Deck 19: Equity and Hybrid Instruments

Question 1

When dividends that have been in arrears are paid, the preferred shares have a ______ provision.

A)participating
B)cumulative
C)non-cumulative
D)retractable

Answer 1

cumulative

Question 2

Residual owners are:

A)bond holders
B)equity holders
C)equity and preferred shareholders
D)all of the above

Answer 2

equity holders

Question 3

You are given the following shareholders' equity figures for Toronto Skaters Inc.(TS)for the fiscal year end of 2022.What is TS's dividend yield, including and excluding the special dividend, respectively?

A)4.9%, 3.9%
B)8.9%, 3.9%
C)11.3%, 25.3%
D)2.7%, 1.2%

Answer 3

8.9%, 3.9%

Question 4

In the event of liquidation, preferred shareholders rank ahead of:

A)subordinated debt holders.
B)secured debt.
C)common shareholders.
D)debenture holders.

Question 5

The right of shareholders to receive new shares when new shares are issued is called:

A)a residual owner.
B)a general cash offer.
C)a private placement.
D)a pre-emptive right.

Question 6

The book value of the shareholders' equity is represented by:

A)total assets minus the current liabilities.
B)the sum of preferred stock, retained earnings, and common equity.
C)the sum of common share capital and retained earnings.
D)the total assets minus equity.

Question 7

The retraction feature:

A)protects the issuer from interest-rate risk.
B)allows the shareholder to sell it to the issuer at an early maturity date.
C)allows the issuer to buy it back from the shareholder at an early maturity date.
D)protects both the shareholder and the issuer regardless of interest rates.

Question 8

Which of the following statements about dividends is true?

A)Dividends are paid before interest is paid.
B)Dividends received by Canadian households are taxed at the marginal personal tax rate.
C)Dividends are tax deductible.
D)Dividends received by one Canadian corporation from another Canadian corporation are not taxed.

Question 9

Which of the following statements about family trusts is true?

A)Family trusts separate ownership and control.
B)Income flows to the trust beneficiaries.
C)The trustees retain the voting power.
D)All of the above statements are true.

Question 10

You are given the following shareholders' equity figures for Toronto Skaters Inc.(TS)for the fiscal year ends of 2020, 2021, and 2022.What is TS's book value per share for each of the three years, beginning with 2020?

A)$1.92, $2.25, and $1.01
B)$2.50, $2.87, and $1.68
C)$7.38, $7.82, and $6.62
D)$1.30, $1.28, and $1.66

Question 11

Use the following statements to answer this question:
I.A retractable preferred share can be sold back to the issuer.
II.Preferred shares provide the investor an income tax benefit given that dividend income receives preferential tax treatment as compared to interest income.

A)I and II are correct.
B)I and II are incorrect.
C)I is correct and II is incorrect.
D)I is incorrect and II is correct.

Question 12

Which one of the following is the reason for paying a different price for different classes of shares in the case of a takeover?

A)Prices depend on the tax treatment of each class.
B)Prices depend on the dividend yield offered by the class.
C)Prices depend on the voting rights of the shares.
D)Prices depend on the floating of shares.

Question 13

Which of the following characteristics apply to straight preferred shares?
I.No maturity date
II.Pay a fixed dividend
III.Dividends are paid at regular intervals
IV.Historically have outperformed long Canada bonds
V.The right to sell them back to the issuer

A)I and II
B)I, II, and III
C)I, II, III, and IV
D)I, II, IV, and V

Question 14

You are given the following shareholders' equity figures for Toronto Skaters Inc.(TS)for the fiscal year end of 2022.What is TS's market to book ratio?

A)4.59
B)18.28
C)30.09
D)18.11

Question 15

Interest rates have gone up to 14% since you purchased your 10% preferred shares.You would be best off if the shares had a(n)______ feature.

A)call
B)extraction
C)redemption
D)retraction

Question 16

Use the following statements to answer this question:
I.Today, the pre-emptive right is always used by corporations to protect their investors from dilution.
II.A common share has the characteristics of a call option because it has unlimited upside potential.

A)I and II are correct.
B)I and II are incorrect.
C)I is correct and II is incorrect.
D)I is incorrect and II is correct.

