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Chapter 19 - Convertibles, Warrants, and Derivatives
1. A convertible security is one that can be converted into common stock only at the option of
the issuer.
2. A $1,000 par value convertible bond has a conversion ratio of 50. The bond conversion
price is $20.
3. The face value of a convertible bond divided by the conversion price equals the number of
shares a bondholder will receive upon conversion.
Chapter 19 - Convertibles, Warrants, and Derivatives
4. The conversion price divided into the market value of a convertible bond provides the
conversion ratio.
5. The conversion premium represents the dollar difference between the conversion value and
the pure bond value.
6. The conversion premium is equal to the market price minus the conversion value.
Chapter 19 - Convertibles, Warrants, and Derivatives
7. Conversion premiums are found by subtracting the current stock price from the bond's
semiannual interest payment.
8. Conversion premiums are influenced heavily by expectations of future stock performance.
9. Generally, once a convertible bond trades at a certain premium to its intrinsic value, or at a
certain multiple of its conversion price, the bond must be converted into common stock.
Chapter 19 - Convertibles, Warrants, and Derivatives
10. A convertible bond has two separate sources of value, the bond investment value and the
bond conversion value.
11. A convertible bond has both a downside limit (the pure bond value) and an upside limit
(the conversion price).
12. The floor value of a bond can change if market interest rates for competitive bonds
change.
13. Convertible securities are attractive because of their downside protection characteristics as
well as upside potential.
Chapter 19 - Convertibles, Warrants, and Derivatives
14. For the most downside protection, an investor should search for convertibles trading
below par value near their floor value.
15. The downside protection of a convertible bond's floor value insulates the investor from
any possible loss.
16. Generally speaking, convertible bonds reverse the risk-return tradeoff that applies to most
investments.
17. The interest rate on convertible bonds is typically one-third higher than similar non-
convertible issues.
Chapter 19 - Convertibles, Warrants, and Derivatives
18. If you purchased a convertible bond when first issued, you would pay more for the shares
of stock you are entitled to than if you purchased the shares directly on the market at that
point in time.
19. The primary issuers of convertible bonds are smaller, less than top-grade companies.
20. In general the average size of convertible issues is small compared to normal bond issues.
21. On average, convertible bonds have conversion premiums of less than 10% at time of
issue.
Chapter 19 - Convertibles, Warrants, and Derivatives
22. A call provision is a commonly used device by a corporation to force conversion into
common stock.
23. Forced conversion refers to the corporation calling a convertible bond when the market
price of the stock is above the conversion price by more than a small percentage.
24. A forced conversion will alter the corporate balance sheet.
25. On average, convertible bonds have call premiums of less than 10% at time of issue.
Chapter 19 - Convertibles, Warrants, and Derivatives
26. Basic earnings per share includes all convertible bonds outstanding.
27. Basic earnings per share does not include the dilutive effects of all of a firm's convertible
bonds.
28. Diluted earnings per share must include all convertible securities.
29. In order to calculate basic earnings per share, the earnings after taxes have to be adjusted
for the elimination of the convertible bond interest expense.
Chapter 19 - Convertibles, Warrants, and Derivatives
30. Warrants never sell for more than their intrinsic value.
31. A warrant may carry a speculative premium above intrinsic value if it will not expire until
far into the future.
32. Because a warrant is dependent on the market movement of an underlying stock, it is
highly speculative in nature.
33. Warrants are often attached to debt securities to increase the debt issue's attractiveness to
investors.
Chapter 19 - Convertibles, Warrants, and Derivatives
34. The premium for a warrant would increase if its underlying common stock has a negative
market outlook.
35. A warrant's speculative premium equals the market price of the underlying common stock
minus the option price.
36. A warrant loses some of its financial leverage when the stock rises far above the exercise
price.
37. As a financing device for creating common stock, warrants are usually more desirable
than convertible bonds.
Chapter 19 - Convertibles, Warrants, and Derivatives
38. Warrants are considered only in the computation of diluted earnings per share.
39. Theoretically, stock options are granted to employees so that the employees will make
decisions that benefit shareholders.
40. Most corporations include call provisions in agreements relating to the issue of warrants.
41. Forced conversions of convertible bonds occur when unethical corporate executives call
corporate bonds prematurely.
Chapter 19 - Convertibles, Warrants, and Derivatives
42. Convertible bonds and convertible preferred stock are used on a regular basis by
corporations to diversify their capital structure.
43. The conversion value is equal to the conversion ratio times the conversion price.
44. When the market price of a common stock rises above the conversion price, the
convertible should always be converted immediately before it drops.
45. The conversion premium of a convertible is generally greater when the market price of the
stock is below the conversion price.
Chapter 19 - Convertibles, Warrants, and Derivatives
46. Convertible bonds offer minimal risk of loss to the investor due to their floor value.
47. Investors will generally choose the call price rather than the shares of stock during a
forced conversion.
48. A convertible security is almost always
Chapter 19 - Convertibles, Warrants, and Derivatives
49. A convertible bond is currently selling for $970. It is convertible into 15 shares of
common which presently sell for $50 per share. The conversion premium is
50. If the price of common stock associated with a convertible bond is less than the
conversion price
51. The conversion ratio is the
Chapter 19 - Convertibles, Warrants, and Derivatives
52. The conversion premium will be large
53. Which of the following is true?
54. Expectations of a significant increase in the price of a firm's common stock will result in
Chapter 19 - Convertibles, Warrants, and Derivatives
55. A convertible bond is currently selling for $1,125. It is convertible into 20 shares of
common which presently sell for $40 per share. The conversion premium is
56. A $1,000 par value bond with a conversion price of $50 has a conversion ratio of
57. The theoretical floor value for a convertible bond is its
Chapter 19 - Convertibles, Warrants, and Derivatives
58. The floor price of a convertible bond cannot fall below
59. The price of a convertible bond
60. The conversion premium is the greatest and the downside risk the smallest when
Chapter 19 - Convertibles, Warrants, and Derivatives
61. The "floor" or pure bond value of a convertible bond is found by
62. The interest rate on convertibles is generally ____________ the interest rate on similar
nonconvertible instruments.
63. A convertible bond is often utilized
Chapter 19 - Convertibles, Warrants, and Derivatives
64. A disadvantage to the investor of a convertible bond is that
65. Conversion price is usually set _______ the prevailing market price of the common stock
at the time the bond issue is sold.
66. Which of the following is not a characteristic of convertible bond issues?
