Exam 17: Hybrid and Derivative Securities

An operating lease is when the present value of all its payments included as an asset and corresponding liability on a firm's balance sheet.

A firm needs $2 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 $42 per share. To sell this new issue, the stock would have to be underpriced by $2 and sold for $40 per share. The firm currently has 300,000 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 $50 per share, and the bond could be sold at par. The earnings for the firm are expected to be $500,000 in the coming year. Assuming the firm chooses the sale of common stock, the earnings per share in the coming year will be ________.

Which of the following statements about put and call options is true?

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

Both warrants and rights result in new capital equity. However, warrants are issued at an exercise price below the prevailing market price of the stock, whereas rights are issued at a subscription price above the prevailing market price.

A firm can raise capital by issuing securities such as convertibles, warrants, and calls and puts.

A conversion feature is an option that is included as part of a common stock issue that allows its holder to change the stock into a stated number of shares of preferred stock.

An option is a security that is neither debt nor equity but derives its value from an underlying asset that is often another security.

Derivatives are used by corporations as a useful tool for managing certain aspects of a firm's risk.

Renewal options normally require the lessor to maintain the assets and to make insurance and tax payments.

In a financial statement of the firm, put and call options ________.

The conversion value is the value of a convertible security as measured by the market price of the common stock into which it can be converted.

Diluted earnings per share (EPS) are found by adjusting basic EPS for the impact of converting all convertibles and exercising all warrants and options that would have diluting effects on a firm's earnings.

A firm has an outstanding 15-year convertible bond issue with a $1,000 par value and a stated annual interest rate of 7 percent. The bond is convertible into 50 shares of common stock which has a current market price of $25. A straight bond could have been sold with a 10 percent stated interest rate. The conversion value of the bond is ________.

By using convertible bonds, an issuing firm can temporarily raise debt, which is typically less expensive than common stock, to finance projects.

A type of lease in which the lessor acquires or purchases the asset in order to lease to a given lessee is known as ________.

A hybrid security is a form of debt or equity financing that possesses characteristics of both debt and equity.

Which of the following is an advantage of leasing from a lessee's perspective?

Tangshan Mining Company has an outstanding issue of convertible bonds with a $1,000 par value. The bonds have a 10 percent coupon rate, have a 10-year maturity, and are convertible into 100 shares of common stock. The yield to maturity on bonds of similar risk is 10 percent and the market price of the firm's common stock is currently $15.00. Based on this information, the conversion value of the bond is ________.

Unlike convertible securities, warrants cannot be called, but their limited life stimulates holders to exercise them when the exercise price is below the market price of the firm's stock.