Question 17

Which of the following is the correct classification for a preferred share when calculating its price?

A)As an annuity
B)As a growing annuity due
C)As a perpetuity
D)As a growing perpetuity

Question 18

Which of the following statements is correct?

A)Family trusts ensure income flows to the people descended from the company founder.
B)Family trusts ensure all the votes are held by the trustees.
C)Family trusts nominate the managers of the corporation.
D)all of the above.
E)a and b

Question 19

Preferred shares are ______ financing.

A)a form of debt
B)a form of equity
C)a combined form of debt and equity
D)different from debt and equity

Question 20

When a corporation has only one class of shares, which of the following is NOT one of the rights of shareholders?

A)To vote at any shareholder meeting of the corporation.
B)To vote at any director meeting of the corporation.
C)To receive any dividend declared by the corporation.
D)To receive any residual property of the corporation on dissolution.

Question 21

Which of the following support the rationale for issuing convertible bonds?

A)To reduce underwriting costs
B)To provide less expensive initial financing
C)To minimize dilution
D)All of the above are good reasons for issuing convertible bonds.

Question 22

In which of the following ways do warrants differ from call options?
I.Warrants impact the firm while call options do not.
II.Call options generally have shorter maturities than warrants.
III.Any profit received from call options is taxable while that from warrants is not taxable.
IV.Volatility increases the value of call options but makes warrants less valuable.
V.The longer maturities of warrants make them less valuable.

A)I, II, and III
B)I, III, and V
C)II, IV, and V
D)I and II

Question 23

Which of the following statements is correct?

A)Companies issue preferred shares only to have better control of the firm.
B)Preferred shares pay a guaranteed dividend.
C)Preferred dividends are not tax deductible by the issuing firm.
D)None of the above

Question 24

Issuing bonds plus warrants is similar to issuing:

A)Retractable bonds.
B)Convertible bonds.
C)Floating rate bonds.
D)Preferred shares.

Question 25

The ______ specifies the number of shares received for each convertible bond.

A)conversion price
B)subscription price
C)conversion ratio
D)subscription ratio

Question 26

Hudson Bay Fishing Corporation has issued bonds that can be converted into common shares when the share price is $50.The current market price of the stock is $35.The bond has a face value of $1,000 and currently sells for $975.What is the conversion ratio for this bond?

A)20
B)29
C)24
D)28

Question 27

Which of the following are also referred to as a hybrid security?

A)Cumulative preferred shares
B)Convertible bonds
C)Preferred shares
D)All of the above

Question 28

Warrants are similar to call options on stocks.What is the warrant equivalent of the strike price?

A)The initial price of the warrant
B)The market price of the warrant
C)The exercise price of the warrant
D)None of the above

Question 29

Punta Oil Company has 600,000 shares outstanding and has just issued 640,000 warrants.Each warrant entitles its owner to buy one share anytime in the next quarter at a price of $40.The common stock price is current $50.What is the payoff to the warrant holders exercising them, rounded to the nearest dollar?

A)$774.193.54
B)$3,096,774.19
C)$3,577,684.67
D)$3,844,599.16

Question 30

Which of the following statements regarding convertible bonds is true?

A)The floor value is the lowest price a convertible bond will sell for.
B)The convertible bond's floor value is determined by the maximum of the straight bond value and the conversion value.
C)If the share price rises above the conversion price, investors will convert the bonds.
D)All of the above statements are true.

Question 31

The price at which a convertible bond would sell for if it could NOT be converted into common shares is called:

A)floor value.
B)straight bond value.
C)convertible bond value.
D)conversion value.

Question 32

Warrants attached to a bond:

A)are used as sweeteners to make bond issues less attractive.
B)will typically increase the risk of the bond.
C)will typically decrease the risk of the bond.
D)all of the above.

Question 33

Evaluate the following statement:
The cost of a preferred share is the rate of return shareholders require on the firm's preferred stock.

Question 34

Use the following statements to answer this question:
I.A warrant's value is due, in part, to its long-term maturity.
II.The intrinsic value of a warrant does not depend on the volatility of the stock.

