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Chapter 19 - Convertibles, Warrants, and Derivatives
67. If the stock price rises substantially above the conversion price, an advantage to the
corporation would be
68. One advantage to the corporation in selling a convertible bond is:
69. Which of the following characteristics are drawbacks of convertible bonds?
Chapter 19 - Convertibles, Warrants, and Derivatives
70. The principle device used by the corporation to force conversion
71. When a company has a convertible bond in its capital structure,
72. A step-up in the conversion price refers to
Chapter 19 - Convertibles, Warrants, and Derivatives
73. The computation of basic earnings per share will include consideration of
74. Mirrlees Corp. has 10,000 7% bonds convertible into 30 shares per $1000 bond. Mirrlees
has 1,000,000 outstanding shares. Mirrlees has a tax rate of 40%. The average Aa bond yield
at time of issue was 10%. Compute basic earnings per share if after-tax earnings are
$1,400,000.
Chapter 19 - Convertibles, Warrants, and Derivatives
75. Vickrey Technology has had net income of $1,500,000 in the current fiscal year. There are
1,000,000 shares of common stock outstanding along with convertible bonds, which have a
total face value of $8 million. The $8 million is represented by 5,000 different $1,000 bonds.
Each $1,000 bond pays 4 percent interest. The conversion ratio is 30. The firm is in a 30
percent tax bracket. What is Vickrey's diluted earnings per share?
Chapter 19 - Convertibles, Warrants, and Derivatives
76. Jacobs and Company has warrants outstanding, which are selling at a $2.50 premium
above intrinsic value. Each warrant allows its owner to purchase one share of common stock
at $26. If the common stock currently sells for $30, what is the warrant price?
77. Which of the following is true about warrants?
78. The Burma Hat Company's warrant is trading for $10.20. The warrant carries the option to
purchase two shares of common stock for $48. What is the speculative premium if the stock
price is $51.30?
Chapter 19 - Convertibles, Warrants, and Derivatives
79. Warrants are
80. The intrinsic value of a warrant to buy 4 shares of Merton stock at $53 per share is $20.
What is the current market price of Merton stock?
Chapter 19 - Convertibles, Warrants, and Derivatives
81. The Rocky Scholes Swimwear's warrant is trading for $10.00. The warrant carries the
option to purchase a half share of common stock for $50. What is the speculative premium if
the stock price is $65?
82. Sen Corporation warrants carry the right to buy 10 shares of Sen common stock at $11.00
per share. The common stock has a current market price of $11.75 per share. The intrinsic or
minimum value of one Sen warrant is
Chapter 19 - Convertibles, Warrants, and Derivatives
83. A warrant which does not expire until several years in the future which provides its owner
the opportunity to buy a stock. If the stock price rises, the warrant will probably sell for
84. A contract giving the owner the right to buy or sell an asset at a fixed price for a given
period of time is
85. A derivative is a financial instrument whose value is determined by
Chapter 19 - Convertibles, Warrants, and Derivatives
86. Options contracts contrast with futures because
87. The owner of a call has
88. The owner of a put has
Chapter 19 - Convertibles, Warrants, and Derivatives
89. Which contract is an option?
90. All of the following are advantages to the corporation of issuing convertibles except:
91. The following benefits occur to the corporation after forced conversion of a convertible
bond except
Chapter 19 - Convertibles, Warrants, and Derivatives
92. All of the following are motivation for firms to issue warrants except:
Chapter 19 - Convertibles, Warrants, and Derivatives
93. Match the following with the items below:
1. basic earnings
May be traded in to the company for a different form of
2. convertible
Sometimes used as a financial sweetener in a bond
The number of shares an investor will receive if he or
4. conversion
The value of a convertible bond if its present value was
computed at a discount rate equal to interest rates on
The right to buy an asset for a given time at a specified
6. forced
Equals the conversion ratio multiplied by the market
7. pure bond
8. step-up in
Equals earnings after taxes divided by shares
9. conversion
value
This feature, when written into the contract, allows the
conversion ratio to decline over time.
8
Occurs when a company calls a convertible security that
Chapter 19 - Convertibles, Warrants, and Derivatives
94. Match the following with the items below:
1. conversion
2. convertible
Equals the market price of a convertible bond minus the
3. financial
Adjusts earnings per share for potential share issuances
related to outstanding options, convertible securities and
May be exchanged with the company, usually for shares
5. diluted earnings
Equals the market value of the common stock minus the
option price of the warrant all multiplied by the number of
6. warrant
The market price of the warrant minus the warrant's
intrinsic value.
8
May be used as a means to offer lower interest rates on
8. speculative
The use of an equity option to facilitate sale of a debt
9. minimum
The right to sell an asset for a given time at a specified
Chapter 19 - Convertibles, Warrants, and Derivatives
95. Lucky Dog Pet Food has a $1000 convertible bond outstanding with a conversion price of
$12.00 per share. The bond pays an interest payment of $40 semiannually and matures in 20
years unless converted into common stock earlier or called by the company. The common
stock currently sells for $11.25 per share. If the bond sold at its theoretical bond value it
would be priced competitively to yield 10% with bonds of the same risk class.
a) How many shares of stock are received on conversion?
b) What is the conversion value?
c) What is the pure bond value?
d) How much downside protection has the pure bond value provided to investors? (answer in
dollars)
Chapter 19 - Convertibles, Warrants, and Derivatives
96. The Whipple Corporation currently has common stock selling for $40 per share on the
National Stock Exchange. Warrants are also available entitling the warrant holder the option
of purchasing 1 share of common stock for every 3 warrants held. The exercise price is $32
per share. The warrants are currently selling for $7 per warrant.
a) How much would you have to spend to buy one share of stock using the warrants? Does
this make sense?
b) What is the intrinsic value of the warrant?
c) What is the speculative premium on this warrant?
Chapter 19 - Convertibles, Warrants, and Derivatives
97. The XLarge Corporation has a convertible bond outstanding with a conversion price of
$35 per share. The $1000 par value bonds have a 6% annual coupon rate, paid semi-annually,
and 20 years to maturity. The firm's common stock is currently selling for $44 per share and
the convertible bonds are selling for $1,200.00.
a) Calculate the conversion ratio.
b) Calculate the conversion value.
c) If equivalent bonds are currently yielding 12% to maturity, what is the pure bond value of
this bond?
d) How much downside protection does the pure bond value provide to an investor? Would
this be an appropriate investment for a risk-averse investor?
Chapter 19 - Convertibles, Warrants, and Derivatives
19-36
98. Fred Jury is a portfolio manager who has $900,000 of a client's money to invest in highly
speculative instruments. Jury is contemplating the purchase of 40,000 shares of Shakee Corp.
common stock, which is currently selling on the American Stock Exchange at $30.00 per
share. Alternatively, he could buy warrants on Shakee Corp. common for $5.50. Each warrant
gives the holder the right to buy one share of Shakee Corp. common stock at $24.00 per share.
a) How many warrants could Mr. Jury buy with the $900,000?
b) If he had purchased the common stock directly, and its price had increased to $37.20 per
share, calculate his dollar and percentage return on the investment.
c) Assume that when the price of the stock goes to $37.20 per share, the warrant sells for its
intrinsic value. If Jury sells his warrants at this point, calculate his dollar and percentage
return on the investment.
Chapter 19 - Convertibles, Warrants, and Derivatives
