on investing in the common stock directly be higher than investing in the convertible bond?
What will be an ideal response?
The reason for the lower return by buying the convertible bond rather than the stock directly is that the investor has effectively paid $26.57 – $23 = $3.57 per share more for the stock. Thus the convertible bond investor realizes a gain based on a stock price of $26.57 rather than $23 . If one took into account interest paid of $95 per year then the difference would be less. This is because the interest of $95 per year is greater than the dividends that would have been received: ($1,000 / $23)($0.75) = $32.61 .
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