Deck 19: Convertibles, Warrants and Derivatives

Question 1

Diluted earnings per share must include all convertible securities.

Answer 1

True

Question 2

Convertible securities are attractive because of their downside protection characteristics as well as upside potential.

Answer 2

True

Question 3

Most corporations include call provisions in agreements relating to the issue of warrants.

Answer 3

False

Question 4

Warrants are considered only in the computation of diluted earnings per share.

Question 5

Forced conversion refers to the corporation calling a convertible bond when the market price of the stock is above the conversion price.

Question 6

The conversion premium is equal to the market price minus the conversion value.

Question 7

A $1,000 par value convertible bond has a conversion ratio of 50. The bond conversion price is $20.

Question 8

A common stock equivalent is considered to be any security convertible into common stock.

Question 9

For the most downside protection, an investor should search for convertibles trading below par value near their floor value.

Question 10

If you purchased a convertible bond when first issued, you would pay more for the shares of stock you are entitled to than if you purchased the shares directly on the market at that point in time.

Question 11

The interest rate on convertible bonds is typically one-third higher than similar non-convertible issues.

Question 12

The conversion premium represents the dollar difference between the conversion value and the pure bond value.

Question 13

A convertible security is one that can be converted into common stock at the option of the issuer.

Question 14

Warrants are often attached to debt securities to increase the debt issues attractiveness to investors.

Question 15

A convertible bond has two separate bases of value, the bond investment value and the bond conversion value.

Question 16

The face value of a convertible bond divided by the conversion price equals the number of shares a bondholder will receive upon conversion.

Question 17

In order to calculate (basic) earnings per share, the earnings aftertaxes have to be adjusted for the elimination of the convertible bond interest expense.

Question 18

A call provision is a commonly used device by a corporation to force conversion into common stock.

Question 19

The conversion price divided into the market value of a convertible bond provides the conversion ratio.

Question 20

Earnings per share (basic) includes all convertible bonds outstanding.

Question 21

The convertible Eurobond market allows foreign companies to issue and trade their securities in the Canadian markets.

Question 22

A convertible bond has both a downside limit (the pure bond value) and an upside limit (the conversion price).

Question 23

In general the average size of a convertible issue is small compared to normal bond issues.

Question 24

On average, convertible bonds have conversion premiums of less than 10% at time of issue.

Question 25

Because a warrant is dependent on the market movement of an underlying share, it is highly speculative in nature.

Question 26

A warrant may carry a speculative premium above intrinsic value if it will not expire until far into the future.

Question 27

Warrants never sell for more than their intrinsic value.

Question 28

The premium for a warrant would increase if its underlying common stock has a negative market outlook.

Question 29

The downside protection of a convertible bond's floor value will protect the investor against loss.

Question 30

Generally, once a convertible bond trades at a certain premium to its intrinsic value, or at a certain multiple of its conversion price, the bond must be converted into common stock.

Question 31

A forced conversion will alter the corporate balance sheet.

Question 32

The floor value of a bond can change if market interest rates for competitive bonds change.

Question 33

Earnings per share (basic) may not include the dilutive effects of all of a firm's convertible bonds.

Question 34

At issuance, convertible bonds usually have a conversion premium of about 20%.

Question 35

Conversion premiums are found by subtracting the current share price from the bond's semiannual interest payment.

Question 36

A warrant's speculative premium equals the market price of the underlying common stock minus the option price.

Question 37

Conversion premiums are influenced heavily by expectations of future share price performance.

Question 38

The primary issuers of convertible bonds are smaller, less than top grade companies.

Question 39

Foreign investors like convertible Eurobonds because they offer the growth prospects of stocks, rather than the safety of bonds.

Question 40

To entice investors who are looking for a financial sweetener, convertible bonds are often sold at a discount.

Question 41

The use of a derivative contract can be set up to remove all the risk from a commercial transaction.

Question 42

A convertible bond is currently selling for $855. It is convertible into 15 common shares which presently sell for $50 per share. The conversion premium is

A) $105.
B) $57.
C) 57 shares.
D) 17 shares.

Question 43

A $1,000 par value bond with a conversion price of $50 has a conversion ratio of

A) $50.
B) $20.
C) 50 shares.
D) 20 shares.

Question 44

Derivatives can be employed to take on more risk or to reduce risk.

Question 45

As a financing device for creating common shares, warrants are usually more desirable than convertible bonds.

Question 46

Derivatives receive their value based on particular assets such as commodities or foreign exchange.

Question 47

The derivatives market has developed in response to the increased volatility of the world's financial market.

Question 48

The most common derivatives on organized exchanges are interest rate contracts.

Question 49

Forwards, futures, and options are contracts that all must be executed before the expiry date.

Question 50

The theoretical floor value for a convertible bond is its

A) conversion price.
B) conversion value.
C) par value.
D) pure bond value.

Question 51

A convertible security is almost always

A) a security that can be converted into any other type of security.
B) a debt security that can be converted into preferred shares.
C) a security that can be converted into common shares at the holder's option.
D) a security that can be converted into common shares at the option of the issuing corporation.

Question 52

The computation of (basic) earnings per share will include consideration of

A) all convertible securities.
B) only shares outstanding.
C) shares outstanding and common stock equivalents.
D) only common stock equivalents.

