Question 1

The market price of the bond will not go below the pure bond value regardless of what happens to the price of the common stock.

Accepted Answer

A) True 
 B)False  True

Question 2

Conversion price is the face value divided by the conversion ratio.

Accepted Answer

A) True 
 B)False  True

Question 3

Assume that a firm has warrants outstanding that allow the holder to buy one share of stock at $22 per share. Also assume the stock is selling at $28 per share and warrants are now selling at $10 per warrant. You can invest $1,000 in the stock or the warrants. Assume the stock goes to $44 and the warrants trade at their intrinsic value when the stock is at $44. Would you have a larger total dollar profit by initially investing in the stock or the warrants? Compute the leverage.

Accepted Answer

$\begin{array}{lcccccc}
&\text { Beginning } & \text {Beginning} & \text { Number of } & \text {Shares } & \text { Ending } & \text {Ending }\
&\underline{\text {  Investment}} &\underline{\text { Price}} &\underline{\text {Shares }}&\underline{\text { Warrants}}&\underline{\text {  Price }}&\underline{\text { Value }}\ 
\text { Stock } & \$ 1,000 & \$ 28 & 35.71 & \$ 44 & \$ 1,571.24 & \
\text { Convertible }\
\text { Bond }\ & \$ 1,000 & \$ 10 & 100.00 & \$ 22 & & \$ 2,200.00
\end{array}$
 You would have a large total dollar profit investing in the warrant.
Leverage = 120%/57.15% = 2.10 times
Explanation: Stock went up 57.14%: ($44 - $28)/28 = 57.15%
Warrants went up 120%: ($22 - $10)/10 = 120%
Leverage = 120%/57.15% = 2.10 times
You would have a large total dollar profit investing in the warrant.

Question 4

A company usually would not want to issue convertible securities if its stock is undervalued in the market.

Accepted Answer

A) True 
 B)False

Question 5

With convertible bonds, the bond market price minus the conversion value is the conversion premium.

Accepted Answer

A) True 
 B)False

Question 6

If the stock price is low or declining, the pure bond value is not very important in determining the bond price.

Accepted Answer

A) True 
 B)False

Question 7

Companies usually force conversion when conversion values are low.

Accepted Answer

A) True 
 B)False

Question 8

Convertible bonds tend to pay better interest rates than straight bonds, since convertibles are of lower risk.

Accepted Answer

A) True 
 B)False

Question 9

The leverage associated with a warrant increases as the stock price increases.

Accepted Answer

A) True 
 B)False

Question 10

What is the percentage conversion premium of a convertible bond with market value of $900, conversion value of $800, and par value of $1,000?

Accepted Answer

A) 25% 
B) 20% 
C) 12.5% 
D) 10.5% 
A) 25% 
B) 20% 
C) 12.5% 
D) 10.5%

Question 11

Which of the following statements explains the premium paid over the intrinsic value of a warrant?

Accepted Answer

A) The higher the price volatility of the common stock, the greater the premium 
B) The market value may fall below the intrinsic value because of the downside risk 
C) The greater the time period over which the option may be exercised, the higher the premium 
D) More than one of the above are true 
A) The higher the price volatility of the common stock, the greater the premium 
B) The market value may fall below the intrinsic value because of the downside risk 
C) The greater the time period over which the option may be exercised, the higher the premium 
D) More than one of the above are true

Question 12

What factor(s) could cause the pure bond value to change?

Accepted Answer

A) A call provision 
B) An increase in stock price 
C) A change in market interest rates 
D) More than one of the above 
A) A call provision 
B) An increase in stock price 
C) A change in market interest rates 
D) More than one of the above

Question 13

Pure bond value is the conversion price, multiplied by the market price.

Accepted Answer

A) True 
 B)False

Question 14

What variables are needed to calculate basic earnings per share?

Accepted Answer

A) Adjusted earnings after taxes, number of shares outstanding, and number of common shares from all potential securities convertible into common stock 
B) Earnings after taxes and number of shares outstanding 
C) Adjusted earnings after taxes, shares outstanding, common stock equivalents, and all convertibles 
D) Earnings after taxes, common shares outstanding, and all convertible preferred stock 
A) Adjusted earnings after taxes, number of shares outstanding, and number of common shares from all potential securities convertible into common stock 
B) Earnings after taxes and number of shares outstanding 
C) Adjusted earnings after taxes, shares outstanding, common stock equivalents, and all convertibles 
D) Earnings after taxes, common shares outstanding, and all convertible preferred stock

Question 15

The conversion feature always causes the bond's price to vary with the stock price.

