Question 1

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

Accepted Answer

A) True 
 B)False  False

Question 2

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. 
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. C

Question 3

A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.

Accepted Answer

A) True 
 B)False  False

Question 4

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 5

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 6

Volunteer Vegetables' 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 2017. What is the conversion value of the bond?

Accepted Answer

A)  $707.33 
B)  $744.56 
C)  $783.75 
D)  $825.00 
E)  $866.25 
A)  $707.33 
B)  $744.56 
C)  $783.75 
D)  $825.00 
E)  $866.25

Question 7

Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

Accepted Answer

A) True 
 B)False

Question 8

Plowman Industries 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% 
A)  6.66% 
B)  6.99% 
C)  7.34% 
D)  7.71% 
E)  8.09%

Question 9

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

Question 10

E) Thompson Utilities has issued a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?

Accepted Answer

A)  $3.76 
B)  $3.94 
C)  $4.14 
D)  $4.35 
E)  $4.56 
A)  $3.76 
B)  $3.94 
C)  $4.14 
D)  $4.35 
E)  $4.56

Question 11

Which of the following statements is most CORRECT?

Accepted Answer

A)  Warrants have an option feature but convertibles do not. 
B)  One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. 
C)  The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt. 
D)  The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. 
E)  Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual. 
A)  Warrants have an option feature but convertibles do not. 
B)  One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. 
C)  The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt. 
D)  The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. 
E)  Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual.

Question 12

Preferred stockholders have priority over common stockholders with respect to dividends, because dividends must be paid on preferred stock before they can be paid on common stock. However, preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy.

Accepted Answer

A) True 
 B)False

Question 13

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 14

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 15

Seery Services, Inc. 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)  $972.41 
A)  $794.01 
B)  $835.81 
C)  $879.80 
D)  $926.10 
E)  $972.41

Question 16

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

Accepted Answer

A) True 
 B)False

Question 17

Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.

Accepted Answer

A) True 
 B)False

Question 18

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. 
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.

Question 19

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. 
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.

Question 20

Atchley Enterprises' stock price is $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% 
A)  7.83% 
B)  8.24% 
C)  8.65% 
D)  9.08% 
E)  9.54%

Exam 20: Hybrid Financing

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

Which of the following statements is most CORRECT?

A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.

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

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.

Volunteer Vegetables' 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 2017. What is the conversion value of the bond?

Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

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

E) Thompson Utilities has issued a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?

Which of the following statements is most CORRECT?

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

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.

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

Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.

Which of the following statements about convertibles is most CORRECT?

Which of the following statements concerning warrants is CORRECT?

An Overview of Financial Management

Risk and Return: Part I

Risk and Return: Part II

Bond Valuation

Basic Stock Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Financial Planning and Forecasting Financial Statements

Determining the Cost of Capital

Corporate Valuation and Value-Based Management

Capital Budgeting: Decision Criteria

Capital Budgeting: Cash Flows and Risk

Real Options

Capital Structure Decisions: Part I

Capital Structure Decisions: Part II

Distributions to Shareholders

Ipos, Investment Banking, and Financial Restructuring

Lease Financing

Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Derivatives and Risk Management

Bankruptcy, Reorganization, and Liquidation

Mergers, Lbos, Divestitures, and Holding Companies

Multinational Financial Management

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