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Q:
Assume you bought a convertible bond two years ago for $920. The bond has a conversion ratio of 30. At the time the bond was purchased, the stock was selling at $25 per share. The bond pays $100 in annual interest. The stock pays no cash dividend. Assume after two years the stock price rises to $45, and the firm forces investors to convert to common stock by calling the bond (there is no conversion premium). Would you have been better off if you had bought the stock directly or bought the convertible bond and eventually converted it into common stock?
Q:
A convertible bond has a face value of $1,000 and the conversion price is $40 per share. The stock is selling at $30 per share. The bond pays $65 per year in interest and is selling in the market for $950. It matures in 7 years. Market rates are 10% annually.
(a) What is the conversion ratio?
(b) What is the conversion value?
(c) What is the conversion premium (in dollars and percent)?
(d) What is the floor or pure bond value (using annual analysis)?
(e) Compute the downside risk as a percentage.
Q:
When warrants are exercised, the company goes through an accounting process to determine the new number of shares created. This process assumes that the company:A.creates one new share for every warrant exercised.B.reduces the number of shares created by the amount of shares that can be bought in the market with the proceeds of the cash generated by the exercise of the warrants.C.creates one new share in the ratio of the exercise price and the current stock price.D.None of the above
Q:
Corporations may use warrants for which of the following reasons?
A.To issue debt under normal circumstances
B.To use as an 'add-on' in a merger or acquisition agreement
C.To lower the cost of the bonds to the corporation
D.None of the above
Q:
From an institutional investor's standpoint, many convertible securities lack liquidity because:
A.of small trading volume.
B.of the small amount of convertibles that are usually issued by one company.
C.of the high premiums that usually come in with buying a convertible.
D.A and B
Q:
As the stock price moves higher, the conversion premium that the investor is willing to pay:
A.becomes higher.
B.stays the same.
C.becomes lower.
D.None of the above
Q:
The more volatile the stock price as measured by beta or standard deviation of returns,
A.the higher the conversion premium.
B.the lower the conversion premium.
C.the higher the interest rate.
D.the lower the interest rate.
Q:
Generally, the best time to buy convertible bonds is when interest rates are _________ and when stock prices are _______.
A.low; low
B.high; low
C.low; high
D.high; high
Q:
Which of the following statements about convertible securities is true?
A.They provide a guaranteed income stream, minimum value, and conversion
B.The conversion premium is influenced by the volatility of the underlying common stock, term to maturity, and dividend payment relative to interest rate
C.They are potentially dilutive to earnings and must be taken into consideration in the calculation of both primary and fully diluted earnings per share
D.All of the above are true
Q:
A firm has warrants outstanding for investors to purchase 50,000 shares at $25 per share. The current stock price is $40. The firm has l million shares outstanding and earnings per share of $1.50. What are earnings per share when all these warrants are exercised?
A.$1.43
B.$1.47
C.$1.45
D.None of the above
Q:
A firm has warrants outstanding for investors to purchase 50,000 shares at $25 per share. The current stock price is $40. For accounting purposes, what is the assumed net increase in shares from the exercise of these warrants?
A.18,750
B.50,000
C.31,250
D.None of the above
Q:
Why are warrants less desirable than convertible debentures as financing devices for the creation of new common stock?
A.There is no device for forcing investors to exercise warrants
B.The conversion of convertible securities erases debt on the balance sheet
C.Warrants increase the equity of a firm when exercised, but there is no change in the debt
D.All of the above
Q:
How are warrants used by corporations?
A.To decrease the volatility of their common stock
B.To allow for issuance of debt at rates lower than would otherwise be required
C.To decrease the dilution of earnings per share
D.More than one of the above
Q:
Which of the following statements explains the premium paid over the intrinsic value of a warrant?
A.The higher the price volatility of the common stock, the greater the premium
B.The market value may fall below the intrinsic value because of the downside risk
C.The greater the time period over which the option may be exercised, the higher the premium
D.More than one of the above are true
Q:
A warrant carries an option to purchase two shares at $35. The warrant's minimum value is determined to be $25. At what price is this company's common stock currently trading?
A.$25.5
B.$50.0
C.$47.5
D.$70.0
E.$95.0
Q:
Warrants are considered to be highly speculative because:
A.they are attached to the bond issue.
B.they have a short life and their value is magnified by movements in the stock price.
C.the intrinsic value is highly volatile.
D.ownership of warrants provides no dividends or interest.
Q:
Which of the following is NOT a characteristic of a warrant?
A.It is an option to buy a specified number of shares of stock at a given price over a given period of time
B.It represents a cash inflow to the issuing company when exercised
C.When exercised, it replaces debt on the balance sheet
D.It allows the bond to carry a lower coupon rate
Q:
What variables are needed to calculate basic earnings per share?
