Hybrid Financing: Preferred Stock, Warrants, and Convertibles - Certified Exam Study Guide, Exams of Business Economics

Download Hybrid Financing: Preferred Stock, Warrants, and Convertibles - Certified Exam Study Guide and more Exams Business Economics in PDF only on Docsity!

CHAPTER 20—HYBRID

FINANCING:PREFERRED

STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY

GUIDE LATEST UPDATED

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

1. The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock. a. True b. False

ANSWER: False

POINTS: 1

DIFFICULTY: Difficulty: Easy

LEARNING OBJECTIVES: INTE.GENE.16.126 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Preferred stock

KEYWORDS: Bloom’s: Knowledge

2. Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible. a. True b. False

ANSWER: True

POINTS: 1

DIFFICULTY: Difficulty: Easy

LEARNING OBJECTIVES: INTE.GENE.16.126 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Cost of preferred stock

KEYWORDS: Bloom’s: Knowledge

3. A warrant is an option, and as such it cannot be used as a "sweetener."

a. True b. False

ANSWER: False

POINTS: 1

DIFFICULTY: Difficulty: Easy

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

4. A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock. a. True b. False

ANSWER: False

POINTS: 1

DIFFICULTY: Difficulty: Easy

LEARNING OBJECTIVES: INTE.GENE.16.127 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Warrants

KEYWORDS: Bloom’s: Knowledge

5. The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.

a. True b. False

ANSWER: True

POINTS: 1

DIFFICULTY: Difficulty: Easy

LEARNING OBJECTIVES: INTE.GENE.16.127 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Warrants

KEYWORDS: Bloom’s: Knowledge

6. A detachable warrant is a warrant that can be detached and traded separately from the bond with which it was issued. Most traded warrants are originally attached to bonds or preferred stocks.

a. True b. False

ANSWER: True

POINTS: 1

DIFFICULTY: Difficulty: Easy

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

LEARNING OBJECTIVES: INTE.GENE.16.127 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Detachable warrant

KEYWORDS: Bloom’s: Knowledge

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Convertibles

KEYWORDS: Bloom’s: Knowledge

10. Firms generally do not call their convertibles unless the conversion value is greater than the call price.

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

a. True b. False

ANSWER: True

POINTS: 1

DIFFICULTY: Difficulty: Easy

LEARNING OBJECTIVES: INTE.GENE.16.128 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Convertibles

KEYWORDS: Bloom’s: Knowledge

11. Many preferred stocks extend voting rights to preferred shareholders if the preferred dividend has been omitted for some specified period, for example, 4 quarters. a. True b. False

ANSWER: True

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.126 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Preferred stock

KEYWORDS: Bloom’s: Comprehension

12. Preferred stockholders have priority over common stockholders with respect to dividends, because dividends must be paid on preferred stock before they can be paid on common stock. However, preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy.

a. True b. False

ANSWER: False

POINTS: 1

DIFFICULTY: Difficulty: Moderate

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS:^ United^ States^ -^ OH^ -^ Default^ City^ -^ TBA

13. Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders. a. True b. False

ANSWER: True

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.126 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Preferred stock

KEYWORDS: Bloom’s: Comprehension

14. Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost. a. True b. False

ANSWER: True

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.126 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Preferred stock

KEYWORDS: Bloom’s: Comprehension

15. Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, which is desirable for liquidity portfolios, and they also benefit from the 70% tax exemption on preferred dividends received. a. True b. False

ANSWER: True

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.126 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Reflective Thinking

CHAPTER 20—HYBRID FINANCING: PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS:^ United^ States^ -^ OH^ -^ Default^ City^ -^ TBA

TOPICS: Floating-rate preferred stock

KEYWORDS: Bloom’s: Comprehension

16. Which of the following statements is most CORRECT? a. By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firm's common stock. b. From the issuer's point of view, preferred stock is less risky than bonds. c. Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally 25 years or less. d. Unlike bonds, preferred stock cannot have a convertible feature. e. Preferred stock generally has a higher component cost of capital to the firm than does common stock.

ANSWER: b

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.126 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Analytic

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Preferred stock

KEYWORDS: Bloom’s: Analysis

OTHER: TYPE: Multiple Choice: Conceptual

17. Which of the following statements about convertibles is most CORRECT? a. One advantage of convertibles over warrants is that the issuer receives additional cash money when convertibles are converted. b. Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt because convertibles are less risky than straight debt. c. At the time it is issued, a convertible's conversion (or exercise) price is generally set equal to or below the underlying stock's price. d. For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm's otherwise similar straight debt and the expected return on its common stock. e. The coupon interest rate on a firm's convertibles is generally set higher than the market yield on its otherwise similar straight debt.

ANSWER: d

RATIONALE: Response d is correct. From an investor's standpoint, convertibles are normally more risky than straight debt but less risky than common stock, hence the expected return on the convertible lies between that on the stock and that on the straight bond.

