Name:
Class:
Date:
Multiple Choice
1. ____ are forms of options.
a.
Warrants
b.
Convertible securities
c.
Leases
d.
Warrants and convertible securities
d
2. A(n) ____ is a call option issued by a company on its securities, usually common stock.
a.
debenture
b.
warrant
c.
futures contract
d.
extendible note
b
3. A ____ is a fixed income security with a call option on common stock.
a.
convertible security
b.
warrant
c.
futures contract
d.
derivative security
a
4. Which of the following are factors affecting the value of a call option?
a.
Time remaining until expiration date
b.
Interest rates
c.
Expected stock price volatility
d.
All of these factors affect the value of a call option
d
5. The ____ is the price that the call option buyer pays the writer of the option if the buyer decides to exercise the option.
a.
option premium
b.
option discount
c.
conversion price
d.
exercise price
d
6. When a company issues convertible securities, its usual intention is future ____.
a.
issuance of common stock
b.
reduction of outstanding common stock
c.
issuance of nonconvertible debt and preferred stock
d.
issuance of preferred stock
a
Name:
Class:
Date:
7. A warrant has an exercise price of $15. The underlying common stock has a market price of $10. The formula value of
a warrant would be ____.
a.
$5
b.
$0
c.
–$5
d.
Cannot be determined from the information given
b
8. The conversion value (i.e., stock value) of a convertible bond is defined as the ____ multiplied by the ____.
a.
conversion ratio; conversion price
b.
conversion premium; exercise price
c.
conversion ratio; common stock market price
d.
conversion ratio; exercise price
c
9. The difference between the market value of a convertible bond and the higher of its conversion or straight-bond value is
the ____ premium.
a.
exercise
b.
investment
c.
conversion
d.
liquidation
c
10. The conversion premium of a convertible bond tends to be ____ when the conversion value is ____ the straight-bond
value.
a.
smallest; nearly equal to
b.
largest; less than
c.
largest; greater than
d.
largest; nearly equal to
d
11. All other things being equal, the ____ the exercise price, given the stock price, the ____ is the call option value.
a.
higher; higher
b.
higher; lower
c.
lower; lower
d.
lower; higher
b
12. The ____ the time remaining before an option expires, the ____ the option value.
a.
longer; lower
b.
shorter; higher
c.
longer; higher
d.
shorter; lower
c
Name:
Class:
Date:
13. The ____ the expected stock price volatility, the ____ the value of the call option.
a.
greater; higher
b.
lower; higher
c.
greater; lower
d.
lower; lower
a
14. The price at which convertible securities are exchangeable for common stock is the ____.
a.
conversion value
b.
par value
c.
put price
d.
conversion price
d
15. During the life of conversion options, the conversion ratio is most likely to ____.
a.
increase
b.
decrease
c.
stay the same
d.
fluctuate
c
16. All except which of the following are reasons why companies issue convertible securities?
a.
Cheaper total cost than nonconvertible securities
b.
Lower interest payments than nonconvertible securities
c.
Sell common stock at a price above current market price
d.
Deferred issuance of common stock
a
17. The market value of a convertible debt issue is usually above the ____.
a.
conversion ratio
b.
conversion value
c.
straight-bond value
d.
higher of either the conversion value or the straight-bond value
d
18. Conversion of a convertible security may be forced by the issuing company by ____.
a.
raising the interest rate
b.
calling the securities for redemption
c.
lowering the dividend on common stock
d.
None of these are correct
b
19. As a financing device, warrants have been used in connection with ____.
Name:
Class:
Date:
a.
bond swaps only
b.
equity offerings only
c.
debt restructurings and bond swaps only
d.
bond swaps, equity offerings, and debt restructurings
d
20. Which of the following is NOT a common feature of financing with warrants?
a.
An exercise price that is below the market price of common stock at the time the warrant is issued
b.
Typical life of a warrant is between 5 and 10 years
c.
Warrant is usually detachable from a debenture or preferred stock
d.
