Principles of Managerial Finance, 13e, Global Edition (Gitman) Chapter 17 Hybrid and Derivative Securities
17.1 Differentiate between hybrid and derivative securities securities and their roles roles in the corporation. 1) Derivatives are used by corporations as a useful tool for managing certain aspects of the firm's risk. Answer: !"# opic: o pic: Derivative $asics %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) An option is a security that is neither debt nor e*uity but derives its value from an underlying asset that is often another an other security. Answer: !"# opic: +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) -referred stock is considered a hybrid security because it blends the characteristics of both bond and e*uity. Answer: !"# opic: -referred -referre d &tock aluation aluation %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /) A hybrid security is neither debt nor e*uity but instead derives its value from an underlying asset. Answer: 0A opic: o pic: 2ybrid &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 3) A hybrid security is a form of debt or e*uity financing that possesses p ossesses characteristics of both debt and e*uity. e*u ity. Answer: !"# opic: o pic: 2ybrid &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 4) A derivative security is neither debt nor e*uity but instead derives its value from an underlying asset. Answer: !"# opic: o pic: Derivative &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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7) he lessee is the receiver of the services of the assets under a lease whereas a lessor is the owner of the assets that are being leased. Answer: !"# opic: o pic: essee versus versus essor %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) he lessor is the receiver of the services of the assets under a lease whereas a lessee is the owner of the assets that are being leased. Answer: 0A opic: o pic: essee versus versus essor %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 8) An operating lease is often also referred to as a capital lease. Answer: 0A opic: o pic: +perating eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 16) A financial lease is often also referred to as a capital lease. Answer: !"# opic: o pic: 0inancial eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 11) he following securities are all popular hybrid securities #9#- A) financial leases. $) convertible securities. ) options. D) stock purchase warrants. Answer: opic: o pic: 2ybrid &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) A form of debt or e*uity financing that possesses characteristics of both debt and e*uity financing is called A) hybrid security. security. $) convertible security. security. ) derivative security. security. D) none of the above. Answer: A opic: o pic: 2ybrid &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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1,) A form of debt or e*uity financing that possesses characteristics of both is called an) A) derivative security. security. $) hybrid security. security. ) option. D) operating lease. Answer: $ opic: o pic: 2ybrid &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1/) A security that is neither debt nor e*uity but derives its value from an underlying asset is called an) A) derivative security. security. $) hybrid security. security. ) option. D) operating lease. Answer: A opic: o pic: Derivative &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 17. !eview the types of leases; leasing leasing arrangements; the lease
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/) he lease arrangement has many more restrictive covenants than those normally included as part of a long
ed periodic payments for its use. Answer: 0A opic: o pic: everaged eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) easing allows the lessee; in effect; to depreciate land; which is prohibited if the land were purchased. Answer: !"# opic: o pic: easing $asics %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 8) At the end of the term of the lease agreement; the salvage value of an asset; if any; is reali?ed by the lessee. Answer: 0A opic: o pic: easing $asics %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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16) =n a financial lease; the lessor must receive more than the asset's purchase price in order to earn its re*uired return. 2owever; in an operating lease; the total payments made by the lessee to the lessor are generally less than the lessor's initial cost of the leased asset. Answer: !"# opic: o pic: 0inancial eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 11) @hen a firm becomes bankrupt or is reorgani?ed; the ma>imum claim of lessors against the corporation is three years of lease payments. Answer: !"# opic: o pic: easing $asics %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) A capitali?ed lease is a financial lease that has the present value of all its payments included as an asset and corresponding liability on the firm's balance sheet. Answer: !"# opic: o pic: apitali?ed eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1,) =f a lease meets any of the 0A&$ 0A&$ &tandard o. 1, criteria; it should be shown as a capitali?ed lease; meaning the present value of all its payments should be included as an asset and corresponding liability on the firm's balance sheet. Answer: !"# opic: o pic: apitali?ed eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1/) An operating lease need not be capitali?ed; but its basic features must be disclosed in a footnote to the financial statements. Answer: !"# opic: o pic: +perating eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 13) &ince operating leases result in the receipt of services from an asset without increasing the assets or liabilities on the firm's balance sheet; leasing may result in misleading financial ratios. Answer: !"