Exam 15: Financial Instruments: Complex Debt and Equity

On January 1, Year 1, ABC Inc., a publicly traded enterprise, issued $4,000,000 worth of bonds with detachable stock warrants.The bonds mature on December 31st, Year 4 and pay interest annually on December 31st at a coupon rate of 6% per annum.The yield to maturity on similar bonds was 5% at the date of issue.The bonds were issued at 108. Based on the information provided, which of the following statements is most correct?

All of the following are common reasons for a company to issue convertible bonds except:

The crucial aspect of debt is that the creditors can demand payment.

What are hybrid securities?

In order to determine if, in substance, a complex financial instrument is equity, the answer should be no to all of the following except:

On January 1st, 20x12, ABC Inc.agrees to a futures contract to buy 1,000 shares of DEF Inc.for $20 per share in 60 days.The current value of the shares on January 1, 20x12 is $22 per share. The broker requires a 20% margin payment.The fair value of the shares is $24 per share on January 31st, 20x12 and $18 per share on February 29th, 20x12. Required: Prepare all relevant journal entries.

DWWR Ltd.issues a $150,000, 6%, five-year debenture at par, repayable at maturity in common shares at DWWR's option.Interest is repayable annually in cash.Prepare the journal entry at issuance.

Silo Corp.granted to Donna, its superstar accountant, the option to purchase Silo common shares for $10, on Jan.1, 20x1.The market price of the shares on that date was $20.The options can be exercised during the period Jan.1, 20x4 through Jan.1, 20x6.The number of shares under option is determined by a formula based on Silo earnings each year.The number of shares actually under option will be the formula value on Dec.31, 20x3.That formula estimated the following number of shares under option at the end of years: 20x1, 200; 20x2, 300.The formula determined the number of shares at Dec.31, 20x3 to be 400.The market prices for Silo shares at the end of years: 20x1, $25; 20x2, $40, 20x3, $50.What is the recorded compensation expense for 20x2, for Donna?

JMR Ltd.issued $100,000 of 8%, 8 year, non-convertible bond with detachable stock purchase warrants.KER Corp.purchased the entire issue.Each $1,000 bond carries 10 warrants.Each warrant entitles KER to purchase one common share for $20.The bond issue sells for 104 exclusive of accrued interest.Shortly after issuance, the warrants trade for $5 each and the bonds were quoted at 103 ex-warrants.The allocation of the proceeds to bonds using the proportional method was:

At the end of 2014, interest on a perpetual loan is paid to the holder.The perpetual debt is shown as an equity instrument.Based on the above the interest is:

The measurement date of a compensatory stock option must precede the date of grant.

All of the following are characteristics of stock rights except:

Redeemable preferred shares are always classified as debt.

On the statement of cash flows, a hybrid financial instrument should be:

On January 20X2, ABC Corporation issued $1,000,000 face amount of 8%, five year, convertible debentures.Interest is payable semi-annually on 30 June and 31 December.The debentures are convertible at the holder's option at the rate of 20 common shares for each $1,000 bond.The market rate of interest for non-convertible bonds of similar risk and maturity is 6%.The net proceeds received by ABC Corporation amounted to $1,250,000. Prepare a Journal entry to record the issuance of the bonds on 1 January 20X2.

When interest is repayable to investors at a fixed amount per share, the financial instrument in question would be considered debt.

A financial instrument is any contract that gives rise to a financial asset of one party and a financial liability or equity instrument of another party.

KER Corp.issued 150,000 rights allowing the holder to acquire common shares in 3 years' time at an acquisition price of $30 per share-the current market price.It takes 5 rights to acquire each share.The corporation received $40,000 for the rights.Assuming all rights are exercised when the market price was $35, prepare journal entries at: announcement date, issuance date and exercise date

Even if the underlying share value of a convertible bond never reaches the conversion price, management can still force conversion.

When stock rights are issued to current shareholders, it may require more than one such right to later acquire one additional share of the stock covered by the rights.