Deck 17: Corporate Securities, Derivatives, and Swaps

Question 1

When the price of the firm's common stock ___________ the conversion price, the market price of theconvertible security will normally ___________to a level close to its conversion value.

A) equals; fall
B) falls below; rise
C) rises above; rise
D) rises above; fall

Answer 1

rises above; rise

Question 2

The call privilege is generally not exercised until the conversion value of the security is__________ the call price.

A) equal to
B) 10 to 15 percent above
C) 5 to 10 percent below
D) 25 to 30 percent above

Answer 2

10 to 15 percent above

Question 3

A firm has an outstanding 15-year convertible bond issue with a $1,000 par value and a statedannual interest rate of seven percent. The bond is convertible into 50 shares of common stock whichhas 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 __________.

A) $1,000
B) $ 772
C) $1,328
D) $1,250

Answer 3

$1,250

Question 4

When a company hedges its balance sheet risk with a fixed-rate for floating rate interest-rate swap,which part of its balance sheet is affected?

A) Long term as well as short term assets and liabilities
B) Only its long term liabilities
C) Both long-term assets and long term liabilities
D) Only its long term assets

Question 5

Which of the following statements correctly describes the fundamental principle of swaps?

A) The parties of the swap each have a comparative advantage in different markets
B) One party may have excess cash while the other party has insufficient cash
C) The parties face the same rates in the same markets, but they have different objectives regarding their payback period
D) One party has an advantage over the other party in all markets and is willing to share that advantage

Question 6

A convertible security that cannot be forced into conversion using the call feature is

A) an uncallable common equity issue.
B) a debenture.
C) a general obligation bond.
D) an overhanging issue.

Question 7

The market value of a convertible bond will exceed the conversion value or straight bond value, whichever is greater, by an amount called the market premium. This premium exists because

A) buyers and sellers do not usually agree on the conversion value.
B) markets are efficient.
C) purchasers expect future stock price movements to be positive.
D) the straight bond value is close to the conversion value.

Question 8

At the time of issuance, the issuer of a convertible security normally establishes a conversion price ___________the current market price of the firm's stock.

A) equal to
B) above
C) unrelated to
D) below

Question 9

The basic characteristics of warrants include all of the following EXCEPT it

A) has an exercise period shorter than one month.
B) is detachable.
C) lowers the required interest rate.
D) acts as a sweetener in financing.

Question 10

The market value of a warrant is generally ___________the theoretical value of the warrant.

A) not related to
B) above
C) equal to
D) below

Question 11

An investor has $1,000 that she is interested in investing in ABC stock, which is currently selling for$10 per share. ABC's warrants are selling for $7 per warrant. Each warrant entitles the holder topurchase three shares of ABC's common stock for $8 per share. The warrant premium is ___________ .

A) $1
B) $3
C) $2
D) $4

Question 12

The "spread" in swap deal refers to

A) the profit made by the swap dealer by adding to the fixed rates of the swap
B) the difference between the fixed rates the parties of the swap can borrow at in the fixed-rate market
C) the profit made by the counterparties by participating in the swap
D) the difference between the floating rates the parties of the swap can borrow at in the floating-rate market

Question 13

For the counterparties of an interest-rate swap to determine the amount and timing of thepayments they need to make to each other, they must specify

A) the spread, type of interest rate, risk tolerance and maturity date
B) the notional amount, type of interest rate, start date and maturity date
C) the notional amount, spread, risk tolerance and maturity date
D) the type of interest rate, spread, start date and maturity date

Question 14

In Canada, all option contracts are issued, guaranteed, and cleared by the

A) Canada Customs and Revenue Agency.
B) Bank of Canada.
C) Canadian Institute of Chartered Accountants.
D) Canadian Derivatives Clearing Corporation.

Question 15

If counterparty A uses a swap for hedging purposes, the company will be in a position where

A) the value of both its assets and its liabilities remain fixed
B) the value of its assets stays fixed while the value of its liabilities decreases
C) the value of its assets increases while the value of its liabilities decreases
D) the value of its assets fluctuates by the same amount as the value of its liabilities fluctuates

Question 16

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

A) increase the leverage of the firm.
B) time the sale of common stock when the price per share is basing.
C) dilute the ownership interest.
D) minimize dilution in earnings per share.

