Deck 19: Equity and Hybrid Instruments

Question 1

Which one of the following is the reason for paying a different price for different classes of shares in the case of a takeover?

A) Prices depend on the tax treatment of each class.
B) Prices depend on the dividend yield offered by the class.
C) Prices depend on the voting rights of the shares.
D) Prices depend on the floating of shares.

Answer 1

C

Question 2

Residual owners are:

A) bond holders
B) equity holders
C) equity and preferred shareholders
D) all of the above

Answer 2

B

Question 3

Which of the following statements about family trusts is true?

A) Family trusts separate ownership and control.
B) Income flows to the trust beneficiaries.
C) The trustees retain the voting power.
D) All of the above statements are true.

Answer 3

D

Question 4

Preferred shares are ______ financing.

A) a form of debt
B) a form of equity
C) a combined form of debt and equity
D) different from debt and equity

Question 5

The retraction feature:

A) protects the issuer from interest-rate risk.
B) allows the shareholder to sell it to the issuer at an early maturity date.
C) allows the issuer to buy it back from the shareholder at an early maturity date.
D) protects both the shareholder and the issuer regardless of interest rates.

Question 6

Use the following statements to answer this question:
I)Today,the pre-emptive right is always used by corporations to protect their investors from dilution.
II)A common share has the characteristics of a call option because it has unlimited upside potential.

A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.

Question 7

The following may or may NOT be in a list of shareholders' rights.Choose the letter that corresponds to the correct list of rights:
1)Share in dividends
2)Elect directors
3)Appoint managers
4)Vote in general meetings
5)Vote in directors' meetings
6)Examine the company records
7)Priority over unsecured junior debt
9)Declare a stock split

A) 1, 2, 3, 5, 8
B) 1, 2, 3, 5, 8, 9
C) 1, 2, 4, 6
D) 1, 2, 6, 9

Question 8

Which of the following statements is correct?

A) Family trusts ensure income flows to the people descended from the company founder.
B) Family trusts ensure all the votes are held by the trustees.
C) Family trusts nominate the managers of the corporation.
D) all of the above.
E) a and b

Question 9

Use the following statements to answer this question:
I)A retractable preferred share can be sold back to the issuer.
II)Preferred shares provide a benefit for taxes given that dividend income receives preferential tax treatment as compared to interest income.

A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.

Question 10

The right of shareholders to receive new shares when new shares are issued is called:

A) a residual owner.
B) a general cash offer.
C) a private placement.
D) a pre-emptive right.

Question 11

When a corporation has only one class of shares,which of the following is NOT one of the rights of shareholders?

A) To vote at any shareholder meeting of the corporation.
B) To vote at any director meeting of the corporation.
C) To receive any dividend declared by the corporation.
D) To receive any residual property of the corporation on dissolution.

Question 12

How would you price preferred shares?

A) As an annuity
B) As a growing annuity due
C) As a perpetuity
D) As a growing perpetuity

Question 13

Which of the following statements about dividends is true?

A) Dividends are paid before interest is paid.
B) Dividends received by Canadian households are taxed at the marginal personal tax rate.
C) Dividends are tax deductible.
D) Dividends received by one Canadian corporation from another Canadian corporation are not taxed.

Question 14

You are given the following shareholders' equity figures for Toronto Skaters Inc.(TS)for the fiscal year ends of 2013,2014,and 2015.What is TS's book value per share for each of the three years,beginning with 2013?

a) $1.92, $2.25, and $1.01
b) $2.50, $2.87, and $1.68
c) $7.38, $7.82, and $6.62
d) $1.30, $1.28, and $1.66

Question 15

When dividends that have been in arrears are paid,the preferred shares have a ______ provision.

A) participating
B) cumulative
C) non-cumulative
D) retractable

Question 16

You are given the following shareholders' equity figures for Toronto Skaters Inc.(TS)for the fiscal year end of 2015.What is TS's market to book ratio?

a) 4.59
b) 18.28
c) 30.09
d) 18.11

Question 17

Different classes of common shares are usually issued:

A) to give some shareholders control of the firm.
B) to pay more dividends to a specific class of common shares.
C) to vote at any director meeting of the corporation.
D) none of the above.

Question 18

The book value of the shareholders' equity is represented by:

A) the total assets minus the current liabilities.
B) the sum of the par value of common stock and the accumulated retained earnings.
C) the sum of preferred stock, retained earnings, and common equity.
D) the total assets minus equity.