If a warrant is issued as part of a “unit,” it is usually detachable from a debenture or preferred stock
21. All of the following are reasons why firms issue warrants EXCEPT ____.
a.
to lower agency costs
b.
to increase leverage at time of issue
c.
to permit a company to sell common stock at a price above the price prevailing at the time of warrant issue
d.
to allow a firm to sell common stock in the future without incurring underwriting costs at the time of sale
b
22. Prior to a warrant’s expiration, its market price will be ____ the formula value.
a.
equal to
b.
less than
c.
greater than
d.
negative as compared to
23. Craig Supermarkets, Inc. has convertible debentures ($1,000 par value) that are callable at 108% of par value. The
conversion price of the debenture is $40 per share, and the Craig common stock currently is selling at $55 a share. The
company ____.
a.
could not get the convertible holders to convert if it called the debt
b.
has no intention of calling the convertibles
c.
could force conversion by calling the issue
d.
could realize a gain of $15 a share if it called the convertibles
24. A firm that issues warrants ____.
a.
can expect to receive additional funds if the formula value of the warrant is zero at the expiration date
b.
must pay the same per share dividend to the warrant holders as it pays to its stockholders
c.
cannot issue convertible securities while the warrants are outstanding
d.
can expect to receive additional funds if the formula value of the warrant is positive at the expiration date
d
25. Which of the following securities is not an example of an option?
Name:
Class:
Date:
a.
Warrant
b.
Convertible security
c.
Right
d.
Futures contract
d
26. A(n) ____ is a fixed-income security issued by a company with a call option on its common stock.
a.
warrant
b.
convertible debenture
c.
lease
d.
extendible note
b
27. A security whose payoffs (returns) depend on the value of another security is known as a(n) ____.
a.
interest rate swap
b.
master limited partnership
c.
contingent claim
d.
extendible note
c
28. ____ are examples of contingent claims.
a.
Convertible bonds and warrants
b.
Warrants and extendible notes
c.
Options and extendible notes
d.
Convertible bonds, options, and warrants
d
29. The preemptive right allows shareholders the ____.
a.
opportunity to maintain their original ownership percentage
b.
right to purchase shares in the secondary markets
c.
right to vote for members of the board of directors
d.
All of these are correct
a
30. In general, the market price of a “right” is ____ than the theoretical value and this difference in values ____ as the
right’s expiration date approaches.
a.
less; decreases
b.
less; increases
c.
greater; decreases
d.
greater; increases
c
31. ____ earnings per share are calculated based on the assumption that all dilutive securities are converted into common
shares.
Name:
Class:
Date:
a.
Primary
b.
Full primary
c.
Fully diluted
d.
First class
c
32. If the exercise price of an M-tel warrant is $48 and the stock splits 2 for 1, what will be the post-split exercise price of
the warrant? Assume the warrant was selling for $20 before the stock split.
a.
$24
b.
$20
c.
$10
d.
$48
a
33. Which of the following is not a similarity between convertible securities and warrants?
a.
Both tend to reduce agency costs.
b.
The purpose of both is the deferred issuance of common stock.
c.
Both give the company full control over when the common stock is issued.
d.
All of these are correct.
c
34. Bonds may have a ____, which gives the holder of the bond the right to sell it back to the issuer under certain
conditions.
a.
warrant
b.
put option
c.
rights offering
d.
call option
b
35. A type of financial derivative that would allow a firm to hedge against changes in interest rates over a 5-year period is
a(n) ____.
a.
interest rate futures contract
b.
commodity soup
c.
interest rate swap
d.
interest rate put option
c
36. The most basic type of interest rate swap is the ____.
a.
fixed for floating rate swap
b.
exchange-rated swap
c.
LIBOR for prime rate swap
d.
interest rate rights offering
a
Name:
Class:
Date:
37. The conversion price of CRX’s convertible ($1,000 par) subordinated debentures is $40, and the present market price
of CRX common stock is $48. Determine the present conversion value of the convertible issue.
a.
$1,000
b.
$1,200
c.
$833
d.
$1,680
b
38. Rizzo Company has debentures ($1,000 par) outstanding that are convertible into the company’s common stock at a
price of $25. The convertibles have a coupon interest rate of 8% and mature in 12 years. In addition, the convertible
debenture is callable at 110% of the par value. Straight debt of equivalent risk is yielding 12%. The company’s common
stock is selling at $22 per share. The company has a marginal tax rate of 40%. Determine the conversion value of the
issue.
a.
$1,000
b.
$880
c.
$1,136
d.
$1,120
b
39. Rizzo Company has debentures ($1,000 par) outstanding that are convertible into the company’s common stock at a
price of $25. The convertibles have a coupon interest rate of 8% and mature in 12 years. In addition, the convertible
debenture is callable at 110% of the par value. Straight debt of equivalent risk is yielding 12%. The company’s common
stock is selling at $22 per share. The company has a marginal tax rate of 40%. Determine the straight-bond value of the
issue.
a.