# opic: o pic: +perating eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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14) Baintenance clauses are provisions normally included in an operating lease that re*uire the lessor to maintain the assets and to make insurance and ta> payments. Answer: !"# opic: o pic: ease Baintenance Baintenance lauses %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 17) !enewal options normally re*uire the lessor to maintain the assets and to make insurance and ta> payments. Answer: 0A opic: o pic: ease !enewal +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) !enewal options are provisions normally included in an operating lease that grant the lessee the right to repiration of the lease. Answer: !"# opic: o pic: ease !enewal +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 18) -urchase options are provisions fre*uently included in both operating and financial leases that allow the lessee to purchase the leased asset at maturity. maturity. Answer: !"# opic: o pic: ease -urchase -urchase +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 6) !enewal options are provisions fre*uently included in both operating and financial leases that allow the lessee to purchase the leased asset at maturity. maturity. Answer: 0A opic: o pic: ease !enewal +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) +ne advantage of leasing is that in many cases; the return to the lessor is *uite high so the firm in need of the asset might be better off borrowing to purchase it. Answer: 0A opic: o pic: Advantage of easing %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) +ne disadvantage of leasing is that in many cases; the return to the lessor is *uite high so the firm in need of the asset might be better off borrowing to purchase it. Answer: !"# opic: o pic: Disadvantage of easing %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 4 opyright 5 61 -earson #ducation
,) CCCCCCCC lease is a contractual arrangement whereby the lessee agrees to make periodic payments to the lessor for five or fewer years years for an asset's services. his type type of lease may also be canceled at the option of the lessee. A) A financial $) An operating ) A capital D) A direct Answer: $ opic: o pic: +perating eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /) Assets Assets leased under CCCCCCCC leases generally have a usable life longer than the term of the lease. A) financial $) operating ) capital D) direct Answer: $ opic: o pic: +perating eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 3) A capital or capitali?ed lease is otherwise known as A) an operating lease. $) a financial lease. ) a direct lease. D) a leveraged lease. Answer: $ opic: o pic: 0inancial eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 4) A CCCCCCCC is normally n ormally initiated by a firm that needs funds for operations. An asset previously owned by a lessee is sold to the lessor. lessor. A) direct lease $) leveraged lease ) sale
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7) =n a CCCCCCCC; the lessor acts as an e*uity participant supplying part of the necessary capital while a lender supplies the remaining balance. A) direct lease $) leveraged lease ) saleed e*uipment. A) 0inancial $) +perating ) &erial D) Direct Answer: A opic: o pic: 0inancial eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 8) he type of lease in which the lessor ac*uires or purchases the asset in order to lease to a given lessee is known as A) a financial lease. $) a direct lease. ) an operating lease. D) a leveraged lease. Answer: $ opic: o pic: Direct eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,6) he total payments of CCCCCCCC lease over the lease period are greater than the cost of the leased asset to the lessor. A) a financial $) an operating ) a serial D) a direct Answer: A opic: o pic: 0inancial eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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,1) he conse*uences of missing a financial lease payment p ayment are CCCCCCCC those of o f missing an interest or principal payment on debt. A) less severe than $) the same as ) more severe than D) unrelated to Answer: $ opic: o pic: 0inancial eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) Advantages of leasing from the lessee's perspective include all of the following #9#- A) capability of effectively depreciating land. $) ability to avoid restrictive covenants that are normally part of a longimum claim of the lessor in the event of bankruptcy is three years of lease payments. Answer: D opic: o pic: Disadvantage of easing %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,/) All of the following must be considered when making a lease cash flows for each year under the lease alternative. $) the after cash flows for each year under the purchase alternative. ) the present value of all cash flows. D) the depreciation e>pense under the lease. Answer: D opic: o pic: ease versus -urchase Decision %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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,3) 0A&$ &tandard o. 1, establishes re*uirements for the e>plicit disclosure of certain types of lease obligations on the firm's balance sheet. o *ualify as a capital lease; any of the following elements may be present #9#- A) the lease transfers ownership of the property to the lessee by the end of the lease. $) the lease contains an option to purchase the property at a bargain price. ) the lease term is less than 73 percent of the economic life of the property p roperty.. D) at the beginning of the lease; the present value of the lease payment is e*ual to 86 percent or more of the fair market value of the leased property less any investment ta> credit received by the lessor. Answer: opic: o pic: Accounting for eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,4) 0A&$ 0A&$ &tandard o. 1, re*uires e>plicit disclosure of CCCCCCCC obligation on the firm's balance sheet. 0or this type of lease; the present value for all of its payments is shown shown as an asset and the total lease payment obligation is included as a liability on the firm's balance sheet. A) an operating lease $) a leveraged lease ) a sale