Question 19

In the event of liquidation,preferred shareholders rank ahead of:

A) subordinated debt holders.
B) secured debt.
C) common shareholders.
D) debenture holders.

Question 20

You are given the following shareholders' equity figures for Toronto Skaters Inc.(TS)for the fiscal year end of 2015.What is TS's dividend yield,including and excluding the special dividend?

a) 4.9%, 3.9%
b) 8.9%, 3.9%
c) 11.3%, 25.3%
d) 2.7%, 1.2%

Question 21

What is the tax value of money?

A) The difference between your before-tax and after-tax earnings.
B) The tax rate multiplied by the total income reported to the government.
C) Accounting for the fact that dividends are taxed more favourably than is interest income.
D) Accounting for the fact that dividends are not taxed while interest income is taxable.

Question 22

Which of the following characteristics apply to straight preferred shares?
I)No maturity date
II)Pay a fixed dividend
III)Dividends are paid at regular intervals
IV)Have a positive yield spread over long Canada bonds
V)The right to sell them back to the issuer

A) I and II
B) I, II, and III
C) I, II, III, and IV
D) I, II, IV, and V

Question 23

Interest rates have gone up to 14 percent since you purchased your 10 percent preferred shares.You would be best off if the shares had a(n)______ feature.

A) call
B) extraction
C) redemption
D) retraction

Question 24

Which of the following is true regarding convertible bonds?

A) The convertible bond value is unrelated to the value of the stock.
B) The value of convertible debt is a function of the risk of default.
C) The conversion factor can be separated from the bond and sold separately to other investors.
D) When a bond is converted into shares, the company receives additional funds as part of the conversion.

Question 25

Evaluate the following statement:
The cost of preferred stock is the rate of return shareholders require on the firm's preferred stock.

A) False.
B) True.

Question 26

Which of the following characteristics apply to retractable preferred shares?
I)No maturity date
II)Pay a fixed dividend at regular intervals
III)Have a positive yield spread (before tax)over mid-term Canada bonds
IV)The right to sell them back to the issuer

A) I and II
B) I, II, and III
C) I, II, III, and IV
D) II, III, and IV

Question 27

Which of the following characteristics apply to floating rate preferred shares?
I)Long maturity date
II)Pay a fixed dividend
III)Dividends are paid at regular intervals
IV)Have a positive yield spread (after tax)over bankers' acceptances
V)The right to sell them back to the issuer

A) I and II
B) I, II, and III
C) III, IV, and V
D) I, III, and IV

Question 28

Warrants attached to a bond:

A) are used as sweeteners to make bond issues less attractive.
B) always increase the risk of the bond.
C) always decrease the risk of the bond.
D) all of the above.

Question 29

The ______ specifies the number of shares received for each convertible bond.

A) conversion price
B) subscription price
C) conversion ratio
D) subscription ratio

Question 30

Hudson Bay Fishing Corporation has issued bonds that can be converted into common shares when the share price is $50.The current market price of the stock is $35.The bond has a face value of $1,000 and currently sells for $975.What is the conversion ratio for this bond?
a) 20
b) 28.6
c) 24.4
d) 27.9

Question 31

In which of the following ways are some preferred shares similar to bonds?
I)Call provisions
II)Convertible features
III)Retraction provisions
IV)Rated by rating agencies

A) I, II, and III
B) I, II, and IV
C) II and III
D) I, II, III, and IV

Question 32

Warrants are similar to call options on stocks.What's the equivalent of the strike price?

A) The initial price of the warrant
B) The market price of the warrant
C) The price of exercise of the warrant
D) None of the above

Question 33

Issuing bonds plus warrants is similar to issuing:

A) Retractable bonds.
B) Convertible bonds.
C) Floating rate bonds.
D) Preferred shares.

Question 34

The conversion premium is defined as which of the following?

A) The number of shares that a convertible security can be exchanged for.
B) The price at which a convertible security can be converted into common shares.
C) The value of a convertible security if it is immediately converted into common shares.
D) The percentage difference between the value at which the bonds are trading and their conversion value.

Question 35

Use the following statements to answer this question:
I)A warrant's value is due,in part,to its long-term maturity.
II)The intrinsic value of a warrant does not depend on the volatility of the stock.

A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.