A.Adjusted earnings after taxes, number of shares outstanding, and number of common shares from all potential securities convertible into common stock
B.Earnings after taxes and number of shares outstanding
C.Adjusted earnings after taxes, shares outstanding, common stock equivalents, and all convertibles
D.Earnings after taxes, common shares outstanding, and all convertible preferred stock
Q:
What variables are needed to calculate diluted earnings per share?
A.Adjusted earnings after taxes, number of shares outstanding, and number of common shares from all potential securities convertible into common stock
B.Adjusted earnings after taxes and number of shares outstanding
C.Adjusted earnings after taxes, shares outstanding, common stock equivalents, and all convertibles
D.Earnings after taxes, common shares outstanding, and all convertible preferred stock
Q:
From the corporate financial officer's viewpoint, which of the following is a reason for not calling a bond for redemption when the conversion value is above the par value?
A.Calling the bond may encourage everyone to take the stock rather than the par value in cash
B.The after-tax cost of the dividends on the new shares might be higher than the after-tax cost of the interest expense on the existing convertible bond
C.The chief financial officer might want to wait until interest rates decline before calling the bond
D.The number of new shares on the market will cause the diluted earnings per share to decline
Q:
From the corporate financial officer's viewpoint, which of the following is not an advantage of issuing convertible bonds?
A.The market value of the firm's common stock may rise dramatically
B.Interest rates are generally lower than on straight debt instruments
C.Conversion may enhance the firm's stock price
D.None of the above are advantages
Q:
When is the best time to convert a convertible bond to common stock?
A.When the call price exceeds the conversion value
B.After the conversion ratio decreases
C.When the conversion value is below the pure bond value
D.None of the above
Q:
What factor(s) would cause the pure bond value to go up?
A.A decrease in the market interest rate
B.An increase in stock price
C.A change in the conversion ratio
D.More than one of the above
Q:
What factor(s) could cause the pure bond value to change?
A.A call provision
B.An increase in stock price
C.A change in market interest rates
D.More than one of the above
Q:
What is the percentage downside risk on a bond with market value of $900, conversion value of $800, and pure bond value of $650?
A.66.7%
B.27.7%
C.55.6%
D.None of the above
Q:
What is the minimum value on a bond with market value of $900, conversion value of $800, and pure bond value of $650?
A.$900
B.$800
C.$700
D.$650
Q:
What is the percentage conversion premium of a convertible bond with market value of $900, conversion value of $800, and par value of $1,000?
A.25%
B.20%
C.12.5%
D.10.5%
Q:
Which of the following statements describes the relationship between the market value, pure bond value, and associated stock price related to a convertible bond?
A.Both increase as the common stock price increases
B.Market value approaches the pure bond value as the stock price approaches zero
C.As stock price increases, the pure bond value increases
D.None of the above
Q:
A company has a convertible bond with a conversion price of $27 per share. The company's common stock is currently trading at $23 per share. What is the conversion value of the bond (rounded to whole dollars)?
A.$1,000
B.$800
C.$852
D.$828
Q:
What is the conversion ratio of a $1,000 bond convertible at $27 per share? The coupon rate is 10% and the market rate 12%. This company's common stock is currently trading at $23 per share.
A.37.04 shares
B.43.478 shares
C.83 shares
D.35.2 shares
Q:
Which of the following statements about a convertible security is not true?
A.It may be either a bond or share of preferred stock
B.It provides level interest payments
C.The best time to buy is when both bond and stock prices are low
D.All of the statements are true
Q:
A forced conversion is when the company calls the convertible security knowing the owners will take stock and thus convert debt to equity.
Q:
Convertible securities are a good investment for conservative investors, for they offer regular income and potential downside protection against falling stock prices.
Q:
The market price of the bond will not go below the pure bond value regardless of what happens to the price of the common stock.
Q:
If the stock price is low or declining, the pure bond value is not very important in determining the bond price.
Q:
Convertible securities have been used as a medium of exchange for acquiring other companies' stock in mergers and acquisitions.
Q:
Dilution of EPS by warrants is not reflected in computations of earnings.
Q:
Many warrants are callable.
Q:
Premiums paid for warrants often are related to time.
Q:
The leverage associated with a warrant increases as the stock price increases.
Q:
A warrant with an intrinsic value of zero cannot sell at a premium.
Q:
The premium of warrants tends to decrease as the stock price rises.
Q:
The value of a warrant is the market value of the stock minus the option price of the warrant divided by the number of shares it will buy.
Q:
If a warrant is detachable from its bond, the bond converts upon exercise of the warrant.
Q:
A warrant is an option to buy a bond at a specific price over a given period of time.