,8) A lease under which a lessor owns or ac*uires the assets that are leased to a given lessee is called an) A) operating lease. $) financial lease. ) sale
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/) Dwyer orporation is determining whether to lease or purchase p urchase new e*uipment. he firm is in the ,E ta> bracket; and its after cost of debt is currently 7E. he terms of the lease and the purchase are: ease: Annual endercise it option to purchase the e*uipment for F4666 at the termination of the lease. -urchase: he e*uipment; costing F77;666; can be financed entirely with a 1E loan re*uiring annual endt three years. he other lease is a 13
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//) $essey Aviation Aviation is considering leasing or purchasing a small aircraft to transport e>ecutives between manufacturing facilities and the main administrative administrative head*uarters. he firm is in the /6 percent ta> bracket and its after cost of debt is 7 percent. he he estimated after cash flows for the lease and purchase alternatives are given below:
a) (iven the above cash outflows for each alternative; calculate the present value of the after< after< ta> cash flows using the after cost of debt for each alternative. b) @hich alternati alternative ve do you recommendH @hyH @hyH Answer: a)
b) he firm should should lease lease the aircraft. aircraft. opic: o pic: ease versus $uy $uy Analysis Analysis %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 17., Describe the types of convertible securities; securities; their general features; and financing with with convertibles. 1) he conversion ratio is the ratio at which a convertible security can be e>changed for a nonconvertible security. security. Answer: 0A opic: o pic: apitali?ed eases %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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) he conversion feature permits the firm's capital structure to be changed without increasing the total financing. Answer: !"# opic: o pic: apitali?ed 0eature %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) Diluted earnings per share #-&) are found by adJusting basic #-& for the impact of converting all convertibles and e>ercising all warrants and op tions that would have diluting effects on the firm's earnings. Answer: !"# opic: o pic: Diluted #-& %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /) onvertibles can normally be sold with lower interest rates than n onpensive than common stock; to finance proJects. Answer: !"# opic: o pic: onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 4) he presence of contingent securities such as warrants and stock options affects the reporting of the firm's earnings per share. Answer: !"# opic: o pic: ontingent &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 7) $ecause a security is first sold with a conversion price above the current market price of the firm's stock; conversion is initially not attractive. Answer: !"# opic: o pic: onversion -rice %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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) he conversion ratio can be obtained by dividing the par value of the convertible by the conversion price. Answer: !"# opic: o pic: onversion !atio %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 8) onvertibles can be used as a form of deferred common stock financing. Answer: !"# opic: o pic: onvertible &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 16) &ince the conversion feature provides the purchaser of a convertible bond with the possibility of becoming a stockholder; convertible bonds are generally a less e>pensive form of financing than similar
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1/) A conversion feature is an option that is included as part of a common stock issue that allows its holder to change the stock into a stated number of shares of preferred stock. Answer: 0A opic: o pic: onversion 0eature %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 13) +ne motive for issuing convertibles is that convertible securities can be issued with far fewer restrictive covenants than nonconvertibles. Answer: !"# opic: o pic: Botives for =ssuing onvertibles %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 14) ommon stock e*uivalents are all contingent securities that derive a maJor portion of their value from their conversion privileges or common stock characteristics. Answer: !"# opic: o pic: ommon &tock #*uivalents %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 17) An overhanging issue is a convertible security that cannot be forced into conversion by using the call feature. Answer: !"# opic: o pic: +verhanging onvertible onvertible =ssue %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) he conversion feature; which can be part of either a bond or preferred stock; permits the firm to raise additional funds at some point in the future by selling common stock; thereby shifting the company's capital structure to a less highly levered position. Answer: 0A opic: o pic: onversion 0eature %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 18) onverting a convertible security is beneficial when the market price of the common stock into which it can be converted c onverted is greater than its conversion price. Answer: !"# opic: o pic: onversion 0eature %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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6) @hen the market price of the common stock e>ceeds the conversion price; the conversion or stock) value e>ceeds the par value of the convertible security. Answer: !"