Deck 16: Convertible Bonds and Convertible Preferred Stock

Question 1

As the price of the stock rises, the probability that a convertible bond will be called increases.

Answer 1

True

Question 2

Convertible bonds tend to pay more interest thancomparable non convertible bonds.

Answer 2

False

Question 3

Generally, convertible bonds lack a call provision.

Answer 3

False

Question 4

The premium paid over a convertible bond's value as debt tends to decline as the price of the stock rises.

Question 5

The longer it takes to overcome the capital gainsadvantage to the stock, the less attractive is a convertible bond.

Question 6

A convertible bond may be converted at the firm's option into common stock.

Question 7

Convertible preferred stock generally has a call feature designed to force conversion.

Question 8

Convertible preferred stock is usually less risky toinvestors than the firm's convertible bonds.

Question 9

A convertible bond's value fluctuates with the price of the stock into which the bond may be converted.

Question 10

The potential capital gains from a convertible bondtend to be less than the potential capital gains on the stock into which the bond may be converted.

Question 11

Convertible preferred stock may be converted into debt.

Question 12

The value of a convertible bond as a debt instrumentsets a floor (i.e., the minimum price) for the bond.

Question 13

The premium paid over a convertible bond's value asstock tends to fall as the price of the stock rises.

Question 14

If a $1,000 convertible bond may be converted into 25 shares, the exercise (conversion) price is $40 a share.

Question 15

As interest rates increase, the probability that aconvertible bond will be called declines.

Question 16

If the value of the stock rises, the value of aconvertible bond falls.

Question 17

Convertible bonds are often subordinated to the firm's other debt.

Question 18

If a convertible bond is called, the bondholder must convert the bond or lose the appreciation achieved by the stock.

Question 19

Convertible bonds tend to sell for a premium over their value as stock.

Question 20

If interest rates rise, the value of a convertible bond as debt increases.

Question 21

Convertible bonds sell for a premium over their1. market price2. value as stock3. value as debt

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) 1, 2, and 3

Question 22

The value of a convertible bond as debt does notdepend on

A) the bond's coupon
B) the conversion price of the bond
C) current interest rates
D) the term of the bond

Question 23

Convertible bonds have a call feature to

A) protect stockholders from early conversions
B) protect bondholders from conversions by stockholders
C) force stockholders to convert
D) force bondholders to convert

Question 24

The price of a convertible bond increases when1. interest rates rise2. interest rates fall3. the price of the stock rises4. the price of the stock falls

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 25

The value of a convertible bond as stock depends on the1. current rate of interest2. number of shares into which it is convertible3. price of the stock

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) 1, 2, and 3

Question 26

A put bond permits the investor to sell the bond back to the issuer (i.e., redeem the bond) at par prior to maturity.

Question 27

The price of a convertible bond is often1. greater than its value as stock2. less than its value as stock3. greater than its value as debt4. less than its value as debt

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 28

Convertible bonds may dilute current stockholders'equity because

A) the bonds require interest payments
B) the bonds are callable
C) dividends to bondholders reduce earnings
D) new shares are issued when the bonds are converted

Question 29

If the price of common stock falls, the value of aconvertible preferred stock will also tend to fall.

Question 30

When interest rates rise, the price of a put bond willtend to fluctuate more than a bond without the put option.

Question 31

The dividends paid by a convertible preferred stock aretreated as a tax-deductible expense to the firm.

Question 32

The value of convertible preferred stock depends on1. the exercise (i.e., conversion) price2. the number of shares into which the stock maybe converted3. the price of the common stock

A) 1 and 2
B) 1 and 3
C) 2 and 3
D) all of the above

Question 33

A put bond permits

A) the investor to convert the bond into stock
B) the firm to call the bond
C) the investor to sell the bond back to the company
D) the firm to pay a variable rate of interest

Question 34

Generally a convertible bond lacks

A) an indenture
B) a call feature
C) a strong sinking fund
D) a maturity date

Question 35

If interest rates fall, the investor will not exercisethe option in a put bond.

Question 36

Buying a bond with an option to sell the bond back tothe firm at par is more speculative than buying a bond that lacks this feature.

Question 37

Put bonds tend to have lower coupons than bonds that lack the put feature.

Question 38

As the price of common stock rises,

A) the value of convertible bonds and convertible preferred stock declines
B) the value of convertible bonds falls but convertible preferred stock rises
C) the value of convertible bonds rises but convertible preferred stock falls
D) the value of convertible bonds and convertible preferred stock rises

Question 39

When a convertible bond is called,1. interest ceases to accrue2. the bondholder receives the principal3. the bondholder generally converts the bond4. dividends are paid to the bondholder

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 40

Convertible preferred stock1. pays a fixed dividend2. pays a variable dividend3. may be converted into the firm's bonds4. may be converted into the firm's stock

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 41

A $50 par value convertible preferred stock is convertible into 5 shares (exercise price of $10). The preferred is selling for $75, and the price of the common stock is $12.If the price of the common stock rises to $20, what is the minimum percentage price increase the holder of the preferred stock should experience

Question 42

The interest paid by a convertible bond tends1. to exceed the firm's common stock dividends2. to be less than the firm's common stock dividends3. over time to offset the premium paid for the bond4. to increase the premium paid for the bond

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 43

A convertible bond's payback period1. increases as the bond's coupon increases2. decreases as the bond's coupon increases3. increases as the stock's dividend increases4. decreases as the stock's dividend increases

A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4

Question 44

A firm has both a convertible bond and a convertible preferred stock outstanding. The convertible bond has the following features: The convertible preferred stock has the following features:Annual dividend $2.25Convertible into 2.5 shares of common stockCallable at $25 a share.Currently the common stock is selling for $13; the yield on non convertible bonds is 10%, and the yield on comparable preferred stocks is 14%. What is the value of the above securities in terms of the common stock What would be the value of each security if it lacked the conversion feature SOLUTIONS TO THE PROBLEMS

Question 45

If an investor expects the firm to grow slowly, whichof the following strategies would be best

A) sell the stock short
B) buy a convertible bond and short the stock
C) buy the stock
D) buy the firm's convertible securities

Question 46

Corporation HBM has a convertible bond with the following terms: The bond's credit rating is BBB, and comparable BBB rated bonds yield 9 percent.The firm's stock is selling for $45 and pays a dividend of $1.50 a share. The convertible bond is selling for $1,000.
a. What is the premium paid over the bond's value as stock?
b. Given the bond's income advantage, how long must the investor hold the bond to overcome the premium over the bond's value as stock?
c. If the price of the bond stock to $65, is there any reason to expect the firm to call the bond?
d. If the convertible bond is held to maturity, what is the annualized return on an investment in the bond?
e. If the price of the stock declines to $25 a share while interest rates on BBB rated bonds rise to 12 percent, what impact does the increase in interest rates have on this convertible bond?

Question 47

Given the information below, answer the following questions.A convertible bond has the following features:
a. The bond may be converted into how many shares?
b. If comparable non-convertible debt offered an annual yield of 12 percent, what would be the value of this bond as debt?
c. If the stock were selling for $52, what is the value of the bond in terms of stock?
d. Would you expect the bond to sell for its value as debt (i.e., the value determined in b) if the price of the stock were $52?
e. If the price of the bond were $960, what are the premiums paid over the bond's value as stock and its value as debt?