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Chapter 16 Convertible Bonds and Convertible Preferred Stock
TRUE/FALSE
option into common stock.
other debt.
convertible bond falls.
the stock into which the bond may be converted.
shares, the exercise (conversion) price is $40 a share.
comparable non-convertible bonds.
sets a floor (i.e., the minimum price) for the bond.
value as stock.
convertible bond will be called increases.
convertible bond will be called declines.
convert the bond or lose the appreciation achieved by the
stock.
as debt increases.
debt tends to decline as the price of the stock rises.
stock tends to fall as the price of the stock rises.
tend to be less than the potential capital gains on the stock
into which the bond may be converted.
advantage to the stock, the less attractive is a convertible
bond.
investors than the firm's convertible bonds.
feature designed to force conversion.
treated as a tax-deductible expense to the firm.
convertible preferred stock will also tend to fall.
to the issuer (i.e., redeem the bond) at par prior to
maturity.
the option in a put bond.
tend to fluctuate more than a bond without the put option.
the firm at par is more speculative than buying a bond that
lacks this feature.
lack the put feature.
MULTIPLE CHOICE
a. an indenture
b. a call feature
c. a strong sinking fund
d. a maturity date
1. market price
2. value as stock
3. value as debt
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. 1, 2, and 3
1. current rate of interest
2. number of shares into which it is convertible
3. price of the stock
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. 1, 2, and 3
1. greater than its value as stock
2. less than its value as stock
3. greater than its value as debt
4. less than its value as debt
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
a. protect stockholders from early conversions
b. protect bondholders from conversions by stockholders
c. force stockholders to convert
d. force bondholders to convert
a. the value of convertible bonds and convertible
preferred stock declines
b. the value of convertible bonds falls but
convertible preferred stock rises
c. the value of convertible bonds rises but
convertible preferred stock falls
d. the value of convertible bonds and convertible
preferred stock rises
depend on
a. the bond's coupon
b. the conversion price of the bond
c. current interest rates
d. the term of the bond
1. interest rates rise
2. interest rates fall
3. the price of the stock rises
4. the price of the stock falls
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
a. the investor to convert the bond into stock
b. the firm to call the bond
c. the investor to sell the bond back to the company
d. the firm to pay a variable rate of interest
1. interest ceases to accrue
2. the bondholder receives the principal
3. the bondholder generally converts the bond
4. dividends are paid to the bondholder
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
equity because
a. the bonds require interest payments
b. the bonds are callable
c. dividends to bondholders reduce earnings
d. new shares are issued when the bonds are converted
1. pays a fixed dividend
2. pays a variable dividend
3. may be converted into the firm's bonds
4. may be converted into the firm's stock
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
1. the exercise (i.e., conversion) price
2. the number of shares into which the stock may
be converted
3. the price of the common stock
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
of the following strategies would be best?
a. sell the stock short
b. buy a convertible bond and short the stock
c. buy the stock
d. buy the firm's convertible securities
1. to exceed the firm's common stock dividends
2. to be less than the firm's common stock dividends
3. over time to offset the premium paid for the bond
4. to increase the premium paid for the bond
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
1. increases as the bond's coupon increases
2. decreases as the bond's coupon increases
3. increases as the stock's dividend increases
4. decreases as the stock's dividend increases
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
PROBLEMS
1. Given the information below, answer the following
questions.
A convertible bond has the following features:
Principal $1,000
Maturity date 20 years
Interest $80 (8% coupon)
Call price $1,050
Exercise price $65 a share
a. The bond may be converted into how many shares?
b. If comparable non-convertible debt offered an annual yield
of 12 percent, what would be the value of this bond as debt?
c. If the stock were selling for $52, what is the value of
the bond in terms of stock?
d. Would you expect the bond to sell for its value as debt
(i.e., the value determined in b) if the price of the stock
were $52?
e. If the price of the bond were $960, what are the premiums
paid over the bond's value as stock and its value as debt?
f. If the price of the stock were $35, what would be the
minimum price of the bond?
g. What is the probability that the bond will be called when
the price of the stock is $52?
h. If the price of the stock rose to $73, what would happen
to the price of the bond?
i. If the price of the stock were $73, what would the
investor receive if the bond were called?
j. What will the investor receive when the bond matures?
2. A $50 par value convertible preferred stock is convertible
into 5 shares (exercise price of $10). The preferred is
selling for $75, and the price of the common stock is $12.If
the price of the common stock rises to $20, what is the
minimum percentage price increase the holder of the preferred
stock should experience?
3. Corporation HBM has a convertible bond with the following
terms:
coupon 5%
principal $1,000
maturity 10 years
conversion price $50 (20 shares)
call price $1,000 + one year's interest
The bond's credit rating is BBB, and comparable BBB rated
bonds yield 9 percent.
The firm's stock is selling for $45 and pays a dividend of
$1.50 a share. The convertible bond is selling for $1,000.
a. What is the premium paid over the bond's value as stock?
b. Given the bond's income advantage, how long must the
investor hold the bond to overcome the premium over the
bond's value as stock?
c. If the price of the bond stock to $65, is there any reason
to expect the firm to call the bond?
d. If the convertible bond is held to maturity, what is the
annualized return on an investment in the bond?
e. If the price of the stock declines to $25 a share while
interest rates on BBB rated bonds rise to 12 percent, what
impact does the increase in interest rates have on this
convertible bond?
4. A firm has both a convertible bond and a convertible
preferred stock outstanding. The convertible bond has the
following features:
Coupon 6.5%
Maturity date 10 years
Exercise price $20
Principal $1,000
Call price $1,065.
The convertible preferred stock has the following features:
Annual dividend $2.25
Convertible into 2.5 shares of common stock
Callable at $25 a share.
Currently the common stock is selling for $13; the yield on
non-convertible bonds is 10%, and the yield on comparable
preferred stocks is 14%. What is the value of the above
securities in terms of the common stock? What would be the
value of each security if it lacked the conversion feature?
SOLUTIONS TO THE PROBLEMS