# opic: onversion onver sion alue alue %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) ontingent securities such as convertibles; warrants; and stock options affect the reporting of a firm's earnings per share #-&). Answer: !"# opic: o pic: ontingent &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) ontingent securities such as common stocks and bonds affect the reporting of a firm's earnings per share #-&). Answer: 0A opic: o pic: ontingent &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) A security that is neither debt nor e*uity but derives its value from an underlying asset that is often another security is called A) hybrid security. security. $) convertible security. security. ) derivative security. security. D) none of the above. Answer: opic: o pic: Derivative &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /) A CCCCCCCC is an option included as part of a bond or preferred stock that permits the holder to convert the security into a specified number of shares of common stock. A) put option $) stock
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3) onvertible bonds normally have CCCCCCCC CCCC CCCC to permit the issuer to retire or encourage conversion. A) a put option $) a call feature ) a stock purchase warrant D) a striking price Answer: $ opic: o pic: onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 4) onvertible preferred stock is normally converted into A) secured bonds. $) debentures. ) shares of common stock. D) warrants. Answer: opic: o pic: onvertible -referred -referred &tocks %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 7) onvertible securities can usually be sold with interest rates CCCCCCCC other nonconvertible securities. A) lower than $) e*ual to ) higher than D) with no relation to Answer: A opic: o pic: onvertible &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) A CCCCCCCC allows the firm to force conversion. A) warrant $) option ) call feature D) striking price Answer: opic: o pic: all 0eatures %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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8) A convertible security that cannot be forced into conversion using the call feature is A) a general obligation bond. $) a debenture. ) an overhanging issue. D) a noncallable common e*uity issue. Answer: opic: o pic: +verhanging onvertible onvertible =ssue %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,6) Bany holders of convertible bonds will not convert when the firm's common stock price e>ceeds the conversion co nversion price. o protect itself against this behavior; the firm includes a CCCCCCCC on the convertible security. A) warrant $) option ) call feature D) striking price Answer: opic: o pic: all 0eatures %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,1) he call price of the security generally CCCCCCCC the security's par value. A) is less than $) is e*ual to ) is greater than D) has no relation to Answer: opic: all -rice %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) he purchaser of a convertible issue sacrifices a portion of his or her interest return A) to raise temporarily cheap funds. $) due to the reduced risk of default. ) when the call feature is e>ercised. D) for the potential opportunity to become a common shareholder in the future. Answer: D opic: o pic: onvertible &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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,,) An advantage of a convertible security is that it provides for deferred common stock financing. he purpose of deferring the sale of common c ommon stock is to A) increase the leverage of the firm. $) dilute the ownership interest. ) minimi?e dilution in earnings per share. D) time the sale of common stock when the price per share is basing. Answer: opic: o pic: Advantages of onvertibles %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,/) A convertible bond is almost always CCCCCCCC with a call feature. A) a mortgage bond $) an income bond ) an e*uipment trust certificate D) a debenture Answer: D opic: o pic: onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,3) At the time of issuance; the issuer of a convertible security normally establishes a conversion price CCCCCCCC the current market price of the firm's stock. A) below $) e*ual to ) above D) unrelated to Answer: opic: o pic: onversion -rice %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,4) A CCCCCCCC permits the firm's capital structure to be changed without increasing the total financing. A) put option $) stock
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,7) onvertible bonds have all of the following characteristics #9#- A) conversion increases the firm's debt ratio. $) less e>pensive form of financing than straight bonds. ) enhanced marketability. marketability. D) a call feature. Answer: A opic: o pic: onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) onvertible preferred stock and convertible bonds are normally convertible over CCCCCCCC; respectively. A) a limited time period and an unlimited un limited time period $) an unlimited time period and a limited time period ) a limited time period and a limited time period D) an unlimited time period and an unlimited time period Answer: $ opic: o pic: onvertible -referred -referred &tocks %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,8) @hen the price of the firm's common stock CCCCCCCC CC CCCCCC the conversion price; the market price of the convertible security will normally CCCCCCCC to a level close to its conversion value. A) falls belowG rise $) rises aboveG fall ) rises aboveG rise D) e*ualsG fall Answer: opic: o pic: onvertible &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /6) Bany holders of convertible bonds will not convert when the firm's common stock price e>ceeds the conversion price because A) the common stock price may go g o up further. $) they already have the market price benefit and may still receive fi>ed periodic interest payments. ) of the dilution of #-&. D) interest payments are ta> deductible. Answer: $ opic: o pic: onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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/1) he call price of the security generally e>ceeds e>ceed s the security's par value by an amount e*ual to A) one year's stated interest. $) the straight bond value. ) the market value of one share of common stock. D) the market premium. Answer: A opic: all -rice %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /) he call privilege is generally not e>ercised until the conversion value of the security is CCCCCCCC the call price. A) 3 to 16 percent below $) e*ual to ) 16 to 13 percent above D) 3 to ,6 percent above Answer: opic: o pic: onversion -rice %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /,) @hen a call is made on a convertible security; the holder of the security will most likely A) not take any action. $) allow the call to be e>ercised and accept the call premium. ) convert the security into common stock. D) sell the security in the secondary market. Answer: opic: o pic: onvertible &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills //) he key motives for using convertible securities in the firm's financing mi> include all of the following #9#- A) a form of deferred stock financing. $) a sweetener for financing. ) a method of raising temporarily cheap funds. D) an eventual shift in the capital structure to a more levered position. Answer: D opic: o pic: Advantages of onvertible &ecurities %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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/3) 0rom the firm's point
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) he market premium may be defined as the amount by which the conversion value e>ceeds its straight value. Answer: 0A opic: onversion onver sion alue alue %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) =n general; the market value of a convertible security is likely to be greater than its straight value or conversion value. Answer: !"# opic: aluing aluing onvertible onve rtible &ecurities &ecurit ies %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /) =n general; the market value of a convertible security is likely to be less than its straight value or conversion value. Answer: 0A opic: aluing aluing onvertible onve rtible &ecurities &ecurit ies %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 3) he CCCCCCCC value is the price the bond would sell for in the market without the conversion feature. A) conversion $) straight bond ) striking price D) market premium Answer: $ opic: o pic: &traight $ond al alue ue of a onvertible $ond %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 4) he straight bond value is the CCCCCCCC price at which a convertible bond would be traded. A) minimum $) optimum ) ma>imum D) average Answer: A opic: o pic: &traight $ond al alue ue of a onvertible $ond %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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7) he straight bond value is A) the conversion premium minus the conversion value. $) the stock value minus the present value of the interest payments. ) the market value minus the conversion conv ersion value. D) the present value of the interest and principal payments discounted at a rate the firm would have to pay on a nonconvertible bond. Answer: D opic: o pic: &traight $ond al alue ue of a onvertible $ond %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) A firm has outstanding convertible preferred stock with a F36 par value which is convertible into three shares of common stock. he conversion value is F/3. @hat is the current market price of a share of common stockH A) F13.66 $) F14.47 ) F17.,, D) F6.66 Answer: A opic: o pic: onversion al alue ue of onvertible -referred &tocks %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 8) A firm has an outstanding bond with a F1;666 par value that is convertible at F/6 per share of common stock. =f the current market value of common stock per share is F/3; the conversion value of the bond is A) F6. $) F1;666. ) F1;13. D) F1;66. Answer: opic: o pic: onversion al alue ue of onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 16) A firm has an outstanding bond with a F1;666 par value that is convertible into 36 shares of common stock. he bond's conversion ratio is A) 6. $) 3. ) 36. D) 166. Answer: opic: o pic: onversion !atio of onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills
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11) A firm has an outstanding bond with a F1;666 par value that is convertible into 36 shares of common stock. he bond's conversion price per share is A) F6. $) F3. ) F36. D) F166. Answer: A opic: o pic: onversion -rice of onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 1) A firm has an outstanding bond with a F1;666 par value that is convertible at F/6 per share of common stock. he bond's conversion ratio is A) 6. $) 3. ) /6. D) 36. Answer: $ opic: o pic: onversion !atio of onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 1,) he market value of a convertible co nvertible bond will e>ceed the conversion con version value or straight bond value; whichever is greater; by an amount called the market premium. his premium e>ists because A) markets are efficient. $) buyers and sellers do not usually agree on the conversion value. ) purchasers e>pect future stock price movements to be positive. D) the straight bond value is close to the conversion value. Answer: opic: o pic: Analy?ing onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1/) A firm has an outstanding 13
