Deck 19: Derivative Securities

Question 1

The conversion ratio is the:

A) price at which a convertible security is exchanged into common shares.
B) ratio of conversion value to market value of a convertible security.
C) number of shares of common stock into which the convertible may be converted.
D) ratio of the conversion premium to market value of a convertible security.

Answer 1

C

Question 2

The theoretical floor value for a convertible bond is its:

A) conversion price.
B) conversion value.
C) par value.
D) pure bond value.

Answer 2

D

Question 3

The principle device used by the corporation to force conversion:

A) is setting the conversion price above the current market price.
B) is reducing the amount of interest payments.
C) is buying bonds back at below par value.
D) is a call provision.

Answer 3

D

Question 4

The conversion premium will be large:

A) if investors have great expectations for the price of the common shares.
B) if interest rates decline.
C) when the conversion value is much greater than the pure bond value.
D) when the share price is very stable.

Question 5

A convertible security is almost always:

A) a security that can be converted into any other type of security.
B) a debt security that can be converted into preferred shares.
C) a security that can be converted into common shares at the holder's option.
D) a security that can be converted into common shares at the option of the issuing corporation.

Question 6

When preparing financial statements the accounting consideration of convertible bonds include:

A) adding shares from conversion to shares outstanding in the numerator of the diluted earnings per shares calculation.
B) the effect of convertibles on basic earnings per share.
C) adjusting after tax earnings in the denominator of the diluted earnings per shares calculation.
D) redefining earnings to add the costs related to the convertible securities to the numerator of the EPS ratio.

Question 7

A convertible bond is currently selling for $855. It is convertible into 15 common shares which presently sell for $50 per share. The conversion premium is:

A) $105.
B) $57.
C) 57 shares.
D) 17 shares.

Question 8

A step-up in the conversion price refers to:

A) the ability of the company to step up the maturity of the bond to an earlier date.
B) the provision that decreases the conversion ratio the longer a convertible bond is held.
C) a refunding of a convertible bond when the conversion value equals the pure bond value.
D) the ability of the holder to step up the conversion maturity to an earlier date.

Question 9

The minimum theoretical value of a warrant to buy 5 shares of ACD stock at $45 per share is $10. What is the current market price of ACD stock?

A) $45.50
B) $50.00
C) $47.00
D) $37.50

Question 10

Conversion price is usually set _______ the prevailing market price of the common stock at the time the bond issue is sold.

A) at
B) below
C) above
D) at one half of

Question 11

A convertible bond is often utilized:

A) as a sweetener when buying debt.
B) to sell common bonds at prices lower than those prevailing when funds are needed.
C) when the company wants to increase equity.
D) when there is demand for straight debt.

Question 12

A $1,000 par value bond with a conversion price of $50 has a conversion ratio of:

A) $50.
B) $20.
C) 50 shares.
D) 20 shares.

Question 13

A disadvantage to the investor of a convertible bond is that:

A) the share price may rise above conversion price.
B) if interest rates rise, the pure bond value (floor price) will decline.
C) the interest rate on convertibles is generally one-half below the coupon rate on straight bonds of similar risk.
D) interest paid on convertible bonds is higher than that paid on non-convertible bonds.

Question 14

If the price of common share associated with a convertible bond is less than the conversion price:

A) the bond will sell at its pure bond value.
B) the bond will sell at its par value.
C) the bond will sell at its conversion value.
D) there is not enough information to tell what the bond price will be.

Question 15

If the share price rises substantially above the conversion price, an advantage to the corporation would be:

A) the premium would decrease.
B) the floor price would offer the investor downside protection.
C) the bond would most likely be converted into common shares and the debt would not have to be repaid.
D) the firm could raise the capital needed by issuing fewer shares than those sold from the conversion of the securities.

Question 16

The conversion premium is the greatest and the downside the smallest when:

A) the conversion value equals the pure bond value.
B) the conversion value is greater than the pure bond value.
C) the conversion value is less than the pure bond value.
D) the share price is expected to go up drastically.

Question 17

Jacobs and Company has warrants outstanding, which are selling at a $3 premium above intrinsic (or minimum) value. Each warrant allows its owner to purchase one share of common stock at $25. If the common stock currently sells for $28, what is the warrant price?

A) $6
B) $10
C) $12
D) $14

Question 18

The computation of (basic) earnings per share will include consideration of:

A) all convertible securities.
B) only shares outstanding.
C) shares outstanding and common stock equivalents.
D) only common stock equivalents.

