Question 1

The call privilege is generally not exercised until the conversion value of the security is ________ the call price.
A) 5 to 10 percent below
B) equal to
C) 10 to 15 percent above
D) 25 to 30 percent above

Accepted Answer

The call privilege is typically exercised when the conversion value of the security is 10 to 15 percent above the call price, as this allows the issuer to convert the security into equity at a favorable rate.

Question 2

A ________ is an option included as part of a bond or preferred stock that permits the holder to convert the security into a specified number of shares of common stock.
A) put option
B) stock-purchase warrant
C) conversion feature
D) repurchase agreement

Accepted Answer

A conversion feature is an option included as part of a bond or preferred stock that permits the holder to convert the security into a specified number of shares of common stock. Put options give the holder the right to sell an underlying asset at a specified price, stock-purchase warrants give the holder the right to purchase a specified number of shares of common stock at a specified price, and repurchase agreements involve the sale of a security with an agreement to repurchase it at a later date.

Question 3

A ________ allows the firm to force conversion.
A) warrant
B) option
C) call feature
D) striking price

Accepted Answer

A call feature allows the firm to force conversion, meaning they have the right to call back or redeem a security before its maturity date. This gives the issuer more flexibility and control over their financing options. Warrants and options are both types of securities that provide the holder with the right (but not necessarily the obligation) to buy or sell an underlying asset at a predetermined price, while the striking price refers to the price at which the underlying asset can be bought or sold. While these terms are related to the idea of conversion, neither of them allows the firm to force conversion.

Question 4

A convertible bond is almost always ________ with a call feature.
A) a mortgage bond
B) an income bond
C) an equipment trust certificate
D) a debenture

Accepted Answer

Convertible bonds are typically unsecured and are often issued as debentures, which are not backed by specific collateral.

Question 5

Many holders of convertible bonds will not convert when the firm's common stock price exceeds the conversion price because
A) the common stock price may go up further.
B) they already have the market price benefit and may still receive fixed periodic interest payments.
C) of the dilution of EPS.
D) interest payments are tax deductible.

Accepted Answer

Holders of convertible bonds receive the benefit of having the option to convert to common stock if the price exceeds the conversion price, but they may choose not to convert if they prefer to continue receiving fixed periodic interest payments. They already have benefitted from the market price appreciation of the common stock, and converting would forfeit this benefit. Dilution of EPS (choice C) is a potential concern for the issuing company, but not necessarily for the bondholders themselves. Interest payments being tax deductible (choice D) is a factor for the issuing company, but not a consideration for the bondholders. Choice A is not a relevant factor in this decision.

Question 6

Convertible preferred stock and convertible bonds are normally convertible over ________, respectively.
A) a limited time period and an unlimited time period
B) an unlimited time period and a limited time period
C) a limited time period and a limited time period
D) an unlimited time period and an unlimited time period

Accepted Answer

Convertible preferred stock is normally convertible into common stock over an unlimited time period, while convertible bonds are normally convertible into common stock over a limited time period.

Question 7

Convertible bonds normally have ________ to permit the issuer to retire or encourage conversion.
A) a put option
B) a call feature
C) a stock purchase warrant
D) a striking price

Accepted Answer

Convertible bonds typically have a call feature, which allows the issuer to redeem or retire the bonds before their maturity date. This feature is included in convertible bonds to provide an incentive for holders to convert their bonds into shares of common stock instead of waiting until maturity.

Question 8

The call price of the security generally exceeds the security's par value by an amount equal to
A) one year's stated interest.
B) the straight bond value.
C) the market value of one share of common stock.
D) the market premium.

Accepted Answer

The call price of a security typically exceeds its par value by an amount equal to one year's stated interest, which compensates the bondholder for the early redemption.

Question 9

An advantage of a convertible security is that it provides for deferred common stock financing. The purpose of deferring the sale of common stock is to
A) increase the leverage of the firm.
B) dilute the ownership interest.
C) minimize dilution in earnings per share.
D) time the sale of common stock when the price per share is basing.

Accepted Answer

Deferring the sale of common stock through convertible securities can help minimize dilution in earnings per share. This is because the conversion of the security into common stock is typically done at a set price or formula, which can help avoid issuing common stock at a time when the market price is low. By giving investors the option to convert, it also provides more flexibility and potential upside compared to a straight debt issuance.

Question 10

Convertible preferred stock is normally converted into
A) secured bonds.
B) debentures.
C) shares of common stock.
D) warrants.

Accepted Answer

Convertible preferred stock is typically converted into shares of common stock. This means that the investor has the option to exchange their preferred shares for a predetermined number of common shares at any point. This is a common feature of many preferred stock offerings and can be attractive to investors who want the potential for capital appreciation through ownership of common stock in addition to the stability and income benefits of preferred stock.

Question 11

Convertible bonds have all of the following characteristics EXCEPT
A) conversion increases the firm's debt ratio.
B) less expensive form of financing than straight bonds.
C) enhanced marketability.
D) a call feature.

Accepted Answer

Convertible bonds, when converted into equity, decrease the firm's debt ratio as debt is replaced by equity.

Question 12

A convertible security that cannot be forced into conversion using the call feature is
A) a general obligation bond.
B) a debenture.
C) an overhanging issue.
D) a noncallable common equity issue.

