Question 1

A firm has an outstanding bond with a $1,000 par value that is convertible at $40 per share of common stock. The bond's conversion ratio is ________.
A) 20
B) 25
C) 40
D) 50

Accepted Answer

The conversion ratio is calculated by dividing the par value of the bond ($1,000) by the conversion price per share ($40), which equals 25. Therefore, the conversion ratio is 25 shares of common stock per bond.

Question 2

The market value of a convertible security is likely to be greater than its straight value or conversion value.

Accepted Answer

The convertible security has two potential sources of value - its straight value (the value it would have if it were not convertible) and its conversion value (the value it would have if it were converted into stock). The market value of a convertible security usually reflects a premium over these two values, as investors are willing to pay for the option to convert the security into stock at a later date. This means that the market value of a convertible security is likely to be greater than its straight value or conversion value.

Question 3

Find the solution to the following questions regarding convertible bonds.
(a) Calculate the conversion price for each of the following bonds.
A $1,000-par-value bond convertible into 25 shares of common stock.
A $1,000-par value bond convertible into 100 shares of common stock.
(b) Calculate the conversion ratio for each of the following bonds. A $1,000 par-value bond convertible into common stock at $50 per share.
A $1,000 par-value bond convertible into common stock at $40 per share.
(c) Calculate the stock value for each of the following convertible bonds.
A $1,000 par-value bond convertible into common stock at $25 per share. The current market price of the stock is $30 per share.
A $1,000 par-value bond convertible into 100 shares of common stock. The current market price of the stock is $12 per share.

Accepted Answer

The answer of Find the solution to the following questions...

Question 4

The market premium may be defined as the amount by which the conversion value exceeds its straight value.

Accepted Answer

The market premium refers to the difference between the market price of a convertible security and its conversion value, not the amount by which the conversion value exceeds its straight value.

Question 5

The market value of a convertible security is likely to be less than its straight value or conversion value.

Accepted Answer

The market value of a convertible security is typically higher than both its straight value (as a bond) and its conversion value (as stock), because it combines features of both debt and equity, offering investors more flexibility and potential for profit.

Question 6

A straight bond value is the ________.
A) minimum price at which a convertible bond would be traded
B) optimum price at which a callable bond would be traded
C) maximum price at which a callable bond would be traded
D) average price at which a convertible bond would be traded

Accepted Answer

The straight bond value refers to the value of the bond without considering any embedded options such as convertibility into stock or callability. It represents the minimum price at which a convertible bond would trade because it is the value of the bond based purely on its interest payments and principal repayment, without the added value of conversion options.

Question 7

A firm currently has outstanding a 5 percent, $1,000 convertible bond. The bond is convertible into 25 shares of common stock and callable at $1,050. The current market price of the firm's stock is $41 per share. The bond holder will ________.
A) allow the call to be exercised
B) convert the bond into stock
C) sell the bond on the secondary market
D) do nothing and wait until the stock price goes up further

Accepted Answer

The answer of A firm currently has outstanding a 5...

Question 8

A firm has outstanding convertible preferred stock with a $50 par value which is convertible into three shares of common stock. The conversion value is $45. What is the current market price of a share of common stock?
A) $15.00
B) $16.67
C) $17.33
D) $20.00

Accepted Answer

The conversion value of the preferred stock is given as $45, and it is convertible into 3 shares of common stock. To find the current market price of a share of common stock, divide the total conversion value by the number of shares into which it can be converted: $45 / 3 = $15.00.

Question 9

A firm has an outstanding 15-year convertible bond issue with a $1,000 par value and a stated annual interest rate of 7 percent. The bond is convertible into 50 shares of common stock which has a current market price of $25. A straight bond could have been sold with a 10 percent stated interest rate. The straight value of the bond is ________.
A) $1,328
B) $1,217
C) $972
D) $772

Accepted Answer

The answer of A firm has an outstanding 15-year convertible...

