Question

Assume a firm has three claims outstanding: equity, ordinary (zero coupon) bonds, and subordinated convertible (zero coupon) bonds. What factors should be important in valuing these claims and how do they affect these values?

Answer 1

Factors that could affect these claims are as follows and also how it will afftect the values:

1. Interest rate : Interest rate will imapct the zero coupon bond, for the valuaiton of zero coupon bond change in interest rate will lead to change in price of bond. Bond price is inversely proportional to interest rate. It will also impact the subordinate convertibel zero coupon bond.

2. Price of stock: it will impact the subordinate convertible zero coupon bond because if the price is not reaching the fair value of conversion one will not able to convert the zero coupon bond into the equity.

3. For bond other factors which will imapct is : maturity, spread at issuance and subordination, since it is zero coupon bond there is no impact of coupon on it.

4. Duration and convexity will also impact the value of bond. Higher the duration and convexity of the bond higher will be its impact.

5. Market risk: it is one of the prime factor which impact the valuation of the equity. Market risk leads to volatitlity in the stock market and it can change the expected return and beta of the stock which imapct the valuation of the stock.

6. EPS is also impact the equity price, higher EPS is lead to higher valuation of equity.

7. Liquidity risk is one of the risk which imapct all the claims outstanding.