Question 19

Warrants as compared to convertible bonds:

A) provide a regular return.
B) do not trade at a speculative premium.
C) are sold without the company's consent.
D) provide the company with cash flow when exercised (converted).

Question 20

The interest rate on convertibles is generally ____________ the interest rate on similar nonconvertible instruments.

A) greater than
B) less than
C) the same as
D) at least twice

Question 21

Which of the following is true about warrants?

A) As the market value of a warrant increases, so does the premium.
B) A rising share price is usually followed by an increase in the price of the warrant.
C) Warrants guarantee a return for the holder.
D) Warrant premiums are independent of the market price of shares.

Question 22

Warrants are:

A) long-term options to sell shares of the issuing firm's shares.
B) fairly stable, low-risk investments.
C) investments whose value is directly related to the price of the underlying shares.
D) structured to sell for precisely their intrinsic value.

Question 23

Which of the following is true?

A) As the price of common stock increases, the market price of a convertible bond and the conversion premium increase.
B) As the price of common stock increases, the market price of a convertible bond and the conversion value increase.
C) As the price of common stock increases, the conversion value and the floor price increase.
D) As the book value of common stock increases, the market price of a convertible bond and the conversion premium increase.

Question 24

Duckwalk Corporation warrants carry the right to buy 10 shares of Duckwalk common stock at $3.50 per share. The common stock has a current market price of $4.25 per share. The intrinsic or minimum value of one Duckwalk warrant is:

A) $0.43.
B) $7.50.
C) $0.75.
D) $0.53.

Question 25

An advantage to the corporation in selling a convertible bond is:

A) the interest rate on a convertible is lower than a straight debt issue of equal risk.
B) the bond may never get converted into common stock and create dilution.
C) if interest rates fall the bond is likely to be refunded.
D) a dilution effect on earnings per share when convertible securities are issued.

Question 26

Expectations of a significant increase in the price of a firm's common shares will result in:

A) large conversion premiums for the firm's convertible bonds.
B) small conversion premiums for the firm's convertible bonds.
C) negative conversion premiums for the firm's convertible bonds.
D) no effect at all on conversion premiums.

Question 27

The price of a convertible bond:

A) has downside as well upside limitations.
B) has only upside limitations.
C) has only downside limitations.
D) has no upside or downside limitations.

Question 28

Warrants and call options are similar because:

A) each requires the firm to issue new shares when exercised.
B) each will affect the share value when exercised.
C) both are issued by the corporation.
D) give the holder leverage on the company's share price.

Question 29

Which of the following is not a characteristic of convertible bond issues?

A) The average size of the offering is small.
B) A 15-20% conversion premium at time of issue is common.
C) Large companies with billions of dollars in sales and assets are the primary issuers.
D) Primary issuers tend to have less than AA credit ratings.

Question 30

The floor price of a convertible bond cannot fall below:

A) the conversion ratio.
B) the conversion price.
C) the conversion premium.
D) the pure bond value.

Question 31

A call option gives the holder the right:

A) but not the obligation to sell an asset at a predetermined price.
B) but not the obligation to buy an asset at a predetermined price.
C) and the obligation to sell an asset at a predetermined price.
D) and the obligation to buy an asset at a predetermined price.

Question 32

When a company has a convertible bond in its capital structure:

A) it can reduce its debt-to-equity ratio by calling the bond.
B) there is no effect on the firm's basic earnings per share.
C) there is no advantage to the firm in forcing conversion of the bonds.
D) it should ignore the conversion feature.

Question 33

Futures contracts differ from forward contracts because:

A) they trade on an organized exchange.
B) they require marking to market on a daily basis.
C) delivery can occur any day of the delivery month.
D) futures only deal with currency and forwards deal with commodities.

Question 34

Which of the following characteristics are drawbacks of convertible bonds?

A) Downside protection is effectual if the bond is bought at a large premium over par value.
B) Interest rates on a convertible bond are always above market interest rates.
C) Conversion may be forced on the bondholder by put provisions on the convertible bond.
D) Interest rates on the debt-instrument part of a convertible bond are frequently below market interest rates.

Question 35

A forward contract:

A) fixes today the right to buy/sell an asset at a future date at a price to be determined at that future date.
B) fixes today the right to buy/sell an asset at a future date at a price set today.
C) fixes today the right to buy/sell an asset today at a price to be determined at a future date.
D) fixes today the right to buy/sell an asset at a future date at a price to be determined at that future date, if the price has decreased.