Question 53

Canada's derivative market is to be concentrated in Montreal (acquired by the TSX).

Question 54

Options trade at their intrinsic value.

Question 55

A warrant loses some of its financial leverage when the share rises far above the exercise price.

Question 56

Convertibles, rights, and warrants like other derivatives are the obligation of the financial markets.

Question 57

Forwards unlike futures contracts are standardized as to amount and delivery dates.

Question 58

Derivatives generally have an unlimited life, as do common shares.

Question 59

Futures and options require a small good faith deposit to hold the contract.

Question 60

The size of an option's speculative premium will be influenced to a large extent by the volatility of the underlying asset.

Question 61

Jacobs and Company has warrants outstanding, which are selling at a $3 premium above intrinsic (or minimum) value. Each warrant allows its owner to purchase one share of common stock at $25. If the common stock currently sells for $28, what is the warrant price?

A) $ 6
B) $10
C) $12
D) $14

Question 62

The floor price of a convertible bond cannot fall below

A) the conversion ratio.
B) the conversion price.
C) the conversion premium.
D) the pure bond value.

Question 63

The conversion ratio is the

A) price at which a convertible security is exchanged into common shares.
B) ratio of conversion value to market value of a convertible security.
C) number of shares of common stock into which the convertible may be converted.
D) ratio of the conversion premium to market value of a convertible security.

Question 64

Conversion price is usually set_______ the prevailing market price of the common stock at the time the bond issue is sold.

A) at
B) below
C) above
D) at one half of

Question 65

If the price of common share associated with a convertible bond is less than the conversion price

A) the bond will sell at its pure bond value.
B) the bond will sell at its par value.
C) the bond will sell at its conversion value.
D) there is not enough information to tell what the bond price will be

Question 66

Which of the following is true?

A) as the price of common stock increases, the market price of a convertible bond and the conversion premium increase
B) as the price of common stock increases, the market price of a convertible bond and the conversion value increase
C) as the price of common stock increases, the conversion value and the floor price increase
D) two of the other answers are true

Question 67

The conversion premium is the greatest and the downside the smallest when

A) the conversion value equals the pure bond value.
B) the conversion value is greater than the pure bond value.
C) the conversion value is less than the pure bond value.
D) the share price is expected to go up drastically.

Question 68

Which of the following is true about warrants?

A) as the market value of a warrant increases, so does the premium
B) a rising share price is usually followed by an increase in the price of the warrant
C) two of the other answers are correct
D) none of the other answers are correct

Question 69

Foreign companies have begun to sell Euro-convertible bonds

A) with conversion values expressed in foreign currencies.
B) to finance their international operations.
C) with par values and interest payments denominated in dollars.
D) all of the other answers are correct

Question 70

A step-up in the conversion price refers to

A) the ability of the company to step up the maturity of the bond to an earlier date.
B) the provision that decreases the conversion ratio the longer a convertible bond is held.
C) a refunding of a convertible bond when the conversion value equals the pure bond value.
D) None of these

Question 71

A disadvantage to the investor of a convertible bond is that

A) the share price may never rise above conversion price.
B) if interest rates rise, the pure bond value (floor price) will decline.
C) the interest rate on convertibles is generally one-third below the coupon rate on straight bonds of similar risk.
D) all of the other answers are correct

Question 72

If the share price rises substantially above the conversion price, an advantage to the corporation would be

A) the premium would decrease.
B) the floor price would offer the investor downside protection.
C) the bond would most likely be converted into common shares and the debt would not have to be repaid.
D) none of the other answers is correct

Question 73

The interest rate on convertibles is generally ____________ the interest rate on similar nonconvertible instruments.

A) greater than
B) less than
C) the same as
D) at least twice

Question 74

The principle device used by the corporation to force conversion

A) is setting the conversion price above the current market price.
B) is reducing the amount of interest payments.
C) is buying bonds back at below par value.
D) is a call provision.

Question 75

Warrants as compared to convertible bonds

A) provide a regular return.
B) do not trade at a speculative premium.
C) are sold without the company's consent.
D) provide the company with cash flow when exercised (converted).

Question 76

A convertible bond is often utilized

A) as a sweetener when selling debt.
B) to sell common at prices higher than those prevailing when funds are needed.
C) when there is no demand for straight debt.
D) all of the other answers are correct

Question 77

The price of a convertible bond

A) has downside as well upside limitations.
B) has only upside limitations.
C) has only downside limitations.
D) has no upside or downside limitations.

Question 78

An advantage to the corporation in selling a convertible bond is

A) the interest rate on a convertible is lower than a straight debt issue of equal risk.
B) the bond may never get converted into common stock and create dilution.
C) if interest rates fall the bond is likely to be refunded.
D) All of these

Question 79

The minimum theoretical value of a warrant to buy 5 shares of ACD stock at $45 per share is $10. What is the current market price of ACD stock?

A) $45.50
B) $50.00
C) $47.00
D) $37.50

Question 80

The conversion premium will be large

A) if investors have great expectations for the price of the common shares.
B) if interest rates decline.
C) when the conversion value is much greater than the pure bond value.
D) when the share price is very stable.