Question 17

Two companies would like to borrow money. Company A is offered a fixed rate of 4% and afloating rate of the BA rate (= the current yield on Bankers' Acceptances) + 0.4%. Company B isoffered a fixed rate of 6% and a floating rate of the BA rate + 1.4%. Given this information, which of the following statements is correct?

A) Both companies has a comparative advantage in the floating-rate market
B) Company B has a comparative advantage in the floating rate market
C) Company A has a comparative advantage in the floating rate market
D) Both companies has a comparative advantage in the fixed-rate market

Question 18

A firm has an outstanding bond with a $1,000 par value that is convertible into 50 shares of common stock. The bond's conversion ratio is ___________ .

A) 50
B) 100
C) 25
D) 20

Question 19

Which of the following statements about the notional amount of a currency swap is correct?

A) The notional amount is exchanged both when the swap is entered into and when the swap has matured
B) The notional amount is exchanged when the swap is entered into
C) The notional amount is exchanged when the swap has matured
D) The notional amount is never exchanged

Question 20

The swap that has the simplest structure is generally known as a

A) simple swap
B) vanilla swap
C) straight swap
D) plain swap

Question 21

A firm has outstanding convertible preferred stock with a $50 par value which is convertible into three shares of common stock. The conversion value is $45. What is the current market price of a share of common stock?

A) $17.33
B) $16.67
C) $15.00
D) $20.00

Question 22

A firm currently has outstanding a 9 percent, $1,000 convertible bond. The bond is convertible into100 shares of common stock at a conversion price of $10 per share and callable at $1,090. Thecurrent market price of the firm's stock is $12 per share. If the bond is called, the bond holder will most likely

A) convert the bond into stock realizing only par value.
B) do nothing and wait until the stock price goes up further.
C) convert the bond into stock realizing $200 over par value.
D) allow the call to be exercised realizing $90 over par value.

Question 23

An investor is considering buying 500 shares of ABC Company at $32 per share. Analysts agree that the firm's stock price may increase to $45 per share in the next four months. As an alternative, the investor could purchase a 120-day call option at a striking price of $30 for $5,000. What profit would the investor realize if the stock price increased to $42 per share?

A) $6,000
B) $0
C) $1,000
D) $4,000

Question 24

For which of the following purposes would an interest-rate swap be unsuitable?

A) to utilize a low-cost/high-leverage method of establishing a trading position in a particular market
B) to take advantage of a general drop in interest rates
C) to hedge or offset a risk on a company's balance sheet
D) to benefit from comparative advantages in different markets

Question 25

Which of the following describes a major way in which currency swaps differ from interest-rate swaps?

A) The notional amount is exchanged in a currency swap, but not in an interest-rate swap
B) Currency swaps include only interest payments in more than one currency
C) Interest-rate swaps may include more than one currency, currency swaps include one currency
D) The notional amount is exchanged in an interest-rate swap, but not in a currency swap

Question 26

A warrant is attached to a $1,000 par, 10 percent, 10-year bond, paying annual interest and having20 warrants attached for the purchase of the firm's stock. The bonds were initially sold for $1,200.When issued, similar risk, straight bonds were selling at a 14 percent rate of return. The implied price of the warrant is

A) $20.00
B) $10.00.
C) $20.40.
D) $10.40.

Question 27

The purchaser of a convertible issue sacrifices a portion of his or her interest return

A) to raise temporarily cheap funds.
B) when the call feature is exercised.
C) for the potential opportunity to become a common shareholder in the future.
D) due to the reduced risk of default.

Question 28

A firm has outstanding warrants that are exercisable at $53 per share and entitle holders topurchase two shares of common stock. The common stock is currently selling for $55 per share. Thetheoretical value of the warrant is ___________ .

