Deck 25: Warrants and Convertibles

Question 1

The holder of a $1,000 face value bond can exchange the bond any time for 25 shares of stock. The conversion ratio is:

A) 40.
B) 25.
C) 100.
D) 50

Answer 1

25.

Question 2

If all warrants are exercised, what will your fraction of ownership be if you owned 2,000 shares originally.

A) 13.33%
B) 12.12%
C) 13.07%
D) 14.04%

Answer 2

13.07%

Question 3

What would the conversion price and conversion ratio be if Xenron had a 3 for 1 stock split?

A) 22; 25
B) 28.57; 35
C) 9.52; 105
D) 7.33; 75

Answer 3

9.52; 105

Question 4

What is the conversion premium?

A) 29.86%.
B) 106.61%.
C) 0.00%.
D) 59.009%.

Question 5

If the warrants are all exercised immediately, what would be the market price of the stock?

A) $27.00
B) $22.78
C) $25.13
D) $26.96
E) $29.00

Question 6

A warrant gives the owner:

A) the obligation to sell securities directly to the firm at a fixed price for a specified time.
B) the right to purchase securities directly from the firm at a fixed price for a specified time.
C) the obligation to purchase securities directly from the firm at a fixed price for a specified time.
D) the right to sell securities directly to the firm at a fixed price for a specified time.

Question 7

If a corporate security can be exchanged for a fixed number of shares of stock, the security is said to be:

A) callable.
B) convertible.
C) protected.
D) putable.

Question 8

The exercise of warrants creates new shares which:

A) increases the total number of shares but does not affect share value.
B) increases the total number of shares which reduces the individual share value.
C) does not change the number of shares outstanding similar to options.
D) increases share value because cash is paid into the firm at the time of warrant exercise.

Question 9

What is the conversion price?

A) 35
B) 770
C) 28.57
D) 1000

Question 10

What would your gain be from exercising the warrants, assuming all are exercised?

A) $2.00 per share
B) $1.96 per share
C) $0.00 per share
D) $25.00 per share
E) $27.00 per share

Question 11

Which of the following would not describe the difference between warrants and call options?

A) Warrants are issued by firms whereas call options are issued by individuals.
B) Call options have an exercise price whereas warrants do not.
C) Exercising of warrants creates dilution whereas exercising all options does not.
D) When call options are exercised existing shares trade hands whereas if warrants are exercised new stock must be issued.

Question 12

Concerning warrants and call options, which of the following statements generally is correct?

A) The issue procedures for both are quite similar.
B) When a call option is exercised, the firm must issue new stock.
C) When a warrant is exercised, existing stock changes hands.
D) Exercise of a call option does not affect share value, but warrant exercise does.

Question 13

A firm has 100 shares of stock and 40 warrants outstanding. The warrants are about to expire, and all of them will be exercised. The market value of the firm's assets is $2,000, and the firm has no debt. Each warrant gives the owner the right to buy 2 shares at $15 per share. What is the price per share of the stock?

A) $15.00.
B) $17.78.
C) $11.11.
D) $20.00.

Question 14

The holder of a $1,000 face value bond has the right to exchange the bond anytime before maturity for shares of stock priced at $50 per share. The $50 is called the:

A) conversion price.
B) stated price.
C) exercise price.
D) striking price.

Question 15

BrightView Windows issued warrants with an exercise price of $17 for one share per warrant. On May 1, BrightView's common stock is at $20 per share. The lower and upper limits on the warrant value on May 1 are:

A) $0 and $17.
B) $17 and $20.
C) $3 and $17.
D) $0 and $3.
E) $3 and $20.

Question 16

An "equity kicker" most often refers to a:

A) bond with conversion privileges.
B) preferred stock offering with conversion privileges.
C) warrant.
D) lettered common stock.

Question 17

What is the conversion value of the bond?

A) 25
B) 625
C) 40
D) 1000

Question 18

Which of the following would harm the position of a warrant holder?

A) a stock split of 3 for 1.
B) a large stock dividend of 20%.
C) a large cash dividend.
D) listing of the warrants on the NYSE.

Question 19

The holder of a $1,000 face value bond can exchange the bond any time for 25 shares of stock. The conversion price is:

A) $25.
B) $40.
C) $100.
D) $20.

Question 20

Warrants are most often issued in combination with:

A) new publicly placed common stock.
B) new privately placed common stock.
C) new publicly placed debt.
D) new privately placed debt.

Question 21

A convertible bond has a 8% coupon and 15 years to maturity. The face value is $1,000 and the conversion ratio is 40. The stock currently sells for $20 7/8 per share. Similar nonconvertible bonds are priced to yield 9%. The value of the convertible bond is at least:

A) $835.00.
B) $918.56.
C) $1,000.00.
D) $1570.11.

Question 22

A firm has 500 shares of stock and 100 warrants outstanding. The warrants are about to expire, and all of them will be exercised. The market value of the firm's assets is $25,000, and the market value of the debt is $8,000. Each warrant gives the owner the right to buy 5 shares at $25 per share. What is the value of a warrant?

Question 23

A convertible bond is selling for $993. It has 15 years to maturity, a $1,000 face value, and a 8% coupon paid semi-annually. Similar non-convertible bonds are priced to yield 8.5%. The conversion ratio is 20. The stock currently sells for $47.50 per share. Calculate the convertible bond's option value.

Question 24

A firm has experienced a significant increase in share value. In retrospect, which of the following securities would have been best to have issued prior to the change in share value?

A) Common stock.
B) Bond/warrant package.
C) Convertible preferred stock.
D) Straight bonds.
E) Convertible bonds.

