Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

Valdes Enterprises is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.00%. The stock currently sells for $40.00 a share, has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. What is the estimated floor price of the convertible at the end of Year 3?

Accepted Answer

A)   $794.01
B)   $835.81
C)   $879.80
D)   $926.10
E)   $972.41F) A) and D)
G) B) and C)

Question 3

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

A) True 
 B)False

Question 4

Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2009. At any time prior to maturity on February 1, 2029, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

Accepted Answer

A)   $40.00
B)   $42.00
C)   $44.10
D)   $46.31
E)   $48.62F) D) and E)
G) C) and D)

Question 5

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

Accepted Answer

A) True 
 B)False

Question 6

Which of the following statements is most CORRECT?

Accepted Answer

A)   Preferred stock generally has a higher component cost of capital to the firm than does common stock.
B)   By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firm's common stock.
C)   From the issuer's point of view, preferred stock is less risky than bonds.
D)   Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally 25 years or less.
E)   Unlike bonds, preferred stock cannot have a convertible feature.F) B) and D)
G) A) and B)

Question 7

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

A) True 
 B)False  True

Question 8

Which of the following statements concerning warrants is CORRECT?

Accepted Answer

A)   Bonds with warrants and convertible bonds both have option features that their holders can exercise if the underlying stock's price increases. However, if the option is exercised, the issuing company's debt declines if warrants were used but remains the same if it used convertibles.
B)   Warrants are long-term put options that have value because holders can sell the firm's common stock at the exercise price regardless of how low the market price drops.
C)   Warrants are long-term call options that have value because holders can buy the firm's common stock at the exercise price regardless of how high the stock's price has risen.
D)   A firm's investors would generally prefer to see it issue bonds with warrants than straight bonds because the warrants dilute the value of new shareholders, and that value is transferred to existing shareholders.
E)   A drawback to using warrants is that if the firm is very successful, investors will be less likely to exercise the warrants, and this will deprive the firm of receiving any new capital.F) B) and C)
G) All of the above C

Question 9

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

Accepted Answer

A) True 
 B)False

Question 10

Warren Corporation's stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm's straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?

Accepted Answer

A)   7.83%
B)   8.24%
C)   8.65%
D)   9.08%
E)   9.54%F) B) and E)
G) A) and E) B

Question 11

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

A) True 
 B)False

Question 12

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

A) True 
 B)False

Question 13

Its investment bankers have told Donner Corporation that it can issue a 25-year, 8.1% annual payment bond at par. They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.0%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?

Accepted Answer

A)   6.66%
B)   6.99%
C)   7.34%
D)   7.71%
E)   8.09%F) B) and D)
G) A) and B)

Question 14

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

Accepted Answer

A) True 
 B)False

Question 15

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) True 
 B)False

Question 16

Which of the following statements about convertibles is most CORRECT?

Accepted Answer

A)   The coupon interest rate on a firm's convertibles is generally set higher than the market yield on its otherwise similar straight debt.
B)   One advantage of convertibles over warrants is that the issuer receives additional cash money when convertibles are converted.
C)   Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt because convertibles are less risky than straight debt.
D)   At the time it is issued, a convertible's conversion (or exercise)  price is generally set equal to or below the underlying stock's price.
E)   For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm's otherwise similar straight debt and the expected return on its common stock.F) A) and E)
G) A) and D)

Question 17

(The following data apply to Problems 27 through 30. The problems MUST be kept together.) 
The following data apply to Saunders Corporation's convertible bonds:
-What is the bond's conversion value?

Accepted Answer

A)   $698.15
B)   $734.89
C)   $773.57
D)   $814.29
E)   $857.14F) B) and C)
G) C) and E)

Question 18

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

A)   $707.33
B)   $744.56
C)   $783.75
D)   $825.00
E)   $866.25F) B) and E)
G) None of the above

Question 19

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

Accepted Answer

A) True 
 B)False

Question 20

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

A) True 
 B)False

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

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

Correct Answer
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Correct Answer
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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.

Correct Answer
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Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2009. At any time prior to maturity on February 1, 2029, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

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

Correct Answer
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Which of the following statements is most CORRECT?

Correct Answer
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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.

Correct Answer
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True

Which of the following statements concerning warrants is CORRECT?

Correct Answer
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C

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

Correct Answer
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Correct Answer
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B

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.

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

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

Correct Answer
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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.

Correct Answer
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Which of the following statements about convertibles is most CORRECT?

Correct Answer
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(The following data apply to Problems 27 through 30. The problems MUST be kept together.) The following data apply to Saunders Corporation's convertible bonds: -What is the bond's conversion value?

Correct Answer
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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?

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

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

Correct Answer
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Exam 19: Hybrid Financing: Preferred Stock, Warrants, and Convertibles

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2009. At any time prior to maturity on February 1, 2029, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is most CORRECT?

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedTrue

Which of the following statements concerning warrants is CORRECT?

Correct AnswerverifiedC

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedB

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.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Which of the following statements about convertibles is most CORRECT?

Correct AnswerverifiedShow Answer

(The following data apply to Problems 27 through 30. The problems MUST be kept together.) The following data apply to Saunders Corporation's convertible bonds: -What is the bond's conversion value?

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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True

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C

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B

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