Deck 24: Warrants and Convertibles

Question 1

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

Answer 1

Straight bonds

Question 2

Warrants are similar to options, in that the value of the warrant is limited by:

A)expiring worthless if the stock price is below the total warrant exercise price.
B)the trading capabilities of the exchange used.
C)the price of the underlying stock divided by the number of warrants needed to purchase a share.
D)Both A and C.
E)Both B and C.

Answer 2

Both A and C.

Question 3

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.
E)None of the above.

Answer 3

the right to purchase securities directly from the firm at a fixed price for a specified time.

Question 4

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 can reduce an 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.
E)None of the above.

Question 5

Two major differences between a warrant and a call option are:

A)warrants are contracts outside of the firm while options are within the firm.
B)warrants have long maturities while options are usually short maturities.
C)warrant exercise dilutes the value of equity while option exercise does not.
D)Both A and C.
E)Both B and C.

Question 6

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.
E)None of the above.

Question 7

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.
E)None of the above is correct.

Question 8

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

A)a 3 for 1 stock split
B)a large stock dividend of 20%
C)a large cash dividend
D)listing of the warrants on the NYSE
E)None of the above would harm the warrant holders.

Question 9

BrightView Windows issued warrants with an exercise price of $17.BrightView's common stock currently sells for $20 per share.The warrants are:

A)in the money.
B)out of the money.
C)valuable.
D)not very valuable.
E)Both A and C.

Question 10

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.
E)All of the above are correct.

Question 11

The gain from exercising a warrant is similar to the gain from exercising a call option except:

A)the gain on a warrant is greater by the fraction of warrant shares divided by total shares.
B)the gain on a warrant is limited by the firm's value after being reduced by the debt of the firm.
C)the gain on a warrant is decreased by the fraction of original shares divided by total post exercise shares.
D)Both A and B.
E)Both B and C.

Question 12

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.
E)None of the above.

Question 13

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.
E)None of the above.

Question 14

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.
E)More than one of the above is incorrect.

Question 15

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 call options does not.
D)When call options are exercised existing shares trade hands whereas if warrants are exercised new stock must be issued.
E)None of the above.

Question 16

Warrants are similar to traded options except:

A)only warrants have exercise prices.
B)only warrants depend on changes in the underlying stock to determine value.
C)warrants affect the number of shares outstanding.
D)Both A and C.
E)Both A and B.

Question 17

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.
E)preferred stock.

Question 18

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

A)With regard to security, most convertible bonds are secured by common stock (i.e., they are collateral trust bonds).
B)For most convertible bonds, the issuing firm can, under certain circumstances, effectively force bondholders to convert to common stock.
C)When a convertible bond is called, the owner has the option of receiving cash or stock for the bond.
D)All of the above are incorrect.
E)All of the above are correct.

Question 19

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.
E)None of the above.

Question 20

A convertible preferred stock is similar to a convertible bond except:

A)the conversion ratio is fixed (given).
B)the conversion price is fixed (given).
C)the time to maturity is infinite.
D)All of the above.
E)None of the above.

Question 21

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.
E)All of the above are sensible explanations.

Question 22

Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder can purchase a new share of stock for five warrants and $5.00 per warrant. The stock is currently selling for $27 per share.
If all warrants are exercised, what will your fraction of ownership be if you owned 20,000 shares originally?

A)12.12%
B)13.07%
C)13.33%
D)14.04%
E)Without knowing the exercise price the percent can not be determined.

Question 23

The holders of Xenron Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $22.00.
What is the conversion price?

A)$22.00
B)$28.57
C)$35.00
D)$1,000.00
E)No conversion premium is given.

Question 24

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)$11.11
B)$15.00
C)$17.78
D)$20.00
E)None of the above.

Question 25

The holders of Mikayla Corporation's bond with a face value of $1,000 can exchange that bond for 30 shares of stock. The stock is selling for $25.00.
What is the conversion price?

A)$25.00
B)$33.33
C)$35.00
D)$1,000.00
E)No conversion premium is given.

Question 26

Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder can purchase a new share of stock for five warrants and $5.00 per warrant. The stock is currently selling for $27 per share.
If the warrants are all exercised immediately, what would be the market price of the stock?

A)$22.78
B)$25.13
C)$26.96
D)$28.00
E)$29.00

Question 27

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.
E)None of the above.

Question 28

Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder can purchase a new share of stock for five warrants and $5.00 per warrant. The stock is currently selling for $27 per share.
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)Depends on the current market price of the bond.
E)None of the above.

Question 29

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 30

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 issue these instruments.
D)the equity value is dependent on current risks only, not the future risk at conversion.
E)None of the above.

Question 31

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

Question 32

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

A)Convertible bonds
B)Convertible preferred stock
C)Straight debt
D)Indifferent between A and B.
E)Indifferent between A, B, and C.

Question 33

Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder can purchase a new share of stock for five warrants and $5.00 per warrant. The stock is currently selling for $27 per share.
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)25.
B)40.
C)100.
D)Depends on the current market price of the bond.
E)None of the above.

Question 34

The holders of Xenron Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $22.00.
What is the conversion value of the bond?

A)$25
B)$40
C)$770
D)$1,000
E)No conversion premium is given.

Question 35

What would the conversion price and conversion ratio be if Mikayla had a 4 for 1 stock split?

A)$5.33; 75
B)$8.33; 120
C)$22.00; 125
D)$27.50; 135
E)None of the above.

Question 36

The holders of Xenron Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $22.00.
What is the conversion premium?

A)0.00%
B)29.86%
C)59.01%
D)106.61%
E)None of the above.

Question 37

The holders of Mikayla Corporation's bond with a face value of $1,000 can exchange that bond for 30 shares of stock. The stock is selling for $25.00.
What is the conversion premium?

A)10.00%
B)27.58%
C)33.32%
D)103.23%
E)None of the above.

Question 38

Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder can purchase a new share of stock for five warrants and $5.00 per warrant. The stock is currently selling for $27 per share.
What would your gain per share be from exercising the warrants, assuming all are exercised?

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

Question 39

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 undertaken.
D)subordinated debt is issued because monitoring is much easier when subordinated straight debt is issued.
E)None of the above.

Question 40

The holders of Xenron Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $22.00.
What would the conversion price and conversion ratio be if Xenron had a 3 for 1 stock split?

A)$7.33; 75
B)$9.52; 105
C)$22.00; 25
D)$28.57; 35
E)None of the above.

Question 41

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

Question 42

A convertible bond has an 8% annual coupon and 15 years to maturity.The face value is $1,000 and the conversion ratio is 40.The stock currently sells for $20.875 per share.Similar nonconvertible bonds are priced to yield 9%.The value of the convertible bond is at least:

A)$835.00.
B)$919.39.
C)$1,000.00.
D)$1,570.11.
E)None of the above.

Question 43

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

Question 44

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 45

A bond/warrant package is priced to sell at a face value of $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 46

What is the conversion value of the bond?

A)$25
B)$40
C)$750
D)$1,000
E)No conversion premium is given.

Question 47

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 48

A convertible bond is selling for $993.It has 15 years to maturity, a $1,000 face value, and an 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 49

Why are warrants and convertibles issued?

Question 50

A convertible bond is selling for $1,222.70.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 51

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 52

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 53

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 54

A convertible bond is selling for $800.It has 10 years to maturity, a $1,000 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%.
E)None of the above.