26) Which of the following is true of conversion feature of a bond?
A) It adds a degree of speculation to a bond issue, although the issue still maintains its value as a bond.
B) It decreases the marketability and liquidity of a bond since conversion feature is perceived by the
market as a pessimistic approach about the firm’s future.
C) It is analogous to the put option, since it gives the bondholders the option to sell the bonds at any time
till maturity.
D) It increases the cost of debt financing.
27) 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) a limited time period and a limited time period
D) an unlimited time period and an unlimited time period
28) At the time of issuance, the issuer of a convertible security normally establishes a conversion price
________.
A) below the current book value of the firm’s stock
B) equal to the current market price of the firm’s stock
C) above the current market price of the firm’s stock
D) above the current book value of the firm’s stock
29) A ________ permits a firm’s capital structure to be changed without increasing the total financing.
A) put option
B) call option
C) conversion feature
D) repurchase agreement
30) Convertible bonds normally have ________ to permit the issuer to retire or encourage conversion of
outstanding convertibles when appropriate.
A) a put feature
B) a call feature
C) a stock purchase warrant
D) a swap feature
31) Convertible securities can usually be sold with interest rates ________.
A) lower than those of other nonconvertible securities
B) equal to those of other nonconvertible securities
C) higher than those of other nonconvertible securities
D) that has no relation to those of other nonconvertible securities
32) A ________ allows a firm to force conversion.
A) warrant
B) option
C) call feature
D) striking price
33) A convertible security that cannot be forced into conversion using the call feature is ________.
A) a general obligation bond
B) a debenture
C) an overhanging issue
D) a noncallable common equity issue
34) 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.
A) warrant
B) option
C) call feature
D) striking price
35) The call price of a security ________ the security’s par value.
A) is less than
B) is equal to
C) is greater than
D) is less than or equal to
36) The purchaser of a convertible issue sacrifices a portion of his or her interest return ________.
A) to raise temporarily cheap funds
B) due to the reduced risk of default in the future
C) when the call feature is exercised
D) to become a common shareholder in the future
37) An advantage of a convertible security is that it provides deferred common stock financing. The
purpose of deferring the sale of common stock is to ________.
A) increase the leverage of the firm
B) dilute the ownership interest
C) minimize dilution in earnings per share
D) time the sale of common stock when the price per share is increasing
38) Convertible securities can be issued ________.
A) with an intention to raise cheap funds permanently
B) with higher rates of interest than nonconvertibles
C) to raise funds without affecting the capital structure
D) with far fewer restrictive covenants than nonconvertibles
39) When the price of a firm’s common stock ________ the conversion price, the market price of the
convertible security will ________ to a level close to its conversion value.
A) falls below; rise
B) rises above; fall
C) rises above; rise
D) equals; fall
40) Many holders of convertible bonds will not convert when the firm’s common stock price exceeds the
conversion price because ________.
A) the common stock price may go up further and the firm cannot have any other mechanism to stop the
bondholders from taking undue advantage of the conversion feature
B) they already have the market price benefit and may still receive fixed periodic interest payments
C) of the dilution of EPS
D) interest payments are tax deductible and it will affect their earnings
41) The call price of a security generally exceeds the security’s par value by an amount equal to ________.
A) one year’s stated interest
B) the straight bond value
C) the market value of one share of common stock
D) the market premium
42) The call privilege is generally not exercised until the conversion value of a security is ________ the call
price.
A) 5 to 10 percent below
B) equal to
C) 10 to 15 percent above
D) 50 percent above
43) When a call is made on a convertible security, the holder of the security will most likely ________.
A) not take any action
B) allow the call to be exercised and accept the call premium if the conversion value is 10% above the call
price
C) convert the security into common stock if the conversion value is 10% above the call price
D) sell the security in the secondary market
44) Which of the following is a motive for using convertible securities in a firm’s financing mix?
A) a form of long-term financing
B) opportunity bondholders to share in the firm’s future success
C) a method of raising permanent cheap funds for long time
D) an eventual shift in the capital structure to a more levered position
45) From a firm’s point-of-view, which of the following is true of issuance of convertible bonds?
A) It acts as a permanent source of cheap funds.
B) It results in a non-tax-deductible interest payments.
C) It is an immediate sale of common stock.
D) It decreases financial leverage upon conversion.
46) Find the solution to the following questions regarding convertible bonds.
(a) Calculate the conversion price for each of the following bonds.
A $1,000-par-value bond convertible into 25 shares of common stock.
A $1,000-par value bond convertible into 100 shares of common stock.
(b) Calculate the conversion ratio for each of the following bonds. A $1,000 par-value bond convertible
into common stock at $50 per share.
A $1,000 par-value bond convertible into common stock at $40 per share.
(c) Calculate the stock value for each of the following convertible bonds.
A $1,000 par-value bond convertible into common stock at $25 per share. The current market price of
the stock is $30 per share.
A $1,000 par-value bond convertible into 100 shares of common stock. The current market price of the
stock is $12 per share.
47) The conversion value of a bond is the minimum price at which a convertible bond would be traded.
48) The market premium may be defined as the amount by which the conversion value exceeds its
straight value.
