A It Is January 1, 2006 and You Are Considering

question 27

Essay

a. It is January 1, 2006 and you are considering buying $20,000 of Hilever Company's 10% bonds, which come due on December 31, 2015. The bonds pay interest semi-annually on June 30 and December 31 of each year. The prevailing interest rate on bonds of similar risk is 12%. How much would you be prepared to pay for the bond?
b. If coupon rate was 12% on these bonds, how much would you be prepared to pay?
c. If the coupon rate was 10% and the bonds were convertible into common equity (5 shares for every $1,000 face value coupon bond), and common stock is currently trading at $11 per share would this change your answer to part a? Why? Why not?

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Definitions:

Hindsight Bias

The tendency to believe, after learning an outcome, that one would have foreseen it, often referred to as the "I-knew-it-all-along" effect.

Just-World Phenomenon

The cognitive bias that a person's actions are inherently inclined to bring morally fair and fitting consequences to that individual, to the end of all noble actions are rewarded and evil actions are punished.

Scapegoating

The practice of singling out any party for unmerited negative treatment or blame.

Other-Race Effect

The tendency to more easily recognize faces of one's own race, compared to faces of other races, often attributed to social and cognitive factors.