A)I and II are correct.
B)I and II are incorrect.
C)I is correct and II is incorrect.
D)I is incorrect and II is correct.

Question 35

What is the tax value of money?

A)The difference between your before-tax and after-tax earnings.
B)The tax rate multiplied by the total income reported to the government.
C)Dividends are taxed more favourably than is interest income.
D)Dividends are not taxed while interest income is taxable.

Question 36

A company has 20 million shares outstanding that are trading at $30 per share.The company has 2 million warrants outstanding that have an exercise price of $28 per share.Each warrant entitles the owner to purchase one share.What is the payoff to the warrant holders exercising them, rounded to the nearest dollar?

A)$3,636,364
B)$2,800,000
C)- $3,636,364
D)$6,000,000

Question 37

Which of the following characteristics apply to floating rate preferred shares?
I.Long maturity date
II.Pay a fixed dividend
III.Dividends are paid at regular intervals
IV.The right to sell them back to the issuer

A)I and II
B)I, II, and III
C)III and IV
D)I and III

Question 38

Which of the following is true regarding convertible bonds?

A)The convertible bond value is unrelated to the value of the stock.
B)The value of convertible debt is a function of the risk of default.
C)The conversion factor can be separated from the bond and sold separately to other investors.
D)When a bond is converted into shares, the company receives additional funds as part of the conversion.

Question 39

In which of the following ways are some preferred shares similar to bonds?
I.Call provisions
II.Convertible features
III.Retraction provisions
IV.Rated by rating agencies

A)I, II, and III
B)I, II, and IV
C)II and III
D)I, II, III, and IV

Question 40

The conversion premium is defined as which of the following?

A)The number of shares that a convertible security can be exchanged for.
B)The price at which a convertible security can be converted into common shares.
C)The value of a convertible security if it is immediately converted into common shares.
D)The percentage difference between the value at which the bonds are trading and their conversion value.

Question 41

A 10% semiannual coupon convertible bond has 10 years to maturity.Market rates on similar non-convertible bonds are 8.5%.Each bond is convertible into 40 common shares.The shares are currently trading at $30.What is the floor value of the bond?

A)$2,000
B)$1,100
C)$1,200
D)$1,000

Question 42

Where should soft retractable preferred shares be reported on a firm's Balance Sheet??

A)Asset section
B)Liabilities section
C)Share Capital section
D)Retained Earnings

Question 43

Montreal Financing has preferred shares with a stated value of $20 outstanding.These shares pay $1.60 in dividends annually.
a)What is the market price of these shares if the current market yield is 11%?
b)What is the market price of these shares if the current market yield is 11% and the issue is retractable in five years at the stated value?
c)What is the value of this retractable feature? Why does it have value?
d)What is the market price of these shares if the issue is immediately redeemable and retractable at stated value?

Question 44

You want to buy a portfolio of financial securities consisting of three, $1,000 face value Government of Canada bonds and 500 preferred shares of Laurentide Resort Inc.
Laurentide Resort has a preferred share series trading on the Toronto Stock Exchange that pays a dividend of $0.56 semi-annually.The required rate of return on the stock is 12% compounded semi-annually.
The bonds have 4 years to maturity and an 8% coupon rate, with payments made semi-annually.Currently, the yield to maturity on these bonds is 10% compounded semi-annually.
a)What is the current intrinsic value of Laurentide Resort's preferred stock?
b)What is the current price of the 4-year coupon bonds?
c)What is the current value of your portfolio (i.e., bonds + preferred stock)?
d)It is now 2 years later.Market interest rates have dropped and the yield to maturity on these bonds is now 8%.What is the value of the bonds at this time?
e)It is still 2 years later and the yield to maturity has dropped to 8%.Assume that the price of Laurentide Resort Inc.preferred shares is now $8.50 per share.What is the expected annual rate of return on your portfolio over the two years from your investment?

Question 45

Where should hard retractable preferred shares be reported on a firm's Balance Sheet?

A)Asset section
B)Liabilities section
C)Share Capital section
D)Retained Earnings

Question 46

A 12% coupon convertible bond has 20 years to maturity.Market rates on similar non-convertible bonds are 9.25%.Each bond is convertible into 20 common.The shares are currently trading at $40.What is the floor value of the bond, assuming annual coupon payments?

