Exam 17: Hybrid and Derivative Securities

An operating lease is noncancellable and obligates the lessee to make payments for the use of an asset over a predefined period of time.

Since operating leases result in the receipt of services from an asset without increasing the assets or liabilities on a firm's balance sheet, leasing may result in misleading financial ratios.

A firm has an outstanding bond with a $1,000 par value that is convertible at $40 per share of common stock. The bond's conversion ratio is ________.

The market value of a warrant is ________ the theoretical value of the warrant.

Options are a special type of security that provides the holder with the right to purchase or sell specified assets at a stated price on or before a set expiration date.

A firm needs $5 million of new long-term financing. The firm is considering the sale of common stock or a convertible bond. The current market price of the common stock is $65 per share. To sell this new issue, the stock would have to be underpriced by $2 and sold for $63 per share. The firm currently has 600,000 shares of common stock outstanding. The alternative is to issue 20-year, 10 percent, and $1,000 par-value convertible bonds. The conversion price would be set at $73 per share, and the bond could be sold at par. The earnings for the firm are expected to be $4,000,000 in the coming year. Assuming the firm chooses the convertible bond, the earnings per share after all bonds are converted will be ________.

In their simplest form, bonds are pure ________.

A straight bond value is the ________.

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

A leveraged lease is a lease under which the lessee sells an asset for cash to a prospective lessor and then leases back the same asset, making fixed periodic payments for its use.

Nico Yong is considering the purchase of 100 shares of Cisco Systems stock at $22 per share. Because the economy is picking up, Nico believes the demand for Oracle's router systems will increase substantially causing the price of Cisco's shares to increase to $30 per share. As an alternative, Nico is considering the purchase of a call option for 100 shares of Cisco at with an exercise price of $25. This 180 day option will cost Nico $200. Assume no brokerage costs or dividends. (a) What will Nico's profit be on the stock transaction if he decides to buy the stock and its price does increase to $30 per share and he sells? (b) How much will Nico earn on the option transaction if he purchases the option and the underlying stock price rises to $30? (c) How much must the stock price rise for Nico to break even on the option transaction? (d) Based on parts (a) and (b) above, what should Nico do? Explain.

In a(n) ________ a lessor owns or acquires the assets that are leased to a given lessee.

The market value of a convertible security is likely to be greater than its straight value or conversion value.

A firm currently has outstanding a 5 percent, $1,000 convertible bond. The bond is convertible into 25 shares of common stock and callable at $1,050. The current market price of the firm's stock is $41 per share. The bond holder will ________.

Renewal options are provisions normally included in an operating lease that grant the lessee the right to re-lease assets at the expiration of the lease.

A ________ is normally initiated by a firm that needs funds for operations. Here, lessors acquire leased assets by purchasing assets already owned by the lessee and leasing them back.

At the end of the term of the lease agreement, the terminal value of an asset, if any, is realized by the lessee.

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.

The conversion ratio is the ratio at which a convertible security can be exchanged for a nonconvertible security.

Convertible securities can be issued ________.