Q:
It is normal to issue convertibles and not have their presence reflect dilution until they are converted.
Q:
A drawback to using convertibles is their dilutive effect.
Q:
A company usually would not want to issue convertible securities if its stock is undervalued in the market.
Q:
Companies usually force conversion when conversion values are low.
Q:
Convertible bonds tend to pay better interest rates than straight bonds, since convertibles are of lower risk.
Q:
Floor values are sensitive to interest rates.
Q:
The shorter the term to maturity, the higher the conversion premium for the bond.
Q:
The amount of downside risk cannot vary.
Q:
Downside risk is:
Q:
A convertible bond's price is usually the same as the stock price times the conversion ratio.
Q:
The conversion feature always causes the bond's price to vary with the stock price.
Q:
With convertible bonds, the bond market price minus the conversion value is the conversion premium.
Q:
Pure bond value is the conversion price, multiplied by the market price.
Q:
Conversion value represents the total value of the underlying shares of common stock into which the security may be converted.
Q:
Conversion value is the conversion price multiplied by the conversion ratio.
Q:
Conversion ratio is the face value divided by the conversion price.
Q:
Conversion price is the face value divided by the conversion ratio.
Q:
The upward slope of the yield curve is caused by investors' recognition of the relative difficulty of converting long-term securities to cash. This is the:
A.expectations hypothesis.
B.liquidity preference theory.
C.market segmentation theory.
D.More than one of the above
Q:
Assuming interest rates are expected to fall, which of the following will most likely maximize price increase?
A.Commercial paper
B.U.S. Treasury bills
C.30-year corporate bonds
D.There is not enough information to tell
Q:
What effect, if any, will a decrease in interest rates have on bond values?
A.Bond values will increase
B.Bond values will decrease
C.Bond values may increase or decrease, depending on the maturity, quality, and coupon rate
D.None of the above
Q:
The Oxford Fixed Income Fund invests heavily in bonds. If the fund manager thinks that interest rates are going to fall, what changes should she make in her investment portfolio?
A.Increase investment in long-term bonds
B.Increase investment in short-term debt instruments
C.Increase investment in equity securities
D.Buy callable bonds
E.Buy real assets
Q:
Which of the following bond pricing rules is incorrect?
A.Bond prices and interest rates are inversely related
B.Prices of long-term bonds are less sensitive to changes in interest rates than short-term bonds
C.Bond price sensitivity increases at a decreasing rate as maturity increases
D.Bond prices are more sensitive to a decline in market yield to maturity
Q:
The term structure of interest rates refers to:
A.the relationships between interest rates and term to maturity.
B.the idea that any long-term rate is the average of expected future short-term rates.
C.a general expectation of higher future interest rates.
D.the idea that the terms of the bond may change as time to maturity changes.
E.More than one of the above are true
Q:
Which is not a theory related to the term structure of interest ratio?
A.Expectations hypothesis
B.Liquidity preference theory
C.Efficient market hypothesis
D.Market segmentation theory
Q:
What will happen to the market value of a bond if interest rates increase?
A.The market value will decrease
B.The market value will increase
C.The market value will increase or decrease, depending on the general economic climate
D.The market value should remain level
Q:
When should an investor calculate both yield to maturity and yield to call?
A.Whenever there is a call provision
B.When the sum of the present values of the interest payments exceeds the call price
C.When the market price is greater than or equal to the call price
D.Whenever the funds can be reinvested
E.When interest rates increase above the coupon rate
Q:
What formula measure would an investor use to calculate the yield on a 20-year bond with 10 years to maturity, if he or she only intends to hold the bond for 5 years?
A.Anticipated realized yield
B.Yield to call
C.Current yield
D.Yield to maturity
E.Any one of the above will measure the yield
Q:
The total return an investor would receive from income plus capital appreciation, assuming a bond is held to maturity, is called the:
A.call premium.
B.current yield.
C.yield to maturity.
D.capital gains yield.
E.More than one of the above
Q:
The value of a bond at any given time is the sum of:
A.the future interest payments and the par value.
B.the present value of future interest payments and the present value of the par value.
C.the future value of the interest payments and the future value of the par value.
D.the present value of future interest payments and the market value.
E.the present value of future interest payments and the future value of the par value.
Q:
If an investor needs to increase the quality of his portfolio during the low-confidence periods of a recession, he can enjoy usually high returns on lower-grade instruments relative to higher grades.
Q:
The expectations hypothesis is that any long-term rate is an average of the expectations of future short-term rate over the applicable time horizon.
Q:
The anticipated realized yield represents the return over the holding period.
Q:
Lower-quality bonds tend to be in high demand during a recession.
Q:
Deep discount bonds are not prone to calls because they sell at low prices.
Q:
Deep discount bonds reflect questionable quality.