Accepted Answer

The answer of A convertible security that cannot be forced...

Question 13

The call price of the security generally ________ the security's par value.
A) is less than
B) is equal to
C) is greater than
D) has no relation to

Accepted Answer

The call price of a security is the price at which the holder of the security can exercise their right to buy the underlying asset. The par value of a security is the face value of the security, which is typically the amount that the issuer of the security promises to pay to the holder of the security at maturity. The call price of a security is generally greater than the security's par value because the holder of the security has the right to buy the underlying asset at a price that is below the market price of the asset.

Question 14

Convertible securities can usually be sold with interest rates ________ other nonconvertible securities.
A) lower than
B) equal to
C) higher than
D) with no relation to

Accepted Answer

Convertible securities have the advantage of being convertible into shares of stock, making them more attractive to investors. As a result, they can usually be sold with lower interest rates than other nonconvertible securities.

Question 15

A ________ permits the firm's capital structure to be changed without increasing the total financing.
A) put option
B) stock-purchase warrant
C) conversion feature
D) repurchase agreement

Accepted Answer

A conversion feature in a security such as a bond or preferred stock allows the holder to convert their security into a specified number of common shares of the issuing company. This allows the firm's capital structure to be changed without increasing the total financing since the conversion simply changes the form of the security already issued. Therefore, the correct answer is option C.

Question 16

Many holders of convertible bonds will not convert when the firm's common stock price exceeds the conversion price. To protect itself against this behavior, the firm includes a ________ on the convertible security.
A) warrant
B) option
C) call feature
D) striking price

Accepted Answer

A call feature allows the issuer of a convertible security to force conversion upon the holder if certain conditions are met, such as the common stock price being above a certain level for a certain period of time. This protects the firm from holders who may choose not to convert even if the conversion is financially beneficial to them. Warrants and options are separate securities that are not included in a convertible bond. Striking price is the price at which an option can be exercised, and is not directly relevant to convertible bonds.

Question 17

When the price of the firm's common stock ________ the conversion price, the market price of the convertible security will normally ________ to a level close to its conversion value.
A) falls below; rise
B) rises above; fall
C) rises above; rise
D) equals; fall

Accepted Answer

When the price of the firm's common stock rises above the conversion price, the market price of the convertible security will normally rise to a level close to its conversion value because the conversion option becomes more valuable.

Question 18

The purchaser of a convertible issue sacrifices a portion of his or her interest return
A) to raise temporarily cheap funds.
B) due to the reduced risk of default.
C) when the call feature is exercised.
D) for the potential opportunity to become a common shareholder in the future.

Accepted Answer

A convertible issue allows the purchaser to convert the bond or preferred stock into common stock of the issuing company. This potentially gives them the opportunity to benefit from future price appreciation of the common stock. However, in exchange for this potential opportunity, the purchaser typically accepts a lower interest rate or lower dividend payment than non-convertible bonds or preferred stock. This sacrifice in interest/dividend return is the portion the purchaser gives up in exchange for the potential opportunity to become a common shareholder in the future.

Question 19

A security that is neither debt nor equity but derives its value from an underlying asset that is often another security is called
A) hybrid security.
B) convertible security.
C) derivative security.
D) none of the above.

Accepted Answer

A derivative security derives its value from an underlying asset, which can be another security, such as stocks, bonds, or commodities.

Question 20

At the time of issuance, the issuer of a convertible security normally establishes a conversion price ________ the current market price of the firm's stock.
A) below
B) equal to
C) above
D) unrelated to

Accepted Answer

The issuer of a convertible security normally establishes a conversion price above the current market price of the firm's stock to provide investors an incentive to convert their bonds into stock. This allows the issuer to issue debt at a lower interest rate than non-convertible debt.

Quiz 17: Hybrid and Derivative Securities

The call privilege is generally not exercised until the conversion value of the security is ________ the call price.

A ________ is an option included as part of a bond or preferred stock that permits the holder to convert the security into a specified number of shares of common stock.

A ________ allows the firm to force conversion.

A convertible bond is almost always ________ with a call feature.

Many holders of convertible bonds will not convert when the firm's common stock price exceeds the conversion price because

Convertible preferred stock and convertible bonds are normally convertible over ________, respectively.

Convertible bonds normally have ________ to permit the issuer to retire or encourage conversion.

The call price of the security generally exceeds the security's par value by an amount equal to

An advantage of a convertible security is that it provides for deferred common stock financing. The purpose of deferring the sale of common stock is to

Convertible preferred stock is normally converted into

Convertible bonds have all of the following characteristics EXCEPT

A convertible security that cannot be forced into conversion using the call feature is

The call price of the security generally ________ the security's par value.

Convertible securities can usually be sold with interest rates ________ other nonconvertible securities.

A ________ permits the firm's capital structure to be changed without increasing the total financing.

Many holders of convertible bonds will not convert when the firm's common stock price exceeds the conversion price. To protect itself against this behavior, the firm includes a ________ on the convertible security.

When the price of the firm's common stock the conversion price, the market price of the convertible security will normally to a level close to its conversion value.

The purchaser of a convertible issue sacrifices a portion of his or her interest return

A security that is neither debt nor equity but derives its value from an underlying asset that is often another security is called

At the time of issuance, the issuer of a convertible security normally establishes a conversion price ________ the current market price of the firm's stock.