Question 10

From a firm's point-of-view, which of the following is true of issuance of convertible bonds?
A) It acts as a permanent source of cheap funds.
B) It results in a non-tax-deductible interest payments.
C) It is an immediate sale of common stock.
D) It decreases financial leverage upon conversion.

Accepted Answer

Issuance of convertible bonds decreases financial leverage upon conversion as the convertible bonds are converted into equity, thereby reducing the amount of debt on the company's balance sheet. This can also potentially reduce the company's interest expense in the future. However, this is not a permanent source of cheap funds as it involves the payment of interest during the bond tenure, and the conversion may not always result in an immediate sale of common stock. Additionally, the interest payments on convertible bonds may be tax-deductible depending on the jurisdiction.

Question 11

A firm has an outstanding bond with a $1,000 par value that is convertible at $40 per share of common stock. If the current market value of common stock per share is $45, the conversion value of the bond is ________.
A) $880
B) $1,000
C) $1,125
D) $1,200

Accepted Answer

The conversion value is the value at which the bond can be converted into common stock. To calculate the conversion value, we multiply the conversion ratio by the market price of the common stock.

Conversion ratio = par value of bond / conversion price per share of common stock
= $1,000 / $40
= 25 shares of common stock

Conversion value = conversion ratio x market price of common stock
= 25 x $45
= $1,125

Therefore, the conversion value of the bond is $1,125, and the answer is (C).

Question 12

The conversion value of a bond is the minimum price at which a convertible bond would be traded.

Accepted Answer

The conversion value of a bond is the value of the bond if it were converted into the underlying shares today, not the minimum price at which it would be traded. The minimum trade price would more closely relate to the bond's market value, which could be influenced by factors other than just its conversion value, such as interest rates and the creditworthiness of the issuer.

Question 13

A firm has an outstanding bond with a $1,000 par value that is convertible into 50 shares of common stock. The bond's conversion price per share is ________.
A) $20
B) $25
C) $50
D) $100

Accepted Answer

The conversion price per share is calculated by dividing the bond's par value by the number of shares it can be converted into, which is $1,000 / 50 = $20.

Question 14

The straight bond value is ________.
A) the conversion premium minus the conversion value
B) the present value of the interest and principal payments discounted at a rate the firm would have to pay on a convertible bond
C) the market value minus the conversion value
D) the present value of the interest and principal payments discounted at a rate the firm would have to pay on a nonconvertible bond

Accepted Answer

The straight bond value is the present value of the interest and principal payments discounted at a rate the firm would have to pay on a nonconvertible bond, which is option D. Option A is incorrect because it refers to the conversion premium and conversion value, which are not relevant in determining the straight bond value. Option B is incorrect because it refers to the rate that would be paid on a convertible bond, whereas the question is specifically asking about the rate on a nonconvertible bond. Option C is incorrect because it subtracts the conversion value from the market value, which again is not relevant in determining the straight bond value.

Question 15

A firm currently has outstanding a 9 percent, $1,000 convertible bond. The bond is convertible into 100 shares of common stock at a conversion price of $10 per share and callable at $1,090. The current market price of the firm's stock is $12 per share. The bond holder will ________.
A) allow the call to be exercised realizing $90 over par value
B) convert the bond into stock realizing $200 over par value
C) convert the bond into stock realizing only par value
D) wait until the stock price goes up further

Accepted Answer

The bondholder would choose to convert the bond into stock as it allows them to realize $200 over the par value ($10 * 100 shares - $1,000 bond value = $200). This is more favorable than allowing the call to be exercised, which would only result in a $90 profit over par value ($1,090 call price - $1,000 bond value = $90). Waiting for the stock price to go up further may or may not be a good strategy, as it is uncertain if the price will rise above the conversion price of $10 per share.

Question 16

A firm has an outstanding bond with a $1,000 par value that is convertible into 50 shares of common stock. The bond's conversion ratio is ________.
A) 20
B) 25
C) 50
D) 100

Accepted Answer

The bond is convertible into 50 shares of common stock, which means the conversion ratio is 50.

