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Exam 20: Hybrid Financing: Preferred Stock, Warrants, and Convertibles

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Question 21

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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.

F) A) and D)
G) A) and C)

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Question 22

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Neuman Corporation Convertible Bonds The following data apply to Neuman Corporation's convertible bonds: $\begin{array}{lcc}\text { Maturity: } & \text { 10Stock price: } & \$ 30.00 \\\text { Par value: } & \$ 1,000.00 \text { Conversion price: } & \$ 35.00 \\\text { Annual coupon: } & 5.00 \% \text { Straight-debt yield: } & 8.00 \%\end{array}$ -Refer to the data for the Neuman Corporation's convertible bonds.What is the bond's conversion value?

A) $698.15
B) $734.89
C) $773.57
D) $814.29
E) $857.14

F) A) and E)
G) A) and D)

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Question 23

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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.

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

Mikkleson Mining stock is selling for $40 per share and has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%.The company is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value.The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock.The required rate of return on an otherwise similar nonconvertible bond is 10.00%.What is the estimated floor price of the convertible at the end of Year 3?

The owner of a convertible bond owns, in effect, both a bond and a call option.

Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.

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

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

Neuman Corporation Convertible Bonds The following data apply to Neuman Corporation's convertible bonds: $\begin{array}{lcc}\text { Maturity: } & \text { 10Stock price: } & \$ 30.00 \\\text { Par value: } & \$ 1,000.00 \text { Conversion price: } & \$ 35.00 \\\text { Annual coupon: } & 5.00 \% \text { Straight-debt yield: } & 8.00 \%\end{array}$ -Refer to the data for the Neuman Corporation's convertible bonds.What is the bond's straight-debt value?