$1,000
b.
$496
c.
$880
d.
$753
d
40. The Marsh Company, whose present balance sheet is summarized below, is considering the issuance of $50 million of
8% subordinated debentures that are convertible into common stock at a price of $20.
Balance Sheet
(millions of dollars)
Current Assets
$150
Current Liabilities
$100
Fixed Assets, net
$350
Long-term Debt
$150
Total
$500
Common Equity
$250
Total
$500
Determine the amount of long-term debt (LTD) and common equity (CE) on the pro forma balance sheet, assuming
conversion of the entire issue. (Answers are in $ million.)
a.
LTD $150, CE $250
b.
LTD $150, CE $300
c.
LTD $200, CE $300
d.
LTD $200, CE $250
b
Name:
Class:
Date:
41. People Southwest Airlines (PSW) has warrants outstanding that have an exercise price of $10. Each warrant entitles
the holder to purchase one share of PSW common stock. Last week PSW common stock was selling for $12 per share,
and at the same time, the warrants traded at $5 each. Determine the formula value of PSW warrants.
a.
$0
b.
$2
c.
$5
d.
$11
b
42. People Southwest Airlines (PSW) has warrants outstanding that have an exercise price of $10. Each warrant entitles
the holder to purchase one share of PSW common stock. Last week PSW common stock was selling for $12 per share,
and at the same time, the warrants traded at $5 each. Determine the warrant’s premium over the formula value.
a.
$0
b.
$2
c.
$3
d.
$5
c
43. The capital structure of Springmaid Company is as follows:
Long-term debt
$ 400 million
Common stock, $1 par
50 million
Contributed capital in excess of par
250 million
Retained earnings
600 million
Total
$1,300 million
The company has decided to raise additional capital by selling $100 million of 8% debentures with warrants attached.
Each $1,000 debenture will have 40 warrants attached, and each warrant will entitle the holder to purchase one share of
common stock at $20. Assume that no other changes in the capital structure occur between now and the time the warrants
are exercised. Determine the common stock at par account balance after exercise of the warrants.
a.
$50 million
b.
$54 million
c.
$56 million
d.
$35 million
b
44. The capital structure of Springmaid Company is as follows:
Long-term debt
$ 400 million
Common stock, $1 par
50 million
Contributed capital in excess of par
250 million
Retained earnings
600 million
Total
$1,300 million
The company has decided to raise additional capital by selling $100 million of 8% debentures with warrants attached.
Each $1,000 debenture will have 40 warrants attached, and each warrant will entitle the holder to purchase one share of
common stock at $20. Assume that no other changes in the capital structure occur between now and the time the warrants
are exercised. Determine the contributed capital in excess of par account balance after exercise of the warrants.
Name:
Class:
Date:
a.
$250 million
b.
$330 million
c.
$254 million
d.
$326 million
d
45. The capital structure of Springmaid Company is as follows:
Long-term debt
$ 400 million
Common stock, $1 par
50 million
Contributed capital in excess of par
250 million
Retained earnings
600 million
Total
$1,300 million
The company has decided to raise additional capital by selling $100 million of 8% debentures with warrants attached.
Each $1,000 debenture will have 40 warrants attached, and each warrant will entitle the holder to purchase one share of
common stock at $20. Assume that no other changes in the capital structure occur between now and the time the warrants
are exercised. Determine how much total capital the company will raise as a result of the issuance of debentures with
warrants attached (after exercise of the warrants).
a.
$100 million
b.
$80 million
c.
$180 million
d.
$20 million
c
46. Sharp Innovations has warrants outstanding and each entitles the holder to purchase 1 share of common stock at an
exercise price of $14 a share. If the current market price of the warrant is $9 and the common stock price is $22, what is
the premium over the formula value for the warrants?
a.
$1
b.
$5
c.
$8
d.
$2
a
47. Graybar recently sold a convertible bond with a $1,000 par value for a flotation cost of 2% (each bond produced $980
for the firm). What is the conversion price if the conversion ratio is 22?
a.
$44.55
b.
$45.45
c.
$50.00
d.
$4.45
b
48. To raise capital funds, Twixt Inc. issued $2 million worth of debentures with warrants attached. The warrants had an
exercise price of $15, and each warrant entitled the holder to two shares of common stock. If the current market price per
share of Twixt is $20, what is the formula value of a Twixt warrant?
a.
$10
b.