Question 17

The market value of a convertible bond will exceed the conversion value or straight bond value, whichever is greater, by an amount called the market premium. This premium exists because ________.
A) markets are efficient
B) buyers and sellers do not usually agree on the conversion value
C) purchasers expect future stock price movements to be positive
D) the straight bond value is close to the conversion value

Accepted Answer

The market premium exists because purchasers expect future stock price movements to be positive, making the conversion option more valuable.

Question 18

When a call is made on a convertible security, the holder of the security will most likely ________.
A) not take any action
B) allow the call to be exercised and accept the call premium if the conversion value is 10% above the call price
C) convert the security into common stock if the conversion value is 10% above the call price
D) sell the security in the secondary market

Accepted Answer

When the conversion value of a convertible security is 10% above the call price, it is generally more advantageous for the holder to convert the security into common stock rather than allowing the call to be exercised or taking other actions. This is because converting allows the holder to benefit from the higher value of the underlying stock, rather than just receiving the call premium or selling the security at market value.

Question 19

Which of the following is a motive for using convertible securities in a firm's financing mix?
A) a form of long-term financing
B) opportunity bondholders to share in the firm's future success
C) a method of raising permanent cheap funds for long time
D) an eventual shift in the capital structure to a more levered position

Accepted Answer

Convertible securities allow bondholders to convert their debt into equity in the future. This provides an opportunity for bondholders to share in the firm's future success if the stock price increases. This can be a motivation for using convertible securities in a firm's financing mix.

Question 20

________ is the price at which a bond would sell in the market without the conversion feature.
A) Conversion value
B) Straight bond value
C) Strike price value
D) Market premium

Accepted Answer

The straight bond value is the price at which a bond would sell in the market without the conversion feature. Conversion value (A) is the value of the bond if converted into stock. Strike price value (C) is the price at which an option can be exercised. Market premium (D) refers to the difference between the market price and the intrinsic value of a security.

Quiz 17: Hybrid and Derivative Securities

A firm has an outstanding bond with a $1,000 par value that is convertible at $40 per share of common stock. The bond's conversion ratio is ________.

The market value of a convertible security is likely to be greater than its straight value or conversion value.

The market premium may be defined as the amount by which the conversion value exceeds its straight value.

The market value of a convertible security is likely to be less than its straight value or conversion value.

A straight bond value is the ________.

A firm currently has outstanding a 5 percent, $1,000 convertible bond. The bond is convertible into 25 shares of common stock and callable at $1,050. The current market price of the firm's stock is $41 per share. The bond holder will ________.

A firm has outstanding convertible preferred stock with a $50 par value which is convertible into three shares of common stock. The conversion value is $45. What is the current market price of a share of common stock?

From a firm's point-of-view, which of the following is true of issuance of convertible bonds?

A firm has an outstanding bond with a $1,000 par value that is convertible at $40 per share of common stock. If the current market value of common stock per share is $45, the conversion value of the bond is ________.

The conversion value of a bond is the minimum price at which a convertible bond would be traded.

A firm has an outstanding bond with a $1,000 par value that is convertible into 50 shares of common stock. The bond's conversion price per share is ________.

The straight bond value is ________.

A firm currently has outstanding a 9 percent, $1,000 convertible bond. The bond is convertible into 100 shares of common stock at a conversion price of $10 per share and callable at $1,090. The current market price of the firm's stock is $12 per share. The bond holder will ________.

A firm has an outstanding bond with a $1,000 par value that is convertible into 50 shares of common stock. The bond's conversion ratio is ________.

The market value of a convertible bond will exceed the conversion value or straight bond value, whichever is greater, by an amount called the market premium. This premium exists because ________.

When a call is made on a convertible security, the holder of the security will most likely ________.

Which of the following is a motive for using convertible securities in a firm's financing mix?

________ is the price at which a bond would sell in the market without the conversion feature.