Deck 16: Convertible Bonds and Convertible Preferred Stock

Question 1

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

Answer 1

False

Question 2

If the value of the stock rises, the value of a convertible bond falls.

Answer 2

False

Question 3

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

Answer 3

True

Question 4

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

Question 5

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

Question 6

Generally, convertible bonds lack a call provision.

Question 7

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

Question 8

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

Question 9

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

Question 10

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

Question 11

Convertible bonds tend to pay more interest than comparable non-convertible bonds.

Question 12

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

Question 13

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

Question 14

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

Question 15

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

Question 16

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

Question 17

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

Question 18

Convertible preferred stock may be converted into debt.

Question 19

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

Question 20

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

Question 21

The value of convertible preferred stock depends on
1. the exercise (i.e., conversion)price
2. the number of shares into which the stock may be converted
3. the price of the common stock

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

Question 22

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 23

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

Question 24

Convertible bonds sell for a premium over their
1. market price
2. value as stock
3. value as debt

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

Question 25

Generally a convertible bond lacks

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

Question 26

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

Question 27

The price of a convertible bond increases when
1. interest rates rise
2. interest rates fall
3. the price of the stock rises
4. the price of the stock falls

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

Question 28

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

Question 29

Convertible preferred stock
1. pays a fixed dividend
2. pays a variable dividend
3. may be converted into the firm's bonds
4. 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 30

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

Question 31

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 32

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 33

When a convertible bond is called,
1. interest ceases to accrue
2. the bondholder receives the principal
3. the bondholder generally converts the bond
4. dividends are paid to the bondholder

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

Question 34

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 35

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 36

The price of a convertible bond is often
1. greater than its value as stock  
2. less than its value as stock
3. greater than its value as debt
4. less than its value as debt

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

Question 37

The value of a convertible bond as debt does not depend on

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

Question 38

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

Question 39

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

Question 40

The value of a convertible bond as stock depends on the
1. current rate of interest
2. number of shares into which it is convertible
3. price of the stock

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

Question 41

Corporation HBM has a convertible bond with the following terms:
     Coupon                       5%
     Principal                   $1,000
     Maturity                    10 years
     Conversion price             $50 (20 shares)
     Call price               $1,000 + one year's interest
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The bond's credit rating is BBB, and comparable BBB rated bonds yield 9 percent.
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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.
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a. What is the premium paid over the bond's value as stock?
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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?
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c. If the price of the bond stock to $65, is there any reason to expect the firm to call the bond?
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d. If the convertible bond is held to maturity, what is the annualized return on an investment in the bond?
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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 42

Given the information below, answer the following questions.

   A convertible bond has the following features:
     Principal            $1,000
     Maturity date            20 years
     Interest                $80 (8% coupon)
     Call price           $1,050
     Exercise price          $65 a share


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?

f. If the price of the stock were $35, what would be the minimum price of the bond?

g. What is the probability that the bond will be called when the price of the stock is $52?
  
h. If the price of the stock rose to $73, what would happen to the price of the bond?

i. If the price of the stock were $73, what would the investor receive if the bond were called?

j. What will the investor receive when the bond matures?

Question 43

A convertible bond's payback period
1. increases as the bond's coupon increases
2. decreases as the bond's coupon increases
3. increases as the stock's dividend increases
4. 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 $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 45

If an investor expects the firm to grow slowly, which of 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

The interest paid by a convertible bond tends
1. to exceed the firm's common stock dividends
2. to be less than the firm's common stock dividends
3. over time to offset the premium paid for the bond
4. 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 47

A firm has both a convertible bond and a convertible preferred stock outstanding. The convertible bond has the following features:
      Coupon         6.5%
      Maturity date   10 years
      Exercise price $20
      Principal   $1,000
      Call price  $1,065
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The convertible preferred stock has the following features:
      Annual dividend    $2.25
      Convertible into 2.5 shares of common stock
      Callable at $25 a share
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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?