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3) The exercise price or option price of a warrant is normally set below the market price of the firm's stock
at the time of issuance.
4) Unlike convertible securities, warrants cannot be called, but their limited life stimulates holders to
exercise them when the exercise price is below the market price of the firm's stock.
5) In comparison to convertibles, the exercise of a warrant shifts the firm's capital structure to a less
highly levered position.
6) Both warrants and rights result in new capital equity. However, warrants are issued at an exercise
price below the prevailing market price of the stock, whereas rights are issued at a subscription price
above the prevailing market price.
7) One of the major reasons for attaching a stock purchase warrant is that investors do not require the
issuing firm to pay an interest rate as high as on a security that does not have an attached warrant.
8) One of the major reasons for not attaching a warrant is that investors require the issuing firm to pay a
higher interest rate if a warrant is attached than if it is not.
9) A detachable stock purchase warrant means that the bondholders may sell the warrant without selling
the security to which it is attached.
10) All stock purchase warrants are non-detachable, which means that the bondholders must keep the
warrants until they mature.
11) A stock purchase warrant permits a 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.
12) The market value of a warrant is generally below the theoretical value of the warrant.
13) A warrant premium depends largely on investor expectations and on the ability of investors to get
more leverage from the warrants than from the underlying stock.
14) 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) put option
B) convertible bond
C) stock purchase warrant
D) repurchase agreement
15) 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) stock purchase warrant
C) conversion feature
D) repurchase agreement
16) Majority of actively traded warrants are listed on the ________.
A) NASDAQ
B) American Stock Exchange
C) New York Stock Exchange
D) Singapore Stock Exchange
17) The exercise price or option price of a warrant is normally set ________.
A) below the book value of the firm's stock at the time of issuance
B) equal to the market price of the firm's stock at the time of issuance
C) above the market price of the firm's stock at the time of issuance
D) above the book value of the firm's stock at the time of issuance
18) Which of the following is a basic characteristic of warrants?
A) It improves the marketability of an issue.
B) It is non detachable.
C) It increases the required interest rate.
D) It has an exercise period shorter than one month.
19) When warrants are used as "sweeteners" by a new firm, the firm is essentially allowing creditors to
________.
A) vote along with common stockholders
B) share the possible future success of the firm
C) protect their interest
D) receive extra income
20) Which of the following is true of a stock right and a warrant?
A) They are similar to a put option.
B) They both result in new equity capital for a firm.
C) They are both issued with exercise or subscription prices below the prevailing market price of stock.
D) They both may be traded independently from the security to which they were attached.
21) When warrants are exercised, ________.
A) only the number of common shares outstanding increases
B) debt is increased
C) both debt and equity are reduced
D) there is no effect on the firm's capital structure
22) Which the following is true of stock purchase warrants?
A) When a firm makes a large issue of debt, the attachment of stock purchase warrants may deteriorate
the marketability of the issue.
B) Warrants are similar to conversion features on debt.
C) Suppliers of debt are more likely to require warrants on an issue of debt from an existing corporation
than from a new firm.
D) The attachment of warrants increases the required interest rate.
23) The effect of exercising a warrant on a firm's capital structure ________.
A) reduces leverage less than a converting a convertible security
B) increases leverage as much as a converting a convertible security
C) reduces leverage more than a converting a convertible security
D) is unrelated to a converting a convertible security
24) A warrant is attached to a $1,000 par, 10 percent, 10-year bond, paying annual interest and having 20
warrants attached for the purchase of a 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) $10.40
B) $20.40
C) $10.00
D) $20.00
25) A firm has outstanding warrants that are exercisable at $53 per share and entitle holders to purchase
two shares of common stock. The common stock is currently selling for $55 per share. The theoretical
value of the warrant is ________.
A) $1
B) $2
C) $3
D) $4
26) The market value of a warrant is ________ the theoretical value of the warrant.
A) below
B) equal to
C) above
D) less than or equal to
27) 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 to purchase
three shares of ABC's common stock for $8 per share. The warrant premium is ________.
A) $1
B) $2
C) $3
D) $4
28) As the price of the underlying stock falls below the exercise price of a warrant, the investor's ability to
earn larger potential return diminishes. Therefore, the warrant premium will ________.
A) increase
B) decrease
C) remain unchanged
D) double
29) A warrant is attached to a $1,000 par, 10 percent, 15-year bond, paying annual interest and having 10
warrants attached for the purchase of the firm's stock. The bonds were initially sold for $1,020. When
issued similar risk straight bonds were selling to yield a 12 percent rate of return. Calculate the implied
price of the warrant.
30) Mia's Pet Store has warrants that allow the purchase of two shares of its outstanding common stock at
$30 per share. The common stock price per share is $33 and the market value of the warrant is $8.
(a) Calculate the theoretical value of the warrant.
(b) Calculate the market premium for the warrant.
17.5 Options
1) Options are a special type of security that provides the holder with the right to purchase or sell
specified assets at a stated price on or before a set expiration date.