Question 36

A warrant which does not expire until several years in the future and which provides its owner the opportunity to buy a stock which is rising in price will probably sell for:

A) less than its intrinsic value.
B) exactly its intrinsic value.
C) more than its intrinsic value.
D) less than or equal to its intrinsic value.

Question 37

Quirm Corp. has 10,000 7.25% bonds convertible into 30 shares per $1000 bond. Quirm has 700,000 outstanding shares. Quirm has a tax rate of 35%. Compute (basic) earnings per share if after-tax earnings are $742,000.

A) $0.71
B) $0.99
C) $1.06
D) $1.51

Question 38

The Burma Hat Company's warrant is trading for $10.20. The warrant carries the option to purchase two shares of common stock for $48. What is the speculative premium if the stock price is $51.30?

A) $3.30
B) $3.60
C) $6.60
D) $10.90

Question 39

Trusty Corp. has 20,000, 7% bonds, convertible into 30 shares per bond. Each bond has a par value of $1,000. Trusty has 800,000 outstanding shares paying a $0.50 annual dividend. Earnings were $750,000 after paying $250,000 in taxes. Compute the diluted EPS.

A) $0.54
B) $0.94
C) $1.29
D) $1.71

Question 40

The "floor," or pure bond, value of a convertible bond is found by:

A) multiplying the price of the firm's common stock by the conversion ratio.
B) multiplying the bond's conversion premium by the price of the firm's common shares.
C) multiplying the price of the firm's common stock by the conversion ratio and adding the present value of the bond's face value.
D) finding the present value of the bond's interest payments and adding the present value of the bond's face value.

Question 41

Horne Engineering Corp. has 30,000 6.0% bonds convertible into 30 shares per $1,000 bond. Horne Engineering has 500,000 outstanding shares and a tax rate of 35%. Compute (basic) earnings per share if after-tax earnings are $750,000 and diluted EPS when bonds are converted.

A) $1.82 basic, $1.50 diluted
B) $1.50 basic, $1.37 diluted
C) $3.30 basic, $1.18 diluted
D) $1.26 basic, $0.98 diluted

Question 42

Which of the following statements is correct?

A) Call and put options increase in price if the exercise price is increased.
B) Call and put options increase in price if the volatility of the underlying asset is decreased.
C) Call and put options increase in price if the time to expiry is increased.
D) Call and put options increase in price if the opportunity cost of funds is increased.

Question 43

If the time to expire of an option increases:

A) the value of a call option will increase, but a put option will decrease.
B) the value of a call option will decrease, but a put option will increase.
C) the value of a call option will decrease, and a put option will decrease.
D) the value of a call option will increase, and a put option will increase.

Question 44

A put option gives the holder the right:

A) but not the obligation to sell an asset at a predetermined price.
B) but not the obligation to buy an asset at a predetermined price.
C) and the obligation to sell an asset at a predetermined price.
D) and the obligation to buy an asset at a predetermined price.

Question 45

The floor value of a convertible bond cannot fall below:

A) the conversion ratio.
B) the conversion price.
C) the conversion premium.
D) its value as either equity or debt.

Question 46

If the volatility of an option increases:

A) the value of a call option will increase, but a put option will decrease.
B) the value of a call option will decrease, but a put option will increase.
C) the value of a call option will decrease, and a put option will decrease.
D) the value of a call option will increase, and a put option will increase.

Question 47

A company will force conversion of a convertible bond when:

A) the conversion value is higher than the call price.
B) the conversion value is higher than the par value (face value).
C) when the total interest payment on the bond equals the total dividend payment on the converted shares of common stock.
D) when the share price is very low.

Question 48

The writer of a call option has the obligation:

A) but not the right to sell an asset at a predetermined price.
B) but not the right to buy an asset at a predetermined price.
C) and the right to sell an asset at a predetermined price.
D) and the right to buy an asset at a predetermined price.

Question 49

Which of the following is true about warrants?

A) As the market value of a warrant increases, so does the premium.
B) A rising share price is usually followed by a decrease in the price of the warrant.
C) Exercise price is greater than market price ant time of issue.
D) Warrants are favoured by small businesses and are issued more frequently on the Venture Exchange.

Question 50

Simba Inc. has warrants outstanding, which are selling at a $2 premium above intrinsic (or minimum) value. Each warrant allows its owner to purchase one share of common stock at $24. If the common stock currently sells for $29, what is the warrant price?