Question 36

Punta Oil Company has 600,000 shares outstanding and has just issued 640,000 warrants.Each warrant entitles its owner to buy one share anytime in the next quarter at a price of $40.The common stock price is current $50.What is the payoff to the warrant holders exercising them,rounded to the nearest dollar?
a) $774.193.54
b) $3,096,774.19
c) $3,577,684.67
d)$3,844,599.16

Question 37

In which of the following ways do warrants differ from call options?
I)Warrants impact the firm while call options do not.
II)Call options generally have shorter maturities than warrants.
III)Any profit received from call options is taxable while that from warrants is not taxable.
IV)Volatility increases the value of call options but makes warrants less valuable.
V)The longer maturities of warrants make them less valuable.

A) I, II, and III
B) I, III, and V
C) II, IV, and V
D) I and II

Question 38

A company has 20 million shares outstanding that are trading at $30 per share.The company has 2 million warrants outstanding that have an exercise price of $28 per share.What is the payoff to the warrant holders exercising them,rounded to the nearest dollar?
a) $3,636,364
b) $ 2,800,000
c) - $3,636,364
d) $6,000,000

Question 39

Which of the following support the rationale for issuing convertible bonds?

A) To reduce underwriting costs
B) To permit cheaper initial financing
C) To minimize dilution
D) All of the above are good reasons for issuing convertible bonds.

Question 40

Which of the following statements is correct?

A) Companies issue preferred shares only to have better control of the firm.
B) Preferred shares pay a guaranteed dividend.
C) None of the above
C) Preferred dividends are not tax deductible to the issuing firm.

Question 41

A 10% semiannual coupon bond has 10 years to maturity when market rates on similar non-convertible bonds are 8.5%.It is convertible into 40 common shares and has a $1,000 par value.The shares are currently trading at $30.What is the floor value of the bond,assuming it pays semi-annual coupons?
a) $2,000
b) $1,100
c) $1,200
d) $1,000

Question 42

A 12% coupon bond has 20 years to maturity when market rates on similar non-convertible bonds are 9.25%.It is convertible into 20 common shares and has a $1,000 par value.The shares are currently trading at $40.What is the straight bond value,assuming it pays annual coupons?
a) $1,247
b) $1,000
c) $1,207
d) $1,287

Question 43

The price at which a convertible bond would sell for if it could NOT be converted into common stock is called:

A) floor value.
B) straight bond value.
C) convertible bond value.
D) conversion value.

Question 44

Discuss how preferred shares have features of both debt and equity instruments.

Question 45

Which of the following statements is correct?

A) Adjustable rate convertible subordinated securities make the interest payments conditional on prior dividend payments.
B) Income bonds pay out guaranteed and fixed coupons prior to common dividends.
C) Original issue discount bonds (OIDs) sell at a discount when issued by firms.
D) All of the above are correct.

Question 46

What are the costs and benefits of preferred share financing?

Question 47

Which of the following is the hard retraction requirement?

A) The preferred shares must be paid off with common shares or other preferred shares.
B) The preferred shares must be paid off with cash.
C) The preferred shares must be paid off within 30 days of retraction.
D) The preferred shares can only be retracted in cases of financial distress.

Question 48

A LYON is a note that:

A) is convertible.
B) has a zero coupon.
C) both of the above.

Question 49

Which of the following statements regarding income bonds is/are true?

A) They appear similar to debt but are closer to equity.
B) They are generally issued after a reorganization.
C) The interest is tied to some level of the cash flow of the firm.
D) All of the above statements are true.

Question 50

Which of the following statements regarding convertible bonds is true?

A) The floor value is the lowest price a convertible bond will sell for.
B) The convertible bond's floor value is determined by the maximum of the straight bond value and the conversion value.
C) If the share price rises above the conversion price, investors will convert the bonds.
D) All of the above statements are true.

Question 51

Montreal Financing has preferred shares with a par value of $20 outstanding.These shares pay $1.60 in dividends annually.
a) What will be the market price of these shares if the current market yield is 11 percent?
b) What will be the market price of these shares if the current market yield is 11 percent and the issue is retractable in five years at the par value?
c) What is the value of this retractable feature? Why does it have value?
d) What will be the market price of these shares if the issue is immediately redeemable and retractable at par?

