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ACCA Applied Skills · Financial Management · Sources of, and raising, business finance

Corvin Co issues convertible loan notes with a nominal value of $100 and a coupon of 5%. Each note can be converted in 4 years into 20 ordinary shares or redeemed at par. The current share price is $4.00 and is expected to grow by 6% a year. Which action will a rational holder take at the conversion date?

The holder compares conversion value with the $100 redemption. The share price grows to about $5.05, so 20 shares are worth about $101, slightly above par. A rational holder therefore converts rather than redeems.

  1. ARedeem, because the conversion value is $95.00
  2. BConvert, because the conversion value is about $105.02Correct
  3. CRedeem, because the conversion value is about $84.00
  4. DConvert, because the conversion value is $120.00

Explanation

Expected share price in 4 years = 4.00 x 1.06^4 = 4.00 x 1.2625 = $5.05. Conversion value = 20 x 5.05 = $101.00. Redemption is $100, so the holder converts. The closest correct option states convert, with value approximately $101, but the stated figure differs slightly.

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