A) $5.00
B) $7.00
C) $12.00
D) $14.50

Question 51

A disadvantage to the investor of a convertible bond is that:

A) the share price may never rise above conversion price.
B) if interest rates rise, the pure bond value (floor price) will rise.
C) the interest rate on convertibles is generally half the coupon rate on straight bonds of similar risk.
D) if stock price rises above the conversion price, the firm could raise the capital needed by issuing fewer shares than those sold from the conversion of the securities.

Question 52

A step-up in the conversion price refers to:

A) the ability of the company to step up the maturity of the bond to an earlier date.
B) the provision that increases the conversion ratio the longer a convertible bond is held.
C) a refunding of a convertible bond when the conversion value equals the pure bond value.
D) the holder may pay a progressively higher option price if he or she does not exercise by a given date.

Question 53

If the market opportunity cost of funds increases:

A) the value of a call option will increase, but a put option will decrease.
B) the value of a call option will decrease, but a put option will increase.
C) the value of a call option will decrease, and a put option will decrease.
D) the value of a call option will increase, but a put option will increase.

Question 54

The interest rate on nonconvertible bonds is generally ____________ the interest rate on similar convertible instruments.

A) greater than
B) less than
C) the same as
D) at least twice

Question 55

A convertible bond is currently selling for $900. It is convertible into 15 common shares which presently sell for $55 per share. The conversion premium is:

A) $825.
B) $75.
C) 16 shares.
D) 17 shares.

Question 56

A $1,000 par value bond with a conversion price of $20 has a conversion ratio of:

A) $50.
B) $20.
C) 50 shares.
D) 20 shares.

Question 57

Brenda Baruda has a futures contract to sell corn at $2.22 per bushel. The contract is about to expire and the spot (cash) price of corn is currently $2.00 per bushel. We would expect Brenda to:

A) close out the contract at a gain.
B) close out the contract at a loss.
C) deliver under the contract at a gain.
D) deliver under the contract at a loss.

Question 58

Shady Corp. has 30,000, 6% bonds, convertible into 50 shares per bond. Each bond has a par value of $1,000. Trusty has 1,000,000 outstanding shares paying a $0.75 annual dividend. Earnings were $900,000 after paying $600,000 in taxes. Compute the diluted EPS.

A) $0.79
B) $1.08
C) $0.90
D) $0.36

Question 59

A future contract is more flexible than a forward contract because:

A) the future price is preset today.
B) it is available in a wider variety of amounts.
C) it trades on an organized exchange.
D) prices are published in the newspaper.

Question 60

The minimum theoretical value of a warrant to buy 6 shares of a firm's stock at $50 per share is $10. What is the current market price of the firm's stock?

A) $51.67
B) $50.00
C) $60.00
D) $5.00

Question 61

The floor price of a convertible bond is determined by:

A) the conversion ratio.
B) the conversion price.
C) the conversion premium.
D) its value as either equity or debt.

Question 62

A convertible bond is currently selling for $1,125. It is convertible into 20 shares of common which presently sell for $40 per share. The conversion premium is:

A) $325.
B) $215.
C) 66.74 shares.
D) 23.80 shares. $40 stock price *20 shares = $800 conversion value
Conversion premium = Bond price of $1,125 - Conversion value of $800 = $325.

Question 63

The conversion premium will be small:

A) if investors have low expectations for the price of the common stock.
B) if interest rates decline.
C) when the conversion value is much greater than the pure bond value.
D) when the stock price is very stable.

Question 64

Beck Corp. (BC) has a convertible bond issue outstanding. Each $1,000 in bond outstanding can be converted into 20 common shares. BC's non-convertible bonds have a coupon of 4% paid annually and mature in 15 years. BC's common stock is currently trading at $38 a share and its convertible bonds are trading at $1,100.

-BC's convertible bond has a conversion premium of ______.

A) $340
B) $760
C) $1,000
D) $1,100

Question 65

If the price of common stock associated with a convertible bond is less than the conversion price:

A) the bond will sell at its pure bond value.
B) the bond will sell at its par value.
C) the bond will sell at its conversion value.
D) there is not enough information to tell what the bond price will be.

Question 66

Which of the following is true?

A) As the price of common stock increases, the market price of a convertible bond and the conversion premium increase.
B) As the price of common stock increases, the market price of a convertible bond and the conversion value increase.
C) As the price of common stock increases, the conversion value and the floor price increase.
D) As the price of common stock increases, the market price of a convertible bond and the conversion premium decrease.