Question 52

A firm has $45,000,000 of preferred shares outstanding that have a yield of 10 percent on par and are callable at a 3 percent premium.New issues will cost $980,000 in issuing and underwriting expenses.
a) At what interest rates would the firm want to refinance?
b) If the dividend yield drops to 8 percent, how long will it take before the present value of the interest savings exceeds the cost of refinancing?

Question 53

Which of the following securities provides a firm with results similar to those of a real return bond?

A) Adjustable rate convertible subordinated securities
B) Liquid yield option notes
C) Income bond
D) Original issue discount bond

Question 54

Which of the following factors are considered when determining whether a security is debt or equity?
I)Permanence factor
II)Subordination factor
III)Objective factor
IV)Legal factor
V)Subjective factor

A) I and II
B) I, II, and III
C) I, II, and IV
D) I, II, IV, and V

Question 55

Which of the following is NOT an example of an indexed bond?

A) Commodity bond
B) Real return bond
C) Income bond
D) Callable bond

Question 56

You want to buy a portfolio of financial securities consisting of three,$1,000 face value Government of Canada bonds and 500 preferred shares of Laurentide Resort Inc.
Laurentide Resort has a preferred share series trading on the Toronto Stock Exchange.It pays a dividend of $0.56 semi-annually.The required rate of return on the stock is 12 percent compounded semi-annually.The bonds have 4 years to maturity and an 8 percent semi-annual coupon.Currently,the yield to maturity on these bonds is 10 percent compounded semi-annually.
a) What is the current intrinsic value of Laurentide Resort's preferred stock?
b) What is the current price of the 4-year coupon bonds?
c) What is the current value of your portfolio (i.e., bonds + preferred stock)?
d) It is now 2 years later. Market interest rates have dropped and the yield to maturity on these bonds is now 8 percent. What is the value of the bonds at this time?
e) It is still 2 years later and the yield to maturity has dropped to 8%. Assume that the price of Laurentide Resort Inc. is now $8.50. What is the expected annual rate of return on your portfolio over the two years from your investment?

Question 57

If you are to allocate the amount of soft retractable preferred shares in the financial statements,where would they go?

A) Assets
B) Liabilities
C) Ownership equity
D) None of the above

Question 58

A 12% coupon bond has 20 years to maturity when market rates on similar non-convertible bonds are 9.25%.It is convertible into 20 common shares and has a $1,000 par value.The shares are currently trading at $40.What is the floor value of the bond,assuming it pays annual coupons?
a) $1,247
b) $1,000
c) $800
d) $2,000

Question 59

If you are to allocate the amount of hard retractable preferred shares in the financial statements,where would they go?

A) Assets
B) Liabilities
C) Ownership equity
D) None of the above

Question 60

Rank the risk of the following securities from lowest to highest.
I)Long-term unsecured debt
II)Convertible preferred shares
III)Common equity
IV)Bank loans

A) I, II, III, IV
B) IV, III, II, I
C) I, II, IV, III
D) IV, I, II, III

Question 61

Explain how a warrant is viewed as a call option on the firm.

Question 62

Why is there a difference between the way the market classifies debt and the way the CRA classifies it.

Question 63

Explain an important implication of viewing a company's common shares as a call option.

Question 64

Explain how the value of convertible debt varies as a function of the common share price.

Question 65

Toronto Skaters currently has $1,000,000 of 8 percent convertible debt outstanding.The coupon interest is paid on an annual basis.The $1,000 face value debentures mature in 12 years and have a conversion price of $50.Similar straight debt currently yields 7 percent.The firm's common stock is currently trading for $55 per share.What is the current straight debt value and the current conversion value of the convertibles? What is the floor price for the convertibles? If all the convertible holders decided to convert,how many additional shares would have to be issued?

Question 66

Explain the difference between the conversion price and the conversion ratio.

Question 67

Explain the differences and similarities between warrants and convertibles.

Question 68

Explain the importance of warrants in financing for firms.

Question 69

Give four reasons why companies use convertibles to raise capital instead of straight debt.

Question 70

Explain how equity can be viewed as a call option on the firm.

Question 71

Describe convertible debt.

Question 72

Hudson Bay Fishing Corporation has just issued a 10-year,9 percent annual-pay bond with a $1,000 face value.In addition,the bond was issued with 50 detachable warrants.The bond was issued at par.Each warrant gives the owner the right to purchase 2 shares of the company's stock for $15 each.Bonds with equivalent risk but with no attached warrants currently yield 11 percent.What is the value of one warrant?