$5
Name:
Class:
Date:
c.
$20
d.
$0
a
49. JDH Inc. presently has warrants outstanding that expire 5 years from today. Each warrant entitles the holder to
purchase 2 shares of the company’s common stock at an exercise price of $30 a share. The warrants currently are trading
at $4 each, and the JDH common stock currently is trading at $28 a share. Calculate the warrants’ formula value.
a.
–$4.00
b.
–$2.00
c.
$0.00
d.
$2.00
c
50. The Bates Company has debentures ($1,000 par value) outstanding that are convertible into the company’s common
stock at a price of $50. The convertibles have a coupon interest rate of 9% and mature 20 years from today. Straight debt
of equivalent risk is yielding 12% today. The company’s common stock today is selling at $60 a share. Calculate the
conversion value of the issue.
a.
$1,000
b.
$1,200
c.
$800
d.
$300
b
51. Mills Trucking Inc. has debentures ($1,000 par value) outstanding that are convertible into the company’s common
stock at a price of $25. The convertibles have a coupon interest rate of 8% and mature 20 years from today. Straight debt
of equivalent risk is yielding 10% today. The company’s common stock today is selling at $23 a share. Calculate the
straight-bond value of the issue.
a.
about $830
b.
about $1,000
c.
about $950
d.
about $1,500
a
52. The Ogden Company has warrants outstanding that entitle the holder to purchase 4 shares of the company’s common
stock at an exercise price of $20 per share. The market price of the warrants is $30, and the common stock price is $25.
Determine the premium over the formula value that the warrants are selling for.
a.
$20
b.
$25
c.
$10
d.
$30
c
53. The Coatesville Company has decided to sell additional common stock through a rights offering. The company has 12
million shares outstanding and plans to sell an additional 1.5 million shares through a rights offering. Each shareholder
will receive one right for each share currently held, and thus each right will entitle shareholders to purchase 0.125 shares.
The Coatesville common stock is currently selling at $50 per share, and the subscription price of the rights will be $45 per
Name:
Class:
Date:
share. Determine the theoretical value of the right for the rights on case.
a.
$0.556
b.
$0.455
c.
$0.50
d.
$0.625
a
54. The Coatesville Company has decided to sell additional common stock through a rights offering. The company has 12
million shares outstanding and plans to sell an additional 1.5 million shares through a rights offering. Each shareholder
will receive one right for each share currently held, and thus each right will entitle shareholders to purchase 0.125 shares.
The Coatesville common stock is currently selling at $50 per share, and the subscription price of the rights will be $45 per
share. Determine the theoretical value of the rights for the ex rights case.
a.
$0.455
b.
$0.50
c.
$0.625
d.
$0.556
d
55. What is the value of a CKS Food’s option prior to expiration if the exercise price is $20 and the current stock price is
$20?
a.
Greater than $0
b.
$0
c.
Less than $0
d.
Cannot be valued
a
56. A Sorsi bond has a par value of $1,000 but is currently selling for $920. If the bond has a conversion ratio of 23, what
is the conversion price? Current stock price is $30.
a.
$40.00
b.
$43.48
c.
$33.33
d.
$30.67
b
57. Lear Holdings plans to sell 60,000 units, each unit consisting of a $1,000 debenture and 15, 7-year warrants. Each
warrant allows the holder to purchase one common-share at $30. If the stock price goes to $38 and all warrants were
exercised, what is the total capital raised by Lear?
a.
$94.2 million
b.
$90.6 million
c.
$87 million
d.
$77 million
c
58. Jackson Electronics (40% marginal tax rate) is considering issuing convertible debentures. Its investment banker
tentatively has agreed to issue a 9.0%, 20-year convertible debenture ($1,000 par value). The conversion price will be $50
Name:
Class:
Date:
a share. Jackson’s financial managers only want to issue the convertible if its after-tax component cost of capital is less
than or equal to 8.0%. Otherwise, they plan to issue non-convertible debt. Jackson’s current common stock price is $43 a
share. The company expects to call the convertible issue 5 years from now when the common stock price is expected to be
$60 a share. Under the conditions given in this problem, what is the minimum price per debenture that Jackson can
receive and keep the after-tax cost of capital for the debentures at 8.0%?
a.
About $1,033
b.
About $946
c.
About $897
d.