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13) A firm currently has outstanding a 8 percent; F1;666 F 1;666 convertible bond. he bond is convertible into 166 shares of common stock at a conversion price of F16 per share and callable at F1;686. he current market price of the firm's stock is F1 per share. he bond holder will most likely A) allow the call to be e>ercised e>e rcised reali?ing F86 over par value. $) convert the bond into stock reali?ing F66 over par value. ) convert the bond into stock reali?ing only par value. D) do nothing and wait until the stock price goes up further. Answer: $ opic: o pic: Analy?ing onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 14) A firm currently has outstanding a 3 percent; F1;666 F 1;666 convertible bond. he bond is convertible into 3 shares of common stock and callable at F1;636. he current market price of the firm's stock is F/1 per share. he bond holder will most likely A) allow the call to be e>ercised. $) convert the bond into stock. ) sell the bond on the secondary market. D) do nothing and wait until the stock price goes up further. Answer: A opic: o pic: Analy?ing onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 17) A firm has an outstanding 13
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1) A firm has an outstanding 13pected to be F366;666 in the coming year. Assuming the firm chooses the sale of common stock; the earnings per share in the coming year will be CCCCCCCC. A) F1./, $) F1.// ) F1./3 D) F1./7 Answer: A opic: o pic: Analy?ing onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 6) A firm needs F3 million of new longpected to be F/;666;666 in the coming year. Assuming Assuming the firm chooses the convertible bond; the earnings per share after all bonds are converted will be CCCCCCCC. A) F4.47 $) F3.8 ) F3.81 D) F3. Answer: $ opic: o pic: Analy?ing onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills
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1) A firm needs F1.3 million of new longpected to be F766;666 in the coming year. @hich plan results results in less dilution of the earnings per shareH A) he common stock with an #-& of F1.17. $) he convertible bond with an #-& of F1.6/. ) he common stock with an #-& of F1.66. D) he convertible bond with an #-& of F1.66. Answer: $ opic: o pic: =ssuing ommon &tock versus onvertible onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills ) angshan angshan Bining ompany has an outstanding issue of convertible bonds with a F1;666 par value. he bonds have a 16 percent coupon rate; have a 16
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/) Mheng &en's -en ompany has an outstanding issue of convertible bonds with a F1;666 par value. hese bonds are convertible into 36 shares of common stock. hey have a 16 percent coupon and a 16pect the bond to sell for for at a market price price of common stock of F1KshareH Answer: a) $ I F166K F166K.6 .6)>N )>N1<1 1<1K1 K1.6) .6)16O P F1;6661.6)<16 I F1;1,/ b) 36 L F,6Ksh F,6Kshare are I F1;36 F1;366 6 c) F1;1,/; the straight value of the bond is the minimum value of the bond regardless of the price of the common stock. opic: o pic: Analy?ing onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 3) Qulian's &ports #*uipment must decide whether to obtain F1;666;666 of financing by selling common stock at its current price of F/6 per share or selling convertible bonds. he firm currently has 36;666 shares of common stock outstanding. onvertible bonds can be sold for their F1;666 par value and would be convertible at F/3. he firm e>pects its earnings available to common stockholders to be F766;666 each year over the ne>t several years. a) alculate the number of shares the firm would need to sell to raise the F1;666;666. b) alculate the earnings per share resulting resulting from the the sale of common stock. c) alculate the number number of shares outstanding once all bonds have been converted. d) alculate the earnings per share associated associated with the bond financing after conversion. conversion. e) @hich of the financing alternatives would would you recommend the company adoptH @hyH @hyH Answer: a) 1;666;666K/6 1;666;666K/6 I 3;666 3;666 shares b) 766;666K36;66 766;666K36;666 6 P 3;666) I F.33 F.33 #-& c) 1;666;666K1;66 1;666;666K1;666 6 I 1;666 bonds 1;666K/3 I . shares 1;666 bonds >. shares I ; shares 36;666 P ; I 7; shares outstanding d) 766;666K36;66 766;666K36;666 6 P ;) I F.37 F.37 #-& e) &ince the convertible bond issue results in less dilution dilution and higher #-& although the #-& are very close); it is therefore recommended. he risk of an overhanging issue should be considered since the marginal increase in #-& is slight. opic: o pic: Analy?ing onvertible $onds %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills
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17.3 #>plain the key characteristics characteristics of stock stock purchase warrants; the implied price of an attached warrant; and the values of warrants. 1) A stockercise price or option price of a warrant is normally set below the market price of the firm's stock at the time of issuance. Answer: 0A opic: 0eatures 0eature s of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) he stockercise them when the e>ercise e> ercise price is below the market price of the firm's stock. Answer: !"# opic: 0eatures 0eature s of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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7) =n comparison to convertibles; the e>ercise of a warrant shifts the firm's capital structure to a less highly levered position. Answer: !"# opic: 0eatures 0eature s of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) $oth warrants and rights result in new capital e*uity. 2owever; 2owever; warrants are issued at an e>ercise price below the prevailing market price of the stockG rights are generally issued at a subscription price above the prevailing market price. Answer: 0A opic: @arrants @arrants versus !ights %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 8) he warrant premium depends largely on investor e>pectations and the ability of investors to get more leverage from the warrants than from the underlying stock. Answer: !"