Accepted Answer

A) True 
 B)False

Question 16

Generally, the best time to buy convertible bonds is when interest rates are _________ and when stock prices are _______.

Accepted Answer

A) low; low 
B) high; low 
C) low; high 
D) high; high 
A) low; low 
B) high; low 
C) low; high 
D) high; high

Question 17

Which of the following statements about convertible securities is true?

Accepted Answer

A) They provide a guaranteed income stream, minimum value, and conversion 
B) The conversion premium is influenced by the volatility of the underlying common stock, term to maturity, and dividend payment relative to interest rate 
C) They are potentially dilutive to earnings and must be taken into consideration in the calculation of both primary and fully diluted earnings per share 
D) All of the above are true 
A) They provide a guaranteed income stream, minimum value, and conversion 
B) The conversion premium is influenced by the volatility of the underlying common stock, term to maturity, and dividend payment relative to interest rate 
C) They are potentially dilutive to earnings and must be taken into consideration in the calculation of both primary and fully diluted earnings per share 
D) All of the above are true

Question 18

Which of the following statements about a convertible security is not true?

Accepted Answer

A) It may be either a bond or share of preferred stock 
B) It provides level interest payments 
C) The best time to buy is when both bond and stock prices are low 
D) All of the statements are true 
A) It may be either a bond or share of preferred stock 
B) It provides level interest payments 
C) The best time to buy is when both bond and stock prices are low 
D) All of the statements are true

Question 19

A firm has warrants outstanding for investors to purchase 50,000 shares at $25 per share. The current stock price is $40. For accounting purposes, what is the assumed net increase in shares from the exercise of these warrants?

Accepted Answer

A) 18,750 
B) 50,000 
C) 31,250 
D) None of the above 
A) 18,750 
B) 50,000 
C) 31,250 
D) None of the above

Question 20

The shorter the term to maturity, the higher the conversion premium for the bond.

Accepted Answer

A) True 
 B)False

Exam 13: Convertible Securities and Warrants

The market price of the bond will not go below the pure bond value regardless of what happens to the price of the common stock.

Conversion price is the face value divided by the conversion ratio.

A company usually would not want to issue convertible securities if its stock is undervalued in the market.

With convertible bonds, the bond market price minus the conversion value is the conversion premium.

If the stock price is low or declining, the pure bond value is not very important in determining the bond price.

Companies usually force conversion when conversion values are low.

Convertible bonds tend to pay better interest rates than straight bonds, since convertibles are of lower risk.

The leverage associated with a warrant increases as the stock price increases.

What is the percentage conversion premium of a convertible bond with market value of $900, conversion value of $800, and par value of $1,000?

Which of the following statements explains the premium paid over the intrinsic value of a warrant?

What factor(s) could cause the pure bond value to change?

Pure bond value is the conversion price, multiplied by the market price.

What variables are needed to calculate basic earnings per share?

The conversion feature always causes the bond's price to vary with the stock price.

Generally, the best time to buy convertible bonds is when interest rates are _________ and when stock prices are _______.

Which of the following statements about convertible securities is true?

Which of the following statements about a convertible security is not true?

A firm has warrants outstanding for investors to purchase 50,000 shares at $25 per share. The current stock price is $40. For accounting purposes, what is the assumed net increase in shares from the exercise of these warrants?

The shorter the term to maturity, the higher the conversion premium for the bond.

The Investment Setting

Security Markets

Participating in the Market

Investment Companies: Mutual Funds, Exchange-Traded Funds, Closed-End Funds, and Unit Investment Trusts

Economic Activity

Industry Analysis

Valuation of the Individual Firm

Financial Statement Analysis

Efficient Markets and Anomalies

Behavioral Finance and Technical Analysis

Bond and Fixed-Income Fundamentals

Principles of Bond Valuation and Investment

Put and Call Options

Commodities and Financial Futures

Stock Index Futures and Options

A Basic Look at Portfolio Management and Capital Market Theory

Duration and Bond Portfolio Management

International Securities Markets

Investments in Real Assets

Alternative Investments: Private Equity and Hedge Funds

Measuring Risks and Returns of Portfolio Managers

A Comprehensive Analysis for Real Estate Investment Decisions

The Makeup of Institutional Investors

Filters

Generally, the best time to buy convertible bonds is when interest rates are ___ and when stock prices are _.