A) $1
B) $3
C) $2
D) $4

Question 29

Griffen Incorporated entered into a swap deal with Ontario Provincial Bank as swap dealer in earlyMay one year. In September that same year, the swap dealer identified Prodborski ManufacturingLimited as as the other counterparty to the swap deal. In this situation, Ontario Provincial Bank as swap dealer is said to have

A) staggered the deal
B) warehoused the deal
C) layered the deal
D) lagged the deal

Question 30

The straight bond value is

A) the market value minus the conversion value.
B) the present value of the interest and principal payments discounted at a rate the firm would have to pay on a nonconvertible bond.
C) the stock value minus the present value of the interest payments.
D) the conversion premium minus the conversion value.

Question 31

The following securities are all popular hybrid securities EXCEPT

A) options.
B) financial leases.
C) stock purchase warrants.
D) convertible securities.

Question 32

The available options of the firm with an overhanging issue to finance the call include all of the following EXCEPT

A) selling additional preferred stock resulting in higher financial leverage.
B) using current retained earnings.
C) selling additional debt resulting in a higher debt ratio.
D) selling additional common equity resulting in less dilution of eps.

Question 33

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

A) $1,250
B) $750
C) $1,000
D) $772

Question 34

A firm has an outstanding 15-year convertible bond issue with a $1,000 par value and a stated annual interest rate of seven 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) $1,328
B) $772
C) $1,250
D) $1,000

Question 35

A ___________gives the holder an option to purchase a certain number of shares of common stock at a specified price over a certain period of time.

A) repurchase agreement
B) put option
C) convertible bond
D) stock-purchase warrant

Question 36

In a currency swap, which of the following type of payment exchange is impossible?

A) fixed payment in one currency for floating payment in another currency
B) fixed payment in one currency for floating payment in the same currency
C) floating payment in one currency for floating payment in another currency
D) fixed payment in one currency for fixed payment in another currency

Question 37

Which of the following is one of the main factors that determine the quoted fixed rates for swaps?

A) The size of the notional amount
B) The counterparties' default risk
C) The time of the taxation year the swap deal is entered into
D) The swap dealers' ability to add large spreads

Question 38

If the market price of the underlying share is $27, what is the intrinsic value of a call option that has a premium of $5 and a strike (exercise) price of $25?

A) $5
B) $2
C) $30
D) The option does not have an intrinsic value.

Question 39

A derivative that gives the holder the right, but not the obligation to sell the underlying security iscalled a ___________

A) put
B) right
C) call
D) warrant

Question 40

A convertible bond is almost always ___________with a call feature.

A) a debenture
B) a mortgage bond
C) an income bond
D) an equipment trust certificate

Question 41

For puts and calls, the exercise price is called

A) the option price.
B) the market price.
C) the striking price.
D) the expected value.

Question 42

All of the following are true of calls and puts EXCEPT

A) the presence of options trading in the firm's stock could, by increasing trading activity, stabilize the firm's share price in the marketplace.
B) options are not a source of funding to the corporation.
C) the financial manager of a corporation has very little need to deal with options.
D) options are issued by businesses.

Question 43

Which of the following statements about the notional amount of an interest-rate swap is correct?

A) The notional amount is just another term for the swap dealer's profit
B) The notional amount is added to the lowest fixed rate available and shared between the counterparties
C) The notional amount is the amount that is subject to this swap, but not exchanged
D) The notional amount is the loan amount exchanged in the swap

Question 44

A form of debt or equity financing that possesses characteristics of both debt and equity financing is called

A) derivative security.
B) convertible security.
C) hybrid security.
D) none of the above.

Question 45

The straight bond value is the___________price at which a convertible bond would be traded.

A) optimum
B) maximum
C) average
D) minimum

Question 46

The companies involved in a swap are called

A) counterparties
B) dealers
C) interest swappers
D) transactors

Question 47

The effect of exercising a warrant on the firm's capital structure reduces leverage___________converting a convertible security.

A) more than
B) without relationship to
C) less than
D) as much as

Question 48

The call price of the security generally___________the security's par value.

A) has no relation to
B) is greater than
C) is less than
D) is equal to

Question 49

Two companies would like to borrow money. Company A is offered a fixed rate of 6% and a floating rate of the BA rate (= the current yield on Bankers' Acceptances) + 1.25%. Company B is offered a fixed rate of 7% and a floating rate of the BA rate + 0.25%. Given this information, which of the following statements is correct?