2) A strike price is a price at which the holder of a call option can buy a specified amount of stock at any
time prior to the option's expiration date.
3) An option buyer who expects a stock price to decline will purchase a put option.
4) A call option is an option to sell a specified number of shares of a stock on or before some future date at
a stated price.
5) Call options are purchased with the expectation that the market price of the underlying security will
rise while put options are purchased with the expectation that the market price of the underlying security
will fall.
6) Call options are sold with the expectation that the market price of the underlying security will fall
while put options are sold with the expectation that the market price of the underlying security will rise.
7) The dominant organized options exchange in which options are traded is the Chicago Board Options
Exchange (CBOE).
8) A firm can raise capital by issuing securities such as convertibles and warrants but options do not
typically raise new capital for firms.
9) A firm can raise capital by issuing securities such as convertibles, warrants, and calls and puts.
10) Which of the following statements about put and call options is true?
A) They are traded only over-the-counter.
B) They are a form of deferred equity financing by a firm.
C) They can be used to lock in a gain or prevent a loss on a stock holding.
D) They provide the seller with an opportunity to earn larger returns than simply buying or selling
common stock.
11) Options are the most popular type of ________.
A) derivative security
B) hybrid security
C) convertible security
D) fixed interest bearing security
12) For puts and calls, the exercise price is called ________.
A) the expected value
B) the market price of the stock
C) the strike price
D) the option price
13) A ________ option is an option to purchase a specified number of shares of a stock on or before some
future date at a specified price, whereas a ________ option is an option to sell a specified number 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) put; call; Puts
B) call; put; Puts
C) put; call; Calls
D) call; put; Calls
14) The dominant organized options exchange is the ________.
A) over-the-counter exchange
B) CBOE
C) NASDAQ
D) NYSE
15) 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 4 months. As an alternative, the investor
could spend $5,000 to purchase a 120-day call option granting the right to buy 500 shares at a striking
price of $30. At what stock price would the investor break even?
A) $35
B) $40
C) $42
D) $45
16) The option buyer who expects a stock price to decline will purchase ________.
A) a call
B) a warrant
C) a put
D) a convertible bond
17) 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 spend $5,000 to purchase a 120-day call option granting the right to buy 500 shares at a
striking price of $30. What profit would the investor realize if the stock price increased to $42 per share?
A) $0
B) $1,000
C) $4,000
D) $6,000
18) If an investor buys a 100-share call option for $250 with an exercise price of $60 and the underlying
price per share of the stock at expiration is $66, what is the amount of profit or loss, ignoring brokerage
fees?
A) There would be a profit of $350.
B) There would be a profit of $600.
C) There would be a profit of $250.
D) There would be a loss of $250.
19) If an investor buys a 100-share call option for $300 with an exercise price of $30 and the underlying
price per share of the stock at expiration is $32, what is the amount of profit or loss, ignoring brokerage
fees?
A) There would be a profit of $200.
B) There would be a profit of $100.
C) There would be a loss of $100.
D) There would be a loss of $300.
20) If an investor buys a 100-share put option for $400 with an exercise price of $40 and the underlying
price per share of the stock at expiration is $32, what is the amount of profit or loss, ignoring brokerage
fees?
A) There would be a profit of $800.
B) There would be a profit of $400.
C) There would be a loss of $400.
D) There would be a loss of $800.
21) If an investor buys a 100-share put option for $150 with an exercise price of $38 and the underlying
price per share of the stock at expiration is $39, what is the amount of profit or loss, ignoring brokerage
fees?
A) There would be a profit of $250.
B) There would be a profit of $150.
C) There would be a loss of $250.
D) There would be a loss of $150.
22) If an investor buys a 100-share call option for $325 with an exercise price of $15 and the underlying
price per share of the stock at expiration is $13, what is the amount of profit or loss, ignoring brokerage
fees?
A) There would be a profit of $525.
B) There would be a loss of $125.
C) There would be a loss of $325.
D) There would be a loss of $525.
23) Consider the following options data:
(a) Determine the amount of profit or loss associated with each option, ignoring brokerage fees.
(b) Differentiate a warrant from a right.
24) Nico Yong is considering the purchase of 100 shares of Cisco Systems stock at $22 per share. Because
the economy is picking up, Nico believes the demand for Cisco's routers will increase substantially
causing the price of Cisco's shares to increase to $30 per share. As an alternative, Nico is considering the
purchase of a call option for 100 shares of Cisco at with an exercise price of $25. This 180 day option will
cost Nico $200. Assume no brokerage costs or dividends.
(a) What will Nico's profit be on the stock transaction if he decides to buy the stock and its price does
increase to $30 per share and he sells?
(b) How much will Nico earn on the option transaction if he purchases the option and the underlying
stock price rises to $30?
(c) How much must the stock price rise for Nico to break even on the option transaction?
(d) Based on parts (a) and (b) above, what should Nico do? Explain.
