Deck 24: Warrants and Convertibles

Question 1

A convertible preference share 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)the time to maturity is fixed.
E)None of the above.

Answer 1

the time to maturity is infinite.

Question 2

Warrants are similar to traded options except:

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

Answer 2

Warrants affect the number of shares outstanding.

Question 3

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.

Answer 3

Both B and C.

Question 4

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

A)callable.
B)convertible.
C)protected.
D)putable.
E)None of the above.

Question 5

BrightView Windows issued warrants with an exercise price of €17.BrightView's ordinary equity 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 6

An "equity kicker" most often refers to a:

A)bond with conversion privileges.
B)preference share offering with conversion privileges.
C)warrant.
D)lettered ordinary equity.
E)None of the above.

Question 7

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 equity must be issued.
E)None of the above.

Question 8

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 ordinary equity, convertible bonds are
Generally not callable.
E)None of the above is incorrect.

Question 9

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 equity.
C)When a warrant is exercised, existing equity 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 10

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

A)With regard to security, most convertible bonds are secured by ordinary equity (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 ordinary equity.
C)When a convertible bond is called, the owner has the option of receiving cash or equity for
The bond.
D)The bond ratings of firms using convertibles are lower than those of other firms.
E)All of the above are incorrect.

Question 11

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)Ordinary equity.
B)Bond/warrant package.
C)Convertible preference share.
D)Straight bonds.
E)Convertible bonds.

Question 12

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

A)A 3 for 1 equity split.
B)A large equity 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 13

The holder of a €1,000 face value bond has the right to exchange the bond anytime before maturity for shares 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 14

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.

Question 15

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

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

Question 16

Warrants are most often issued in combination with:

A)new publicly placed ordinary equity.
B)new privately placed ordinary equity.
C)new publicly placed debt.
D)new privately placed debt.
E)preference shares.

Question 17

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 18

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 19

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's 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 20

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 21

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 equity 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.

Question 22

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 ordinary equity.
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 23

Diamond Drill Inc.has 150,000 shares and 15,000 warrants outstanding.A warrant holder can purchase a new share of equity for five warrants and €5.00 per warrant.The equity 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 24

Diamond Drill Inc.has 150,000 shares and 15,000 warrants outstanding.A warrant holder can purchase a new share of equity for five warrants and €5.00 per warrant.The equity is currently
Selling for €27 per share.What would your gain 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 25

The holders of Xenron Corporation's bond with a face value of €1,000 can exchange that bond for 35 shares of equity.The equity 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 26

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

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

Question 27

A convertible bond has an 7% annual coupon and 10 years to maturity.The face value is €1,000 and the conversion ratio is 35.The equity currently sells for €27.375 per share.Similar nonconvertible
Bonds are priced to yield 9%.The value of the convertible bond is at least:

A)€ 871.65.
B)€ 958.13.
C)€ 1,000.00.
D)€ 1,325.20.
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 equity for five warrants and €5.00 per warrant.The equity 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 equity.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

The holders of Xenron Corporation's bond with a face value of €1,000 can exchange that bond for 35 shares of equity.The equity 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 30

Transfer or expropriation of wealth from bondholders to equityholders 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.
E)None of the above.

Question 31

A convertible bond has a 8% annual coupon and 15 years to maturity.The face value is €1,000 and the conversion ratio is 40.The equity 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 32

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 33

BrightView Windows issued warrants with an exercise price of €17 for one share per warrant.On May 1, BrightView's ordinary equity 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 34

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.
E)None of the above.

Question 35

Diamond Drill Inc.has 150,000 shares and 15,000 warrants outstanding.A warrant holder can purchase a new share of equity for five warrants and €5.00 per warrant.The equity 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 equity.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 36

A firm has 100 shares of equity 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 equity?

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

Question 37

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

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

Question 38

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

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

Question 39

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 preference share.
C)Straight debt.
D)Indifferent between A and B.
E)Indifferent between A, B, and C.

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

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 42

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 equity currently sells for €47.50 per share.Calculate the convertible bond's option
value.

Question 43

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

Question 44

A bond/warrant package is priced to sell at face value of €1,000.Each bond comes with 50
detachable warrants.A warrant gives the owner the right to buy 1 share of equity 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 45

A firm has 2,000 shares of equity 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 46

Kida Consultants has 100,000 shares of equity 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 equity.Calculate the gain from exercising a single
warrant.

Question 47

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 equity currently sells for €30.125 per share.Calculate the convertible
bond's option value.

Question 48

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 equity currently sells for €31.375 per share.Determine the bond's
option premium.

Question 49

A firm has 500 shares of equity 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 50

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