49) The market value of a convertible security is likely to be greater than its straight value or conversion
value.
50) The market value of a convertible security is likely to be less than its straight value or conversion
value.
51) ________ is the price at which a bond would sell in the market without the conversion feature.
A) Conversion value
B) Straight bond value
C) Strike price value
D) Market premium
52) A straight bond value is the ________.
A) minimum price at which a convertible bond would be traded
B) optimum price at which a callable bond would be traded
C) maximum price at which a callable bond would be traded
D) average price at which a convertible bond would be traded
53) The straight bond value is ________.
A) the conversion premium 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 convertible bond
C) the market value minus the conversion value
D) the present value of the interest and principal payments discounted at a rate the firm would have to
pay on a nonconvertible bond
54) 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) $15.00
B) $16.67
C) $17.33
D) $20.00
55) 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) $880
B) $1,000
C) $1,125
D) $1,200
56) 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) 20
B) 25
C) 50
D) 100
57) 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 price per share is ________.
A) $20
B) $25
C) $50
D) $100
58) A firm has an outstanding bond with a $1,000 par value that is convertible at $40 per share of
common stock. The bond’s conversion ratio is ________.
A) 20
B) 25
C) 40
D) 50
59) 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) markets are efficient
B) buyers and sellers do not usually agree on the conversion value
C) purchasers expect future stock price movements to be positive
D) the straight bond value is close to the conversion value
60) 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) $1,328
B) $1,217
C) $972
D) $772
61) A firm currently has outstanding a 9 percent, $1,000 convertible bond. The bond is convertible into
100 shares of common stock at a conversion price of $10 per share and callable at $1,090. The current
market price of the firm’s stock is $12 per share. The bond holder will ________.
A) allow the call to be exercised realizing $90 over par value
B) convert the bond into stock realizing $200 over par value
C) convert the bond into stock realizing only par value
D) wait until the stock price goes up further
62) A firm currently has outstanding a 5 percent, $1,000 convertible bond. The bond is convertible into 25
shares of common stock and callable at $1,050. The current market price of the firm’s stock is $41 per
share. The bond holder will ________.
A) allow the call to be exercised
B) convert the bond into stock
C) sell the bond on the secondary market
D) do nothing and wait until the stock price goes up further
63) 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 $15. A straight bond could have been sold with a 10 percent stated interest rate. The
market value of the bond is ________.
A) $750
B) $772 at the minimum
C) $1,250 at the minimum
D) $1,000
64) 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
conversion value of the bond is ________.
A) $1,328
B) $1,250
C) $1,000
D) $771
65) 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 ________.
A) $1.43
B) $1.44
C) $1.45
D) $1.47
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) $6.67
B) $5.97
C) $5.85
D) $5.78
67) 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 $1.17.
C) The common stock with an EPS of $1.00.
D) The convertible bond with an EPS of $1.00.
68) Tangshan Mining Company has an outstanding issue of convertible bonds with a $1,000 par value.
The bonds have a 10 percent coupon rate, have a 10–year maturity, and are convertible into 100 shares of
common stock. The yield to maturity on bonds of similar risk is 10 percent. Based on this information, the
straight bond value of the bond is ________.
A) $1,000.00
B) $978.39
C) $1,087.36
D) $1,123.86
69) Tangshan Mining Company has an outstanding issue of convertible bonds with a $1,000 par value.
The bonds have a 10 percent coupon rate, have a 10–year maturity, and are convertible into 100 shares of
common stock. The yield to maturity on bonds of similar risk is 10 percent and the market price of the
firm’s common stock is currently $15.00. Based on this information, the conversion value of the bond is
________.
A) $1,000.00
B) $1,500.00
C) $750.00
D) $1250.00
70) Zheng Sen’s Pen Company has an outstanding issue of convertible bonds with a $1,000 par value.
These bonds are convertible into 50 shares of common stock. They have a 10 percent coupon and a 10–
year maturity. The interest rate on a straight bond of similar risk is 8 percent.
(a) Calculate the straight bond value of the bond.
(b) Calculate the conversion value of the bond when the market price of the stock is $30/share.
(c) What is the least you would expect the bond to sell for at a market price of common stock of
$18/share?
71) Julian’s Sports Equipment must decide whether to obtain $1,000,000 of financing by selling common
stock at its current price of $40 per share or selling convertible bonds. The firm currently has 250,000
shares of common stock outstanding. Convertible bonds can be sold for their $1,000 par value and would
be convertible at $45. The firm expects its earnings available to common stockholders to be $700,000 each
year over the next several years.
(a) Calculate the number of shares the firm would need to sell to raise the $1,000,000.
(b) Calculate the earnings per share resulting from the sale of common stock.
(c) Calculate the number of shares outstanding once all bonds have been converted.
(d) Calculate the earnings per share associated with the bond financing after conversion.
(e) Which of the financing alternatives would you recommend the company adopt? Why?
17.4 Stock purchase warrants
1) A stock purchase warrant gives the holder the right to purchase a certain number of shares of common
stock at a specified price over a certain period of time.
2) Contrary to convertibles, warrants provide for the injection of additional equity capital into a firm
immediately.