A) Both companies can benefit from a swap given this information
B) Company B would benefit from a swap with Company A, but Company A cannot benefit from a swap.
C) Neither company can benefit from a swap given this information
D) Company A would benefit from a swap with Company B, but Company B cannot benefit from a swap.

Question 50

Which of the following statements about the term structure of swap rates is correct?

A) It is regulated by financial market regulators
B) It is similar to the current yield structure
C) It equals the bankers' acceptances' term structure
D) It is determined by the swap dealers

Question 51

A firm currently has outstanding a 5 percent, $1,000 convertible bond. The bond is convertible into25 shares of common stock and callable at $1,050. The current market price of the firm's stock is $41per share. If the bond is called, the bond holder will most likely

A) allow the call to be exercised.
B) do nothing and wait until the stock price goes up further.
C) convert the bond into stock.
D) sell the bond on the secondary market.

Question 52

The exercise price price of a warrant is normally set___________ the market price of the firm's stock atthe time of issuance.

A) above
B) equal to
C) with respect to
D) below

Question 53

Convertible preferred stock is normally converted into

A) shares of common stock.
B) secured bonds.
C) warrants.
D) debentures.

Question 54

The intermediary of a swap deal is called a

A) swap dealer
B) swap agent
C) swap promoter
D) swap transactor

Question 55

A___________ is an option included as part of a bond or preferred stock that permits the holder toconvert the security into a specified number of shares of common stock.

A) repurchase agreement
B) stock-purchase warrant
C) put option
D) conversion feature

Question 56

Convertible preferred stock and convertible bonds are normally convertible over ____________ , respectively.

A) a limited time period and an unlimited time period
B) an unlimited time period and a limited time period
C) an unlimited time period and an unlimited time period
D) a limited time period and a limited time period

Question 57

Many holders of convertible bonds will not convert when the firm's common stock price exceeds the conversion price because

A) interest payments are tax deductible.
B) of the dilution of EPS.
C) the common stock price may go up further.
D) they already have the market price benefit and may still receive fixed periodic interest payments.

Question 58

The premium for a contract of 100 call options is $400. The strike (exercise) price per share is $30 and the current market price of a share is $33. The investor should:

A) Let the option expire because the market price has to be below the strike price of a call before an investor can make a profit on the investment.
B) Allow the option to expire because the premium of $4 is greater than the difference between the strike price and market price.
C) Exercise the options because she will make a profit of $300.
D) Exercise the options in order to minimize the loss to $100.

Question 59

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 inthe coming year. Assuming the firm chooses the sale of common stock, the earnings per share in the coming year will be ___________.

A) $1.43
B) $1.45
C) $1.47
D) $1.44

Question 60

A ____________ option is an option to purchase a specified number of shares of a stock on or beforesome future date at a specified price, whereas a ___________option is an option to sell a specifiednumber of shares of a stock on or before some future date at a specified price. ___________are purchased if the stock price is expected to fall.

A) call; put; Puts
B) put; call; Calls
C) call; put; Calls
D) put; call; Puts

Question 61

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

A) They are a form of deferred equity financing by the firm.
B) They are traded on organized exchanges.
C) They provide the buyer with an opportunity to earn larger returns than simply buying or selling common stock.
D) They can be used to lock in a gain or prevent a loss on a stock holding.

Question 62

In which of the following situations would the swap dealer make a profit of 3 basis points?

A) The dealer receives a fixed rate of 9% from counterparty A but pays a fixed rate of 8.3% to counterparty B
B) The dealer receives a fixed rate of 9% from counterparty A but pays a fixed rate of 6% to counterparty B
C) The dealer receives a fixed rate of 9% from counterparty A but pays a fixed rate of 8.97% to counterparty B
D) The dealer receives a fixed rate of 9% from counterparty A but pays a fixed rate of 8.7% to counterparty B

Question 63

The similarities of a right and a warrant include all of the following EXCEPT

A) they both give the holder an option to acquire a certain number of shares of common stock at a specified price.
B) they both may be traded independently from the security to which they were attached.
C) they both result in new equity capital for the firm.
D) they are both issued with exercise or subscription prices below the prevailing market price of stock.