# opic: 0eatures 0eature s of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 16) +ne of the maJor reasons for attaching a stock purchase warrant is that investors do not re*uire the issuing firm to pay an interest rate as high as on a security that does not have an attached warrant. Answer: !"# opic: &tock -urchase @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 11) +ne of the maJor reasons for not attaching a warrant is that investors re*uire the issuing firm to pay a higher interest rate if a warrant is attached than if it is not. Answer: 0A opic: &tock -urchase @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) Bost stock purchase warrants are detachable; which means that the bondholders may sell the warrant without selling the security to which it is attached. Answer: !"# opic: &tock -urchase @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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1,) Bost stock purchase warrants are nonchange. $) American &tock #>change. ) ew Rork Rork &tock #>change. D) A&DA%. Answer: $ opic: rading @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 14) he e>ercise price or option price of a warrant is normally set CCCCCCCC the market price of the firm's stock at the time of issuance. A) below $) e*ual to ) above D) with respect to Answer: opic: haracteristics harac teristics of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 17) he basic characteristics of warrants include all of the following #9#- it A) acts as a sweetener in financing. $) is detachable. ) lowers the re*uired interest rate. D) has an e>ercise period shorter than one month. Answer: D opic: haracteristics harac teristics of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,, opyright 5 61 -earson #ducation
1) @hen warrants are used as sweeteners by a new firm; the firm is essentially allowing creditors to A) vote along with common stockholders. $) share in the possible future success of the firm. ) protect their interest. D) receive e>tra income. Answer: $ opic: he "se of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 18) A CCCCCCCC permits the firm to raise additional funds at some point in the future by selling common stock and thereby shifting the firm's capital structure to a less highly levered position. A) put option $) stockercise or subscription prices below the prevailing market price of stock. D) they both may be traded independently from the security to which they were attached. Answer: opic: !ights versus @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) he effect of e>ercising a warrant on the firm's capital structure reduces leverage CCCCCCCC converting a convertible conve rtible security. security. A) less than $) as much as ) more than D) without relationship to Answer: A opic: haracteristics harac teristics of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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) A firm has outstanding warrants that are e>ercisable at F3, per p er share and entitle holders to purchase two shares of common stock. he common stock is currently selling selling for F33 per share. he theoretical value of the warrant is A) F1. $) F. ) F,. D) F/. Answer: D opic: aluing aluing @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills ,) he market value of a warrant is generally gen erally CCCCCCCC the theoretical value of the warrant. A) below $) e*ual to ) above D) not related to Answer: opic: aluing aluing @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /) An investor has F1;666 that she is interested in investing in A$ stock; which is currently selling for F16 per share. A$'s warrants are selling for F7 per warrant. #ach warrant entitles the holder to purchase three shares of A$'s common stock for F per share. he warrant premium is A) F1. $) F. ) F,. D) F/. Answer: A opic: aluing aluing @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 3) @hen warrants are e>ercised; A) only the number of common shares outstanding increases. $) debt is reduced. ) debt is reduced while common e*uity e *uity increases. D) there is no effect on the firm's capital structure. Answer: A opic: haracteristics harac teristics of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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4) As the price of the underlying stock rises above the e>ercise price of a warrant; the investor's ability to earn larger potential return diminishes. herefore; the warrant premium will A) increase. $) decrease. ) remain unchanged. D) double. Answer: $ opic: aluing aluing @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 7) All of the following are true of stockisting corporation than from a new firm. D) the attachment of warrants may lower the re*uired interest rate. Answer: opic: haracteristics harac teristics of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) A warrant is attached to a F1;666 par; 16 percent; 16
,6) Bia's -et &tore has warrants that allow the purchase of two shares of its outstanding common stock at F,6 per share. he common stock price per share is F,, and the market value of the warrant is F. a) alculate alculate the theoretica theoreticall value of the warrant. warrant. b) alculate alculate the market premium premium for the warrant. warrant. Answer: a) ,, < ,6) ,6) L I F4 F4 b) b) < 4 I F F opic: Analy?ing @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills 17.4 Define options and discuss calls and puts; options markets; options trading; trading; the role of call and put options in fund raising; and hedging foreignposures with options. 1) he striking price is the price at which the holder of a call option can buy a specified amount of stock at any time prior to the option's e>piration date. Answer: !"# opic: 0eatures 0eature s of @arrants @arrants %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) he option buyer who e>pects a stock price to decline will purchase a put option. Answer: !"# opic: o pic: +ption $asics %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ,) +ptions are a special type of security that provides the holder with the right to purchase or sell specified assets at a stated price on or before a set e>piration date. Answer: !"