Question 25

Based on empirical studies, firms tend to call convertible bonds when the conversion value is:

A) less than the conversion price.
B) greater than the straight bond value.
C) greater than the call price.
D) less than the face value.

Question 26

Issuing convertible bonds or bonds with warrants is useful for a company of unknown risk because:

A) the effects of risk are opposite on the two value components and tend to cancel each other out.
B) if the firm is high risk, the option premium will be higher while the straight bond value is fixed.
C) only risky companies issued these instruments.
D) the equity value is dependent on current risks only, not the future risk at conversion.

Question 27

Kida Consultants currently has 300,000 shares of common outstanding. Firm value net of debt is $3,900,000. Kida has warrants outstanding with an exercise price of $10. How many warrants must the firm have issued if the gain from exercising a single warrant is $8.25?

Question 28

A convertible bond has an option value which is equal to:

A) the market value of the convertible bond minus the straight bond value.
B) The market value of the convertible bond minus the conversion value.
C) the market value of the convertible bond minus the conversion premium.
D) the market value of the convertible bond minus the maximum of the straight bond value or conversion value.

Question 29

Concerning convertible bonds, which of the following statements is not correct?

A) The value of a convertible bond will generally be greater than its straight bond value.
B) The value of a convertible bond will generally be greater than its conversion value.
C) The difference between the conversion value and the straight bond value is the conversion or option premium.
D) The coupon rate on a nonconvertible bond will generally exceed the coupon rate on an otherwise identical convertible bond.

Question 30

A convertible bond is selling for $1222.70. It has 10 years to maturity, a $1,000 face value, and a 10% coupon paid semi-annually. Similar non-convertible bonds are priced to yield 8%. The conversion ratio is 40. The stock currently sells for $30.125 per share. Calculate the convertible bond's option value.

Question 31

Concerning convertible bonds, which of the following statements is not correct?

A) A convertible bond issue would generally have fewer restrictive covenants than an otherwise identical nonconvertible bond.
B) Convertible bonds can be issued at a lower coupon compared with otherwise non-convertible bonds.
C) If the value of a convertible bond exceeds the maximum of its straight bond value or its conversion value, the difference would be referred to as the option value.
D) Since convertible bonds will be exchanged for common stock, convertible bonds are generally not callable.

Question 32

A firm has 2,000 shares of stock and 200 warrants outstanding. The warrants are about to expire, and all of them will be exercised. The market value of the firm's assets is $14,000, and the firm has no debt. Each warrant gives the owner the right to buy 1 share at $5. What is the warrant's effective exercise price?

Question 33

A bond/warrant package is priced to sell at face value ($1,000). Each bond comes with 50 detachable warrants. A warrant gives the owner the right to buy 1 share of stock at $20 per share. The value of a warrant has been estimated at $2. The bonds mature in 20 years. Similar bonds without warrants yield 10%. What is the bond's annual coupon?

Question 34

Which of the following would not be a sensible explanation of why convertibles and warrants are issued if markets are efficient?

A) Cash flow from these securities best match cash flow of the firm.
B) If the firm does well, convertible bonds will turn out to have been the better alternative versus issuing common stock.
C) The securities are useful when it is costly to assess the risk of the issuing firm.
D) The securities may resolve agency problems associated with raising money.

Question 35

Kida Consultants has 100,000 shares of stock outstanding. The firm's value net of debt is $2 million. Kida has 1,000 warrants outstanding with an exercise price of $18, where each warrant entitles the holder to purchase one share of stock. Calculate the gain from exercising a single warrant.

Question 36

Transfer or expropriation of wealth from bondholders to stockholders is less likely to occur when:

A) subordinated straight debt is issued because there are other senior bondholders to protect them.
B) convertible debt is issued because the equity component will reduce these agency costs when value is shared.
C) convertible debt is issued because the holders can more readily sue when a high-risk project is under taken.
D) subordinated debt because monitoring is much easier with subordinated straight debt is issued.

Question 37

A convertible bond has an 7% coupon and 10 years to maturity. The face value is $1000 and the conversion ratio is 35. The stock currently sells for $27 3/8 per share. Similar nonconvertible bonds are priced to yield 9%. The value of the convertible bond is at least:

A) $869.92.
B) $958.125.
C) $1,000.00.
D) $1,325.20.

Question 38

A firm has experienced a significant decrease in share value. In retrospect, which of the following securities would have been best to have issued prior to the change in share value?

A) Convertible bonds.
B) Convertible preferred stock.
C) Common stock.
D) Straight debt.

Question 39

A convertible bond is selling for $800. It has 10 years to maturity, a $1000 face value, and a 10% coupon. Similar nonconvertible bonds are priced to yield 14%. The conversion price is $50 per share. The stock currently sells for $31.375 per share. The conversion premium is:

A) 37.25%.
B) 43.33%.
C) 59.36%.
D) 66.67%.

Question 40

From the shareholder's point of view, the optimum time to call a convertible bond is when the bond's conversion value is:

A) less than the call price, but greater than the face value.
B) greater than the call price, but less than straight debt's value.
C) equal to the face value.
D) less than straight debt's value, but greater than the call price.
E) none of the above.

Question 41

Explain why there is neither a "Free" nor "Expensive Lunch" when convertible bonds are issued?

Question 42

A convertible bond is selling for $800. It has 10 years to maturity, a $1000 face value, and a 10% coupon paid semi-annually. Similar nonconvertible bonds are priced to yield 14%. The conversion price is $50 per share. The stock currently sells for $31.375 per share. Determine the bond's option premium.

Question 43

Illustrate and explain how a convertible bond value is based on both debt and equity value. What is the option value?