Question 1

Which of the following statements is most CORRECT?

Accepted Answer

Preferred stock is considered less risky than bonds from the issuer's perspective because it does not obligate the company to make fixed payments. Failure to pay dividends on preferred stock does not result in bankruptcy, whereas failing to make bond payments can.

Question 2

Unlike bonds,the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis.This is because dividends on preferred stock are not tax deductible,whereas interest on bonds is deductible.

Accepted Answer

Dividends on preferred stock are not tax deductible, whereas interest on bonds is tax deductible. Therefore, the cost of preferred stock remains the same on a before-tax and after-tax basis.

Question 3

Most convertible securities are bonds or preferred stocks that,under specified terms and conditions,can be exchanged for common stock at the option of the holder.

Accepted Answer

Convertible securities are typically bonds or preferred stocks that can be exchanged for common stock under certain conditions.

Question 4

The common stock of Southern Airlines currently sells for $33,and its 8% convertible debentures (issued at par,or $1,000)sell for $850.Each debenture can be converted into 25 shares of common stock at any time before 2025.What is the conversion value of the bond?

Accepted Answer

The answer of The common stock of Southern Airlines currently...

Question 5

A detachable warrant is a warrant that can be detached and traded separately from the bond with which it was issued.Most traded warrants are originally attached to bonds or preferred stocks.

Accepted Answer

This statement is true. Detachable warrants are commonly issued together with bonds or preferred stocks and can be traded separately from the underlying security.

Question 6

Many preferred stocks extend voting rights to preferred shareholders if the preferred dividend has been omitted for some specified period,for example,4 quarters.

Accepted Answer

Some preferred stocks do offer voting rights to preferred shareholders if the dividend has been omitted for a specified period of time. This provision is known as 'cumulative voting.'

Question 7

The problem of dilution of stockholders' earnings never results from the sale of call options,but it can arise if warrants are used.

Accepted Answer

The answer of The problem of dilution of stockholders' earnings...

Question 8

Preferred stockholders have priority over common stockholders with respect to dividends,because dividends must be paid on preferred stock before they can be paid on common stock.However,preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy.

Accepted Answer

In the event of bankruptcy, preferred stockholders have priority over common stockholders with respect to liquidating proceeds, meaning they are paid out before common stockholders.

Question 9

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

Accepted Answer

Preferred stock can be a useful financing tool for companies in certain market conditions, such as when interest rates are high or when the company has reached its debt capacity and cannot issue more bonds. Additionally, preferred stock can provide investors with a preferred claim on assets and dividends, making it an attractive option for some investors.

Question 10

A warrant holder is not entitled to vote,but he or she does receive any cash dividends paid on the underlying stock.

Accepted Answer

Warrant holders do not have voting rights or receive dividends from the underlying stock, as they only have the right to purchase the stock at a specified price before the expiration date.

Question 11

Firms generally do not call their convertibles unless the conversion value is greater than the call price.

Accepted Answer

It is generally not beneficial for firms to call their convertibles if the conversion value (the value if the investor were to convert the bond into stock) is higher than the call price (the price at which the firm can force the investor to convert the bond into stock). This is because the investor would not want to convert the bond and give up the higher value of keeping it as a bond.

Question 12

Which of the following statements is most CORRECT?

Accepted Answer

Answer b is correct; convertibles do normally have a relatively low coupon because the opportunity for capital gains provides part of their expected total return.The other responses are all incorrect.Statement c is incorrect because like other options,the value of the warrant is increased by price volatility in the underlying asset.

Question 13

The owner of a convertible bond owns,in effect,both a bond and a call option.

Accepted Answer

A convertible bond is a type of bond that can be converted into a predetermined number of shares of the issuing company's common stock, at the bondholder's discretion. This gives the bondholder the option to convert the bond into stock and participate in potential stock price appreciation. Therefore, the bondholder owns both a bond and a call option on the company's stock.

Question 14

The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

Accepted Answer

The "preferred" in preferred stock refers to the preferential treatment in dividend payments and upon liquidation, not necessarily a higher expected return compared to common stock.

Question 15

A warrant is an option,and as such it cannot be used as a "sweetener."

Accepted Answer

A warrant can be used as a sweetener in certain financial transactions, such as a bond issuance or a loan agreement. It can be offered as an incentive to investors or lenders to participate in the transaction.

Question 16

Which of the following statements concerning warrants is correct?

Accepted Answer

Warrants are long-term call options that give the holder the right to buy the firm's common stock at the exercise price regardless of how high the stock's price has risen. This means that the holder can benefit from any increase in the stock's value beyond the exercise price.

Question 17

Preferred stock typically has a par value,and the dividend is often stated as a percentage of par.The par value is also important in the event of liquidation,as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

Accepted Answer

This is correct. Preferred stock typically does have a par value, and the dividend is often stated as a percentage of par. In the event of liquidation, preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

Question 18

A convertible debenture can never sell for more than its conversion value or less than its bond value.

Accepted Answer

A convertible debenture can sell for more than its conversion value if the stock price of the underlying company increases significantly, making it more valuable to convert the debenture into stock. It can also sell for less than its bond value if the market perceives the issuing company to be at a higher risk of default.

Question 19

Which of the following statements about convertibles is most CORRECT?

Accepted Answer

Response d is correct.From an investor's standpoint,convertibles are normally more risky than straight debt but less risky than common stock,hence the expected return on the convertible lies between that on the stock and that on the straight bond.

Question 20

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price,which is desirable for liquidity portfolios,and they also benefit from the 70% tax exemption on preferred dividends received.

Accepted Answer

Corporations do indeed benefit from a stable price and the 70% tax exemption on preferred dividends received when investing in floating-rate preferred stock.

Quiz 20: Hybrid Financing: Preferred Stock, warrants, and Convertibles

Which of the following statements is most CORRECT?

Unlike bonds,the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis.This is because dividends on preferred stock are not tax deductible,whereas interest on bonds is deductible.

Most convertible securities are bonds or preferred stocks that,under specified terms and conditions,can be exchanged for common stock at the option of the holder.

The common stock of Southern Airlines currently sells for $33,and its 8% convertible debentures (issued at par,or $1,000) sell for $850.Each debenture can be converted into 25 shares of common stock at any time before 2025.What is the conversion value of the bond?

A detachable warrant is a warrant that can be detached and traded separately from the bond with which it was issued.Most traded warrants are originally attached to bonds or preferred stocks.

Many preferred stocks extend voting rights to preferred shareholders if the preferred dividend has been omitted for some specified period,for example,4 quarters.

The problem of dilution of stockholders' earnings never results from the sale of call options,but it can arise if warrants are used.

Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.

A warrant holder is not entitled to vote,but he or she does receive any cash dividends paid on the underlying stock.

Firms generally do not call their convertibles unless the conversion value is greater than the call price.

Which of the following statements is most CORRECT?

The owner of a convertible bond owns,in effect,both a bond and a call option.

The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

A warrant is an option,and as such it cannot be used as a "sweetener."

Which of the following statements concerning warrants is correct?

Preferred stock typically has a par value,and the dividend is often stated as a percentage of par.The par value is also important in the event of liquidation,as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

A convertible debenture can never sell for more than its conversion value or less than its bond value.

Which of the following statements about convertibles is most CORRECT?

Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price,which is desirable for liquidity portfolios,and they also benefit from the 70% tax exemption on preferred dividends received.