Question 1

Which of the following statements is most CORRECT?

Accepted Answer

Preferred stock is less risky than bonds for the issuer because preferred dividends can be skipped without causing default, unlike bond interest payments.

Question 2

Which of the following statements is most CORRECT?

Accepted Answer

Convertible debt typically has a lower coupon rate than similar straight debt because it offers the added benefit of conversion into equity, which can be attractive to investors despite the higher risk.

Question 3

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

True

Question 4

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

Accepted Answer

Firms will only call their convertible securities if they are at a disadvantageous conversion price. If the conversion value of the securities is greater than the call price, then it would be more profitable for the firm to let investors convert their securities to common stock rather than calling them back.

Question 5

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 issues, 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 6

Orient Airlines' common stock 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 2019. What is the conversion value of the bond?

Accepted Answer

The conversion value of the bond is calculated by multiplying the current stock price by the number of shares the bond can be converted into: $33 * 25 = $825.00.

Question 7

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 8

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

Most convertible securities are indeed bonds or preferred stocks that can be exchanged for common stock at the option of the holder, as stated in the sentence.

Question 9

Which of the following statements concerning warrants is CORRECT?

Accepted Answer

The answer of Which of the following statements concerning warrants...

Question 10

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 is true. Some preferred stocks have provisions known as "cumulative voting" or "participating voting" that grant voting rights to preferred shareholders if the company fails to pay their preferred dividend for a certain number of periods. This is meant to protect the interests of preferred shareholders and give them a voice in the company's decisions if their dividend payments are being jeopardized.

Question 11

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

Preferred stock does typically have a par value, and in the event of liquidation, preferred stockholders are entitled to receive the par value before common stockholders.

Question 12

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

A detachable warrant is indeed a warrant that can be separated from the bond it was originally issued with and traded separately.

Question 13

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 that invest in floating-rate preferred stock can benefit from both a stable price and the 70% tax exemption on preferred dividends.

Question 14

Which of the following statements about convertibles is most CORRECT?

Accepted Answer

The answer of Which of the following statements about convertibles...

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 not tax deductible, making the cost of preferred stock the same on a before-tax and after-tax basis. In contrast, interest on bonds is tax deductible, resulting in a lower cost of debt on an after-tax basis.

Question 16

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

Preferred stockholders typically have priority over common stockholders in both dividend payments and liquidating proceeds in the event of bankruptcy.

Question 17

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

Accepted Answer

A convertible bond grants the holder the right to convert the bond into a predetermined amount of the issuer's shares, like a call option. However, it also pays a regular coupon payment and has a fixed maturity date, making it a bond as well. Therefore, the owner of a convertible bond owns both a bond and a call option simultaneously.

Question 18

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 19

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 market value of the underlying stock increases, making the conversion option more valuable. It can also sell for less than its bond value if the market interest rates increase, making the fixed coupon payments less attractive to investors.

Question 20

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

Accepted Answer

Preferred stock can be an attractive option for firms when market conditions make issuing debt or common stock expensive, as it offers a hybrid financing solution with characteristics of both equity and debt.

Quiz 19: Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Which of the following statements is most CORRECT?

Which of the following statements is most CORRECT?

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

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

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

Orient Airlines' common stock 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 2019. What is the conversion value of the bond?

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

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.

Which of the following statements concerning warrants is CORRECT?

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

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 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.

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.

Which of the following statements about convertibles 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.

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

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

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

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