$1,200
a
59. A debenture of the Allegro Company (par value $1,000) is convertible into the company’s common stock at a price of
$50 per share. The convertible bond has a coupon interest rate of 7% and matures in 10 years. Straight debt of equivalent
risk and maturity is yielding 8%. The company’s common stock is currently selling for $60 per share. Determine the
conversion value and straight-bond value of Allegro Company’s convertible bonds.
a.
$1,200; $1,000
b.
$1,000; $933
c.
$1,200; $933
d.
$1,000; $1,000
c
60. Mercury Inc. issued bonds with warrants attached that had an exercise price of $22. Each warrant allows the holder to
purchase two shares. Since the issuance, the stock split 2 for 1, the current stock price is $24 and the warrant price is $30.
How much is the warrant selling above its formula value?
a.
84.6%
b.
130.8%
c.
15.4%
d.
269%
c
61. Which of the following is (are) a feature of convertible securities?
I. Conversion price
II. Conversion stock
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
a
62. Firms issue warrants for which of the following reasons?
I. Allows the company to sell stock at a price above what other company stock is selling for.
II. Allows the company to choose which investors can buy the company’s stock.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
Name:
Class:
Date:
d
63. In a comparison of warrants and rights, it is found the two are ____.
a.
similar in that the company can discriminate as to who buys new company stock
b.
similar in that they allow the purchase of existing stock only
c.
different in that both allow the firm to receive additional funds at the time they are exercised
d.
different in that rights allow the holder of the right to vote in corporate elections based on the number of shares
the right can purchase
c
64. The value of the right can be calculated under which one of the following circumstances?
a.
Using the Gordon model
b.
Trading ex-rights
c.
Market order
d.
Based on a margin account
b
65. An option has a ____ claim.
a.
fixed
b.
contingent
c.
subordinated
d.
superior
66. The conversion ratio of a convertible security is the ____.
a.
number of shares that can be obtained
b.
value of the shares obtained
c.
price at which the security is exchangeable
d.
loss in the security’s value once it is exchanged
a
67. Conversion of a convertible security can occur in two ways. Which of the following is (are) correct?
I. It can be a voluntary conversion at specific times prior to the expiration date.
II. It can be a forced conversion at any time prior to the expiration date.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
d
68. Sam owns a $1,000 par value, convertible bond that can be converted now. The conversion ratio is 20, and each share
of stock is currently selling for $40 per share. What would be the conversion value of the bond, and should Sam convert
the bond or hold it to maturity?
a.
The conversion value is $2,000, and Sam should convert.
b.
The conversion value is $1,200, and Sam should convert.
Name:
Class:
Date:
c.
The conversion value is $975, and Sam should hold the bond to maturity.
d.
The conversion value is $800, and Sam should hold the bond to maturity.
a
69. Jana owns preferred stock from High Brow Cow Dairy Farms, makers of the finest dairy products. The stock has a par
value of $1,250 and a conversion ratio of 25. The stock is currently convertible. The firm’s common stock is selling for
$57 per share. If Jana converts the preferred stock, what would be the conversion value?
a.
$1,250
b.
$31,250
c.
$2,850
d.
$1,425
c
70. Conversion price is the ____.
a.
number of common stock shares owned after the conversion
b.
effective price of the common stock per share obtained by converting
c.
market price of the common stock per share
d.
difference between the market price of the common stock and the exercise price of the stock
b
71. Conversion premium is the amount by which the market value of a convertible security is higher than the ____.
I. conversion value of the security
II. combined interest or dividend payments of the security
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Neither statement I nor II is correct.
c
72. In general, when a convertible security is exchanged for common stock, the overall effect is which of the following?
I. Stock shares will decrease.
II. Earnings per share will decrease.
a.
Only statement I is correct.
b.
Only statement II is correct.
c.
Both statements I and II are correct.
d.
Nether statement I nor II is correct.
b
73. In calculating fully diluted earnings per share, earnings must be adjusted for ____.
a.
interest saved
b.
the number of convertible securities in the marketplace
c.
the number of executive bonus packages that could impact the firm’s earnings
d.
the company’s credit rating
a
Name:
Class:
Date:
Essay
74. What is an interest rate swap? Describe how it is used.
75. Why would a company issue convertible securities instead of straight bonds?
bonds.
76. List some securities that have option features.
77. What variables affect the call option valuation?
Name:
Class:
Date:
78. Explain how conversion of a convertible security affects earnings and how a firm handles this on its financial
statements.
79. What is the difference between a conversion price and a conversion ratio?
80. Which companies are the primary issuers of convertible securities and why do they do it?