Question 1

Which of the following statements about convertibles is most CORRECT?

Accepted Answer

For a convertible bond to be in equilibrium, the expected return must be between the expected return on the firm's straight debt and the expected return on its common stock, as the bond's value is tied to the underlying stock price. Option A is incorrect because the issuer does not receive additional cash when the convertibles are converted; instead, the issuer exchanges the bonds for shares of stock at the predetermined conversion ratio. Option B is incorrect because convertibles are often seen as more risky than straight debt due to the potential dilution from conversion. Option C is incorrect because the conversion price is generally set above the current stock price, to provide a conversion premium as an incentive for investors to convert. Option E is incorrect because the coupon interest rate on a firm's convertibles is generally lower than the market yield on its straight debt to compensate for the conversion feature.

Question 2

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 offer a means of raising capital for companies when they are in a situation where they cannot obtain debt or common stock at a reasonable cost.

Question 3

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

Accepted Answer

A convertible bond can be converted into a fixed number of shares of the issuing company's common stock. This feature gives the bondholder the flexibility to benefit from potential stock price appreciation while still receiving periodic interest payments. This feature also acts as a call option, giving the bondholder the right (but not the obligation) to convert the bond into shares of common stock at a predetermined conversion ratio. Therefore, the owner of a convertible bond owns both a bond and a call option.

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 conversion value of the bond is calculated by multiplying the number of shares that each debenture can be converted into by the current price of the stock. Therefore, the conversion value = 25 shares * $33/share = $825.

Question 5

Which of the following statements concerning warrants is correct?

Accepted Answer

Warrants are long-term call options that allow the holder to buy a firm's common stock at a fixed price, regardless of how high the stock's price has risen. They are often issued alongside other securities, as an incentive for investors to buy.

Question 6

Which of the following statements is most CORRECT?

Accepted Answer

EPreferred stock is considered less risky than bonds from the issuer's perspective because it does not obligate the firm to make fixed payments. The cost of capital for preferred stock is generally higher than for common stock because preferred dividends do not provide the tax deduction that interest payments on debt do, and preferred stocks often have features that make them more expensive to issue.

Question 7

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 statement is true. Preferred stock often has a par value and the dividend is usually stated as a percentage of par. In the event of liquidation, preferred stockholders typically receive their par value before any payments are made to common stockholders.

Question 8

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

Accepted Answer

A warrant holder does not have the right to vote or receive dividends, as these rights are reserved for actual shareholders. Warrants only give the holder the right to purchase the company's stock at a specified price before the expiration date.

Question 9

Which of the following statements is most CORRECT?

Accepted Answer

Convertible debt typically has a lower coupon rate compared to similar straight debt because convertibles offer the additional value of conversion to equity, which compensates for the lower interest income.

Question 10

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

Accepted Answer

This statement is true. Firms would not want to call their convertibles if the conversion value (the value the convertible would have if converted into equity) is greater than the call price (the price at which the firm can buy back the convertible from the investor). This is because the investor would likely choose to convert their convertible into equity rather than sell it back to the firm at a lower call price.

Question 11

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 it is trading at a premium due to market conditions or investor sentiment. It can also sell for less than its bond value if the company issuing the debenture is considered risky or if interest rates have risen since issuance.

Question 12

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 13

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 converted into common stock at the discretion of the holder, usually at a predetermined price and within a specified time period.

Question 14

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

This statement is true. Many preferred stocks have a provision called "cumulative voting rights" that allows preferred shareholders to vote if the company fails to pay the preferred dividend for a specified period, usually four consecutive quarters. This provision is meant to protect the interests of preferred shareholders and ensure that they have a say in important company decisions if the company is struggling financially.

Question 15

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 paid out of after-tax profits and are not tax deductible for the issuing firm. On the other hand, interest on bonds is tax deductible for the issuing firm, which lowers the cost of debt on an after-tax basis. Therefore, the cost of preferred stock is the same on a before-tax and after-tax basis, while the cost of debt is lower on an after-tax basis.

Question 16

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

Accepted Answer

A warrant is indeed a type of option, but it can be used as a "sweetener" by companies in various financial transactions, such as in bond offerings, to make the deal more attractive to investors by giving them the right to purchase the company's stock at a specific price in the future.

Question 17

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. A detachable warrant allows the holder to separately trade the right to purchase additional securities at a specific price, without having to also trade the underlying bond or preferred stock.

Question 18

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 preference in dividend payments and claims on assets in the event of liquidation, not necessarily a higher expected return compared to common stock.

Question 19

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 benefit from investing in floating-rate preferred stock due to the stable price and the tax exemption on preferred dividends received.

Question 20

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 also have priority over common stockholders with respect to liquidating proceeds. This means they are paid out from the company's assets before common stockholders after debt holders and creditors.

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

Which of the following statements about convertibles is most CORRECT?

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.

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

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?

Which of the following statements concerning warrants is correct?

Which of the following statements is most 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 warrant holder is not entitled to vote,but he or she does receive any cash dividends paid on the underlying stock.

Which of the following statements is most CORRECT?

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

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

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

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.

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

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.

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

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.

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

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.