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.128 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Analytic

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

e. Warrants have an option feature but convertibles do not.

ANSWER: b

RATIONALE: Answer b is correct; convertibles do normally have a relatively low coupon because the opportunity for capital gains provides part of their expected total return. The other responses are all incorrect. Statement c is incorrect because like other options, the value of the warrant is increased by price volatility in the underlying asset.

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.129 - LO: 20-

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

NATIONAL STANDARDS: United States - BUSPROG: Analytic

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Warrants and convertibles

KEYWORDS: Bloom’s: Analysis

OTHER: TYPE: Multiple Choice: Conceptual

20. The common stock of Southern Airlines currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2025. What is the conversion value of the bond? a. $707. b. $744. c. $783. d. $825. e. $866.

ANSWER: d

RATIONALE: Stock price: $33.00Coupon rate: 8.00%

Bond price:

Conversion ratio:

$850.00Par value:

Conversion value = Conversion ratio × Stock price = $

POINTS: 1

DIFFICULTY: Difficulty: Easy

LEARNING OBJECTIVES: INTE.GENE.16.128 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Analytic

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Convertible features: straight-debt value

KEYWORDS: Bloom’s: Application

OTHER: TYPE: Multiple Choice: Problem

21. Convertible debentures for Kulik Corporation were issued at their $1,000 par value in 2012. At any time prior to maturity on February 1, 2032, a debenture holder can exchange a bond for 25 shares of common stock. What is the

conversion price, Pc?

a. $40.

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

POINTS: 1

DIFFICULTY: Difficulty: Easy

LEARNING OBJECTIVES: INTE.GENE.16.128 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Analytic

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Conversion price

KEYWORDS: Bloom’s: Application

OTHER: TYPE: Multiple Choice: Problem

22. Mariano Manufacturing can issue a 25-year, 8.1% annual payment bond at par. Its investment bankers also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.0%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?

a. 6.66% b. 6.99% c. 7.34% d. 7.71% e. 8.09%

ANSWER: a

RATIONALE: Maturity: 25Pfd. exclusion: 70%

Coupon rate:

Risk premium

8.10%Tax rate:

Bond yield AT = BT yield(1 − T) = 4.86% Preferred yield AT = AT bond yield + RP = 5.86% AT pfd yield = BT pfd yield − BT pfd yield(1 − Exclusion)(Tax rate) Preferred yield BT = 5.86%/[1 − (0.3)(0.4)] = 6.66%

Check: base case AT pfd yield = 6.66% − Tax

= 6.66% − 6.66%(1 − Exclusion)(Tax

rate)

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.126 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Analytic

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Preferred stock vs. bond yields

KEYWORDS: Bloom’s: Analysis

OTHER: TYPE: Multiple Choice: Problem

23. Preissle Company, wants to sell some 20-year, annual interest, $1,000 par value bonds. Its stock sells for $42 per

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

ANSWER: d

RATIONALE: Bond par value: $1,000No. of warrants: 20

Bond maturity:

Straight-debt yield:

30Value of warrants:

Total value = Straight-debt value (VB) + Warrant value = $1,000 VB = $1,000 − $200.00 = $800.00 Set N = 30, I/YR = 10, PV = −800, and FV = 1000. Then solve for PMT: $78.78 To get this payment on a $1,000 bond, the coupon rate must be: 7.88%

POINTS: 1

PREFERRED STOCK, WARRANTS, AND

CONVERTIBLES

CERTIFIED EXAM STUDY GUIDE LATEST

UPDATED 2024/

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.127 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Analytic

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Bonds with warrants

KEYWORDS: Bloom’s: Analysis

OTHER: TYPE: Multiple Choice: Problem

25. Potter & Lopez Inc. just sold a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?

a. $3. b. $3. c. $4. d. $4. e. $4.

ANSWER: a

RATIONALE: Bond par value: $1,000No. of warrants: 50

Bond maturity:

Straight-debt yield:

20Convertible coupon:

Find the straight-debt value: N = 20, I/YR = 15, PMT = −120, and FV = −1000. PV = $812. Total value = Straight-debt value + Warrant value. $1,000 = Straight-debt value + 50(Warrant value) Warrant value = ($1,000 − Straight-debt value)/50 = $3.

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.127 - LO: 20-

NATIONAL STANDARDS: United States - BUSPROG: Analytic

STATE STANDARDS: United States - AK - DISC: Investments and hybrid fin - DISC: Investments and hybrid financing

LOCAL STANDARDS: United States - OH - Default City - TBA

TOPICS: Bonds with warrants

KEYWORDS: Bloom’s: Analysis

OTHER: TYPE: Multiple Choice: Problem

26. Mikkleson Mining stock is selling for $40 per share and has an expected dividend in the coming year of $2.00, and has