Question 1

In case of an overhanging issue, if the firm were to call the issue, the bondholders would accept the call price rather than convert the bonds.

Accepted Answer

When a firm calls an overhanging issue, the bondholders generally accept the call price rather than converting the bonds, as the call price usually includes a premium over the bond's face value to compensate for the loss of interest income that the bondholders would have received if the bond had continued to maturity. This premium makes it more attractive for bondholders to accept the call price rather than converting the bonds.

Question 2

Diluted earnings per share (EPS) are found by adjusting basic EPS for the impact of converting all convertibles and exercising all warrants and options that would have diluting effects on the firm's earnings.

Accepted Answer

Diluted EPS takes into account the potential dilution of earnings per share from securities such as options, warrants, and convertible bonds. It adjusts basic EPS by assuming that all these securities have been exercised or converted into common stock, which can potentially dilute the earnings per share.

Question 3

The conversion price is the value of a convertible security as measured by the market price of the common stock into which it can be converted.

Accepted Answer

The conversion price is the predetermined price at which a convertible security can be converted into common stock, not the market price of the stock.

Question 4

Converting a convertible security is beneficial when the market price of the common stock into which it can be converted is greater than its conversion price.

Accepted Answer

Converting a convertible security becomes beneficial when the market price of the common stock into which it can be converted is higher than its conversion price. This allows the investor to receive shares at a lower cost than buying them directly on the market.

Question 5

By using convertible bonds, the issuing firm can temporarily raise debt, which is typically less expensive than common stock, to finance projects.

Accepted Answer

Convertible bonds allow companies to raise debt at a lower cost than common stock, as they offer investors the option to convert the bonds into equity in the future. This can make financing projects more affordable for the issuing firm.

Question 6

An overhanging issue is a convertible security that cannot be forced into conversion by using the call feature.

Accepted Answer

An overhanging issue is a convertible security that cannot be forced into conversion by using the call feature.

Question 7

Since the purchaser of a convertible security is given an opportunity to become a common stockholder and to share in the firm's future success, convertibles can normally be sold with higher interest rates than nonconvertibles.

Accepted Answer

Convertible securities typically offer lower interest rates than nonconvertibles because they provide the added benefit of conversion into common stock, which can be advantageous if the company's stock performs well.

Question 8

The conversion ratio can be obtained by dividing the par value of the convertible by the conversion price.

Accepted Answer

The conversion ratio, which determines how many shares of stock a bondholder can receive upon conversion, is calculated by dividing the bond's par value by the conversion price.

Question 9

Contingent securities such as convertibles, warrants, and stock options affect the reporting of a firm's earnings per share (EPS).

Accepted Answer

Contingent securities such as convertibles, warrants, and stock options can dilute the ownership and the potential earnings of current shareholders, which affects the calculation of a firm's earnings per share (EPS). Therefore, they need to be considered in the reporting of EPS.

Question 10

The conversion feature, which can be part of either a bond or preferred stock, permits the firm to raise additional funds at some point in the future by selling common stock, thereby shifting the company's capital structure to a less highly levered position.

Accepted Answer

The answer of The conversion feature, which can be part...

Question 11

Since the conversion feature provides the purchaser of a convertible bond with the possibility of becoming a stockholder, convertible bonds are generally a less expensive form of financing than similar-risk nonconvertible or straight bonds.

Accepted Answer

Since convertible bonds offer the possibility of converting into stock, they are more attractive to investors, making them less expensive for the issuer compared to nonconvertible or straight bonds.

Question 12

When the market price of the common stock exceeds the conversion price, the conversion (or stock) value exceeds the par value of the convertible security.

Accepted Answer

When the market price of the common stock exceeds the conversion price, the conversion value (which is the market value of the shares that the investor can receive upon conversion) of the convertible security will be higher than its par value.

Question 13

Because a security is first sold with a conversion price above the current market price of the firm's stock, conversion is initially not attractive.

Accepted Answer

This statement is true. When a security is first sold with a conversion price above the current market price of the firm's stock, the conversion feature is not immediately attractive to investors. They would be more likely to exercise the conversion option if the stock price rises above the conversion price at some point in the future.

Question 14

Convertibles can be used as a form of deferred common stock financing.