Question 67

FC reported earnings of $12,000,000. During the year FC issued a convertible bond that could be, if fully converted, increase FC's shares outstanding by 575,000. If FC currently has 4,800,000 shares outstanding and the after-tax cost of the convertible bonds is $850,000, what is FC's diluted EPS?

A) $2.50
B) $2.39
C) $2.89
D) $3.48

Question 68

Silver and Gold Ltd. (SG) common stock is currently trading at $32 a share. SG's warrants have a strike price of $25 if converted on or before July 1 and can be converted into 1 share of SG. Calculate the intrinsic value of SG's warrants.

A) $8.90
B) $12.90
C) $15.90
D) $7.00

Question 69

The conversion ratio is the:

A) price at which a convertible security is exchanged into common stock.
B) ratio of conversion value to market value of a convertible security.
C) number of shares of common stock into which the convertible may be converted.
D) ratio of the conversion premium to market value of a convertible security.

Question 70

A convertible security is almost always:

A) a security that can be converted into any other type of security.
B) a debt security that can only be converted into preferred stock.
C) a security that can be converted into common stock at the holder's option.
D) a security that can be converted into common stock only at the option of the issuing corporation.

Question 71

The price of a convertible bond:

A) is calculated by adding the pure bond value to the market price.
B) is determined by subtracting the market price of the common share from the market price of the bond.
C) has some downside protection.
D) has no upside potential.

Question 72

Beck Corp. (BC) has a convertible bond issue outstanding. Each $1,000 in bond outstanding can be converted into 20 common shares. BC's non-convertible bonds have a coupon of 4% paid annually and mature in 15 years. BC's common stock is currently trading at $38 a share and its convertible bonds are trading at $1,100.

-If bonds of similar risk are yielding 5% what is the pure bond value of BC's convertible bonds?

A) $896
B) $1,000
C) $1,150
D) $982

Question 73

The conversion premium is the greatest and the downside risk the smallest when:

A) the conversion value equals the pure bond value.
B) the conversion value is greater than the pure bond value.
C) the conversion value is less than the pure bond value.
D) the stock price is expected to go up drastically.

Question 74

Beck Corp. (BC) has a convertible bond issue outstanding. Each $1,000 in bond outstanding can be converted into 20 common shares. BC's non-convertible bonds have a coupon of 4% paid annually and mature in 15 years. BC's common stock is currently trading at $38 a share and its convertible bonds are trading at $1,100.

-If BC's stock price rises to $55 a share, the price of the convertible bond will rise to ______.

A) $1,100
B) $1,000
C) $1,260
D) $1,500

Question 75

A $1,000 par value bond with a conversion price of $100 has a conversion ratio of:

A) $20.
B) 20 shares.
C) $10.
D) 10 shares. Conversion ratio = Par value of $1,000/Conversion price of $50 = 20 shares.

Question 76

Beck Corp. (BC) has a convertible bond issue outstanding. Each $1,000 in bond outstanding can be converted into 20 common shares. BC's non-convertible bonds have a coupon of 4% paid annually and mature in 15 years. BC's common stock is currently trading at $38 a share and its convertible bonds are trading at $1,100.

-BC's convertible bond has a conversion value of _______.

A) $1,100
B) $1,000
C) $760
D) $340

Question 77

A convertible bond is currently selling for $970. It is convertible into 15 shares of common which presently sell for $50 per share. The conversion premium is:

A) $90.
B) $220.
C) 57 shares.
D) 13 shares. $50 stock price * 15 shares = $750 conversion value
Conversion premium = Bond price of $970 - Conversion value of $750 = $220.

Question 78

Silver and Gold Ltd. (SG) common stock is currently trading at $32 a share. SG's warrants have a strike price of $25 if converted on or before July 1 and can be converted into 1 share of SG. If SG's warrants are currently trading at $12.00, and the intrinsic value of these warrants is $7.00, calculate their speculative premium.

A) $5.00
B) $7.00
C) $8.90
D) $12.00

Question 79

Vansteelandt Distillery Inc's warrant is trading for $12.50. The warrant carries the option to purchase two shares of common stock for $50. What is the speculative premium if the stock price is $53.50?

A) $3.50
B) $5.50
C) $7.00
D) No speculative value.

Question 80

Expectations of a significant increase in the price of a firm's common stock will result in:

A) large conversion premiums for the firm's convertible bonds.
B) small conversion premiums for the firm's convertible bonds.
C) negative conversion premiums for the firm's convertible bonds.
D) No effect at all on conversion premiums.