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

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CHAPTER 20: HYBRID FINANCING:PREFERRED

STOCK, WARRANTS, AND CONVERTIBLES

COMPREHENSIVE EXAM STUDY GUIDE LATEST

UPDATED 2024/

The Best Study Notes

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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

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

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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

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

AND CONVERTIBLES

COMPREHENSIVE EXAM STUDY GUIDE LATEST UPDATED 2024/

financing

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

TOPICS: Detachable warrant

KEYWORDS: Bloom’s: Knowledge

AND CONVERTIBLES

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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.

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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

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

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

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

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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

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

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

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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

Page 10

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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

AND CONVERTIBLES

COMPREHENSIVE EXAM STUDY GUIDE LATEST UPDATED 2024/

TOPICS: Convertibles

KEYWORDS: Bloom’s: Analysis

OTHER: TYPE: Multiple Choice: Conceptual

18. Which of the following statements concerning warrants is correct? a. Warrants are long-term put options that have value because holders can sell the firm's common stock at the exercise price regardless of how low the market price drops. b. Warrants are long-term call options that have value because holders can buy the firm's common stock at the exercise price regardless of how high the stock's price has risen. c. A firm's investors would generally prefer to see it issue bonds with warrants than straight bonds because the warrants dilute the value of new shareholders, and that value is transferred to existing shareholders. d. A drawback to using warrants is that if the firm is very successful, investors will be less likely to exercise the warrants, and this will deprive the firm of receiving any new capital. e. Bonds with warrants and convertible bonds both have option features that their holders can exercise if the underlying stock's price increases. However, if the option is exercised, the issuing company's debt declines if warrants were used but remains the same if it used convertibles.

ANSWER: b

POINTS: 1

DIFFICULTY: Difficulty: Moderate

LEARNING OBJECTIVES: INTE.GENE.16.129 - 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: Warrants and convertibles

KEYWORDS: Bloom’s: Analysis

OTHER: TYPE: Multiple Choice: Conceptual

19. Which of the following statements is most CORRECT? a. One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. b. The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt. c. The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant. d. Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual. 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

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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. b. $42. c. $44. d. $46.

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e. $48.

ANSWER: a

RATIONALE: Par value: $1,000.

Conversion ratio: 25.

Conversion price = Par value/Conversion ratio = $40.

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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

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share, and each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47. The firm's straight bonds yield 10%. Each warrant is expected to have a market value of $2.00 given that the stock sells for $42. What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par? a. 7.83% b. 8.24% c. 8.65% d. 9.08% e. 9.54%

ANSWER: b

RATIONALE: Stock price: $42.00Bond par value: $1,

Exercise price: $47.00Bond maturity: 20

No. of warrants:

Value of warrants:

75Straight-debt yield:

Total value = Straight-debt value + Warrant value = $1,000 = Bond value + $150 VB = $1, − $150 = $850 Now set N = 20, I/YR = 10, PV = −850, FV = 1000 and solve for PMT: $82. To get this payment on a $1,000 bond, the coupon rate must be: 8.24%

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

24. McGovern Enterprises is interested in issuing bonds with warrants attached. The bonds will have a 30-year maturity and annual interest payments. Each bond will come with 20 warrants that give the holder the right to purchase one share of stock per warrant. The investment bankers estimate that each warrant will have a value of $10.00. A similar straight- debt issue would require a 10% coupon. What coupon rate should be set on the bonds-with-warrants so that the package would sell for $1,000? a. 6.75% b. 7.11% c. 7.48% d. 7.88% e. 8.27%

ANSWER: d

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