Accepted Answer

Convertibles are a hybrid security that combines features of both debt and equity. Investors can choose to convert their convertible debt into common stock at a predetermined conversion price, making it a form of deferred common stock financing.

Question 15

Contingent securities such as common stocks and bonds affect the reporting of a firm's earnings per share (EPS).

Accepted Answer

Contingent securities like common stocks and bonds do not directly affect the reporting of a firm's earnings per share (EPS) because EPS calculations are based on existing shares outstanding and current earnings, not on potential future securities.

Question 16

Convertibles can normally be sold with lower interest rates than non-convertibles.

Accepted Answer

Convertibles are considered less risky than non-convertibles because they have the added feature of being able to convert into common stock. This feature gives investors some protection against potential losses, which makes convertible debt more attractive to investors. As a result, issuers of convertible debt can offer lower interest rates to entice investors.

Question 17

A conversion feature is an option that is included as part of a common stock issue that allows its holder to change the stock into a stated number of shares of preferred stock.

Accepted Answer

A conversion feature typically allows holders of convertible securities, like preferred stock or convertible bonds, to convert their holdings into a specified number of shares of common stock, not the other way around.

Question 18

Common stock equivalents are all contingent securities that derive a major portion of their value from their conversion privileges or common stock characteristics.

Accepted Answer

Common stock equivalents include securities such as stock options, convertible bonds, and warrants that have the potential to be converted into common stock, and their value is heavily influenced by this conversion privilege.

Question 19

The presence of contingent securities such as warrants and stock options affects the reporting of the firm's earnings per share.

Accepted Answer

The presence of contingent securities such as warrants and stock options can increase the number of shares outstanding, which in turn affects the calculation of earnings per share. Diluted earnings per share takes into account the potential dilution from these securities.

Question 20

One motive for issuing convertibles is that convertible securities can be issued with far fewer restrictive covenants than nonconvertibles.

Accepted Answer

Convertible securities typically have fewer restrictive covenants because the ability to convert to common stock provides a greater level of flexibility for the investor.

Quiz 17: Hybrid and Derivative Securities

In case of an overhanging issue, if the firm were to call the issue, the bondholders would accept the call price rather than convert the bonds.

Diluted earnings per share (EPS) are found by adjusting basic EPS for the impact of converting all convertibles and exercising all warrants and options that would have diluting effects on the firm's earnings.

The conversion price is the value of a convertible security as measured by the market price of the common stock into which it can be converted.

Converting a convertible security is beneficial when the market price of the common stock into which it can be converted is greater than its conversion price.

By using convertible bonds, the issuing firm can temporarily raise debt, which is typically less expensive than common stock, to finance projects.

An overhanging issue is a convertible security that cannot be forced into conversion by using the call feature.

Since the purchaser of a convertible security is given an opportunity to become a common stockholder and to share in the firm's future success, convertibles can normally be sold with higher interest rates than nonconvertibles.

The conversion ratio can be obtained by dividing the par value of the convertible by the conversion price.

Contingent securities such as convertibles, warrants, and stock options affect the reporting of a firm's earnings per share (EPS).

The conversion feature, which can be part of either a bond or preferred stock, permits the firm to raise additional funds at some point in the future by selling common stock, thereby shifting the company's capital structure to a less highly levered position.

Since the conversion feature provides the purchaser of a convertible bond with the possibility of becoming a stockholder, convertible bonds are generally a less expensive form of financing than similar-risk nonconvertible or straight bonds.

When the market price of the common stock exceeds the conversion price, the conversion (or stock) value exceeds the par value of the convertible security.

Because a security is first sold with a conversion price above the current market price of the firm's stock, conversion is initially not attractive.

Convertibles can be used as a form of deferred common stock financing.

Contingent securities such as common stocks and bonds affect the reporting of a firm's earnings per share (EPS).

Convertibles can normally be sold with lower interest rates than non-convertibles.

A conversion feature is an option that is included as part of a common stock issue that allows its holder to change the stock into a stated number of shares of preferred stock.

Common stock equivalents are all contingent securities that derive a major portion of their value from their conversion privileges or common stock characteristics.

The presence of contingent securities such as warrants and stock options affects the reporting of the firm's earnings per share.

One motive for issuing convertibles is that convertible securities can be issued with far fewer restrictive covenants than nonconvertibles.