Question 64

If a swap dealer's spread on a $100 000 000 deal is 3 basis points, the dealer's profit amounts to

A) $300 000
B) $3 000 000
C) $3 000
D) $30 000

Question 65

If a swap dealer "warehouses" deals, it means the dealer

A) transacts with a large number of clients
B) transacts with clients involving different notional amounts
C) transacts with the counterparties at different times
D) transacts in large swap deals

Question 66

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 ______________.

A) $5.98
B) $5.88
C) $5.91
D) $6.67

Question 67

When an interest-rate swap is used to hedge a financial risk on a company's balance sheet, thecompany will have

A) a short-term liability and a short-term asset with fixed values even if interest rates vary
B) a short-term liability and a long-term asset with offsetting changes in value when interest rates vary
C) a long-term liability and a short-term asset with fixed values even if interest rates vary
D) a long-term liability and a long-term asset with offsetting changes in value when interest rates vary

Question 68

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?

A) the common stock with an eps of $1.17
B) the convertible bond with an eps of $1.00
C) the common stock with an eps of $1.00
D) the convertible bond with an eps of $1.04

Question 69

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

A) 25
B) 20
C) 40
D) 50

Question 70

Two companies would like to borrow money. Company A is offered a fixed rate of 4% and afloating rate of the BA rate (= the current yield on Bankers' Acceptances) + 0.4%. Company B isoffered a fixed rate of 6% and a floating rate of the BA rate + 1.4%. Given this information, which of the following statements is correct?

A) Company A would benefit from a swap with Company B, but Company B cannot benefit from a swap.
B) Neither company can benefit from a swap given this information
C) Company B would benefit from a swap with Company A, but Company A cannot benefit from a swap.
D) Both companies can benefit from a swap given this information

Question 71

A firm has an outstanding bond with a $1,000 par value that is convertible at $40 per share of common stock. If the current market value of common stock per share is $45, the conversion value of the bond is _____________.

A) $1,125
B) $880
C) $1,200
D) $1,000

Question 72

Which of the following options will provide the investor with a profit if the option is exercised?· call option, premium $5, Strike (exercise) price $20, market price $14· put option, premium $5, Strike (exercise) price $20, market price $14

A) put option
B) call option
C) Both are profitable.
D) Neither will provide a profit.

Question 73

The_____________ value is the price the bond would sell for in the market without the conversionfeature.

A) conversion
B) striking price
C) straight bond
D) market premium

Question 74

As the price of the underlying stock rises above the exercise price of a warrant, the investor's ability to earn larger potential return diminishes. Therefore, the warrant premium will

A) remain unchanged.
B) decrease.
C) increase.
D) double.

Question 75

All of the following are true of stock-purchase warrants EXCEPT

A) when a firm makes a large issue of debt, the attachment of stock-purchase warrants may add to the marketability of the issue.
B) the attachment of warrants may lower the required interest rate.
C) warrants are similar to conversion features on debt.
D) suppliers of debt are more likely to require warrants on an issue of debt from an existing corporation than from a new firm.

Question 76

A ______________ permits the firm to raise additional funds at some point in the future by selling common stock and thereby shifting the firm's capital structure to a less highly levered position.

A) put option
B) repurchase agreement
C) conversion feature
D) stock-purchase warrant

Question 77

When warrants are exercised,

A) debt is reduced.
B) there is no effect on the firm's capital structure.
C) debt is reduced while common equity increases.
D) only the number of common shares outstanding increases.

Question 78

Convertible bonds have all of the following characteristics EXCEPT

A) a less expensive form of financing than straight bonds.
B) enhanced marketability.
C) conversion increases the firm's debt ratio.
D) a call feature.

Question 79

An investor is considering buying 500 shares of ABC Company at $32 per share. Analysts agreethat the firm's stock price may increase to $45 per share in the next 4 months. As an alternative, theinvestor could purchase a 120-day call option at a striking price of $30 for $5,000. At what stock price would the investor break even?

A) $35
B) $45
C) $40
D) $42

Question 80

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

A) a put option
B) a stock purchase warrant
C) a striking price
D) a call feature