A)$1,247
B)$1,000
C)$ 800
D)$2,000

Question 47

Explain the importance of warrants in financing for firms.

Question 48

Which of the following statements regarding income bonds is true?

A)They appear similar to debt but are closer to equity.
B)They are generally issued after a reorganization.
C)The interest is tied to some level of the cash flow of the firm.
D)All of the above statements are true.

Question 49

Which of the following factors are considered when determining whether a security is debt or equity?
I.Permanence factor
II.Subordination factor
III.Objective factor
IV.Legal factor
V.Subjective factor

A)I and II
B)I, II, and III
C)I, II, and IV
D)I, II, IV, and V

Question 50

Which of the following is NOT an example of an indexed bond?

A)Commodity bond
B)Real return bond
C)Income bond
D)Callable bond

Question 51

A firm has $45,000,000 of preferred shares outstanding that have a yield of 10% on par and are callable at a 3% premium.New issues will cost $980,000 in issuing and underwriting expenses.
a)At what interest rate would the firm want to refinance?
b)If the dividend yield drops to 8 percent, how long will it take before the present value of the interest savings exceeds the cost of refinancing?

Question 52

Discuss how preferred shares have features of both debt and equity instruments.

Question 53

Why is there a difference between the way the market classifies debt and the way the CRA classifies it.

Question 54

Which of the following securities provides a firm with results similar to those of a real return bond?

A)Adjustable rate convertible subordinated securities
B)Liquid yield option notes
C)Income bond
D)Original issue discount bond

Question 55

Which of the following statements is correct?

A)Adjustable rate convertible subordinated securities make the interest payments conditional on prior dividend payments.
B)Income bonds pay out guaranteed and fixed coupons prior to common dividends.
C)Original issue discount bonds (OIDs)sell at a discount when issued by firms.
D)All of the above are correct.

Question 56

A 12% coupon convertible bond has 20 years to maturity.Market rates on similar non-convertible bonds are 9.25%.Each bond is convertible into 20 common.The shares are currently trading at $40.What is the straight bond value, assuming annual coupon payments?

A)$1,247
B)$1,000
C)$1,207
D)$1,287

Question 57

Describe convertible debt.Why do firms issue convertible debt?

Question 58

To be classified as a hard retraction Which of the following is required?

A)The preferred shares must be paid off with common shares or other preferred shares.
B)The preferred shares must be paid off with cash.
C)The preferred shares must be paid off within 30 days of retraction.
D)The preferred shares can only be retracted in cases of financial distress.

Question 59

What are the costs and benefits to the issuing firm of preferred share financing?

Question 60

From the perspective of the investor/lender, rank the risk of the following securities from lowest to highest.
I.Long-term unsecured debt
II.Convertible preferred shares
III.Common equity
IV.Bank loans

A)I, II, III, IV
B)IV, III, II, I
C)I, II, IV, III
D)IV, I, II, III

Question 61

Explain how a warrant is viewed as a call option on the firm.

Question 62

Explain how the value of convertible debt varies as a function of the common share price.

Question 63

Explain the differences and similarities between warrants and convertibles.

Question 64

Explain how equity can be viewed as a call option on the firm.

Question 65

Explain the difference between the conversion price and the conversion ratio.

Question 66

Toronto Skaters currently has $1,000,000 of 8% convertible debt outstanding.The coupon interest is paid on an annual basis.The $1,000 face value debentures mature in 12 years and have a conversion price of $50.Similar straight debt currently yields 7%.The firm's common stock is currently trading for $55 per share.What is the current straight debt value and the current conversion value of the convertibles? What is the floor price for the convertibles? If all the convertible holders decided to convert, how many additional shares would have to be issued?

Question 67

Hudson Bay Fishing Corporation has just issued a 10-year, 9% annual-pay bond with a $1,000 face value.In addition, the bond was issued with 50 detachable warrants.The bond was issued at par.Each warrant gives the owner the right to purchase 2 shares of the company's stock for $15 each.Bonds with equivalent risk but with no attached warrants currently yield 11%.What is the value of one warrant?