Exam 17: Hybrid and Derivative Securities

The conversion ratio can be obtained by dividing the par value of the convertible by the conversion price.

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.

Since the conversion feature provides the purchaser of a convertible bond with the possibility of becoming a stockholder, convertible bonds are generally a less expensive form of financing than similar-risk nonconvertible or straight bonds.

A lease under which a lessee sells an asset for cash to a prospective lessor and then leases back the same asset is called a(n)

A noncancelable arrangement that requires the lessee to make payments for the use of an asset over a relatively long period of time is called a(n)

One advantage of leasing is that in many cases, the return to the lessor is quite high so the firm in need of the asset might be better off borrowing to purchase it.

The exercise price or option price of a warrant is normally set below the market price of the firm's stock at the time of issuance.

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 ________.

The presence of contingent securities such as warrants and stock options affects the reporting of the firm's earnings per share.

Convertible bonds normally have ________ to permit the issuer to retire or encourage conversion.

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 straight value of the bond is

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

________ leases are noncancelable and are generally used for leasing land, buildings, and large pieces of fixed equipment.

The conversion value of a bond is the minimum price at which a convertible bond would be traded.

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.

Most stock purchase warrants are detachable, which means that the bondholders may sell the warrant without selling the security to which it is attached.

One motive for issuing convertibles is that convertible securities can be issued with far fewer restrictive covenants than nonconvertibles.

A call option is an option to sell a specified number of shares of a stock on or before some future date at a stated price.

The option buyer who expects a stock price to decline will purchase a put option.

A firm needs $1.5 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 $16 per share. To sell this new issue, the stock would have to be underpriced by $1 and sold for $15 per share. The firm currently has 600,000 shares of common stock outstanding. The alternative is to issue 30-year, 8 percent, and $1,000 par-value convertible bonds. The conversion price would be set at $20 per share, and the bond could be sold at par. The earnings for the firm are expected to be $700,000 in the coming year. Which plan results in less dilution of the earnings per share?