Did anybody else run into this question and get screwed over? The question is:

“If Gloucester buys Rockports bond issued in 2008 and Magnolias expectations materialize, the new value of the bond can best be described as the bonds: A. straight value, B. straight value + value of call option, C. Conversion value minus value of call option”

Saving you the calculations, the conversion value is less than the straight value if expectations materialize. I was excited because I knew that the CFA text stated convertibles are priced at the greater of their conversion value/staight value so I went with A.

Wrong --> from the answer sheet: “the straight value sets an absolute floor of 965. However, this floor has to be adjusted upward for the value of a call option”. Isn’t the value of the call option close to or equal to 0 when the conversion value is less than the straight value? why is this mock exam so cruel?