# opic: o pic: +ption $asics %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills /) A call option is an option to sell a specified number of shares of a stock on or before some future date at a stated price. Answer: 0A opic: o pic: all +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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3) all options are purchased with the e>pectation e>p ectation that the market price of the underlying u nderlying security will rise while put options are purchased with the e>pectation that the market price of the underlying security will fall. Answer: !"# opic: o pic: all versus -ut +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 4) all options are purchased with the e>pectation e>p ectation that the market price of the underlying u nderlying security will fall while put options are purchased with the e>p ectation that the market price of the underlying security will rise. Answer: 0A opic: o pic: all versus -ut +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 7) he dominant organi?ed options e>change in which options are traded is the hicago $oard +ptions #>change $+#). Answer: !"# opic: o pic: +ptions Barkets %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills ) A firm can raise capital by issuing securities such as convertibles and warrants but a firm has nothing to do with the creation of options to raise capital. Answer: !"# opic: o pic: +ption $asics %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 8) A firm can raise capital by issuing securities such as convertibles; warrants; calls and puts. Answer: 0A opic: o pic: +ption $asics %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 16) he dominant organi?ed options e>change is the A) overchange. $) hicago $oard +ptions #>change. ) American &tock #>change. D) ew Rork Rork &tock #>change. Answer: $ opic: o pic: +ptions Barkets %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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11) he option buyer who e>pects a stock price to decline will purchase A) a call. $) a warrant. ) a put. D) a convertible bond. Answer: opic: o pic: -ut +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) 0or puts and calls; the e>ercise price is called A) the e>pected value. $) the market price. ) the striking price. D) the option price. Answer: opic: o pic: haracteristics of +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1,) =n the financial statement of the firm; puts and calls A) determine cash management policy. $) influence the capital structure decision. ) affect bond *uality. D) have no influence. Answer: D opic: o pic: haracteristics of +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1/) A CCCCCCCC option is an option to purchase a specified number of shares of a stock on or before some future date at a specified price; whereas a CCCCCCCC option is an option to sell a specified number of shares of a stock on or before some future date at a specified price. CCCCCCCC are purchased if the stock price is e>pected to fall. A) putG callG -uts $) callG putG -uts ) putG callG alls D) callG putG alls Answer: $ opic: o pic: haracteristics of +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills
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13) he available options of the firm with an overhanging issue to finance the call include all of the following #9#- A) selling additional debt resulting in a higher debt ratio. $) using current retained earnings. ) selling additional common e*uity resulting in less dilution of #-&. D) selling additional preferred stock resulting in higher financial leverage. Answer: opic: o pic: haracteristics of +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 14) All of the following are true of calls and puts #9#- A) options are issued by businesses. $) the presence of options trading in the firm's stock could; by increasing trading activity; stabili?e the firm's share price in the marketplace. ) options are not a source of funding to the corporation. D) the financial manager of a corporation has very little need to deal with options. Answer: A opic: o pic: haracteristics of +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 17) @hich of the following statements about put and call options is falseH A) hey are traded on organi?ed e>changes. $) hey are a form of deferred e*uity financing by the firm. ) hey can be used to lock in a gain or prevent a loss on a stock holding. D) hey provide the buyer with an opportunity to earn larger returns than simply buying or selling common stock. Answer: $ opic: o pic: haracteristics of +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: !eflective thinking thinking skills skills 1) An investor is considering buying 366 36 6 shares of A$ ompany at F, per share. Analysts agree that the firm's stock price may increase to F/3 per share in the ne>t ne >t / months. As an alternative; the investor could purchase a 16
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18) An investor is considering buying 366 36 6 shares of A$ ompany at F, per share. Analysts agree that the firm's stock price may increase to F/3 per share in the ne>t ne >t four months. As an alternative; the investor could purchase a 16ercise e> ercise price of F46 and the underlying price per share of the stock at e>piration is F44; what is the amount of profit or loss; ignoring brokerage feesH A) here would be a profit of F,36. $) here would be a profit of F466. ) here would be a loss of F,36. D) here would be a loss of F36. Answer: A opic: aluing aluing +ptions %uestion &tatus: ew AA&$ (uidelines: (uidelines: Analytic skills 1) =f an investor buys a 166ercise e> ercise price of F,6 and the underlying price per share of the stock at e>piration is F,; what is the amount of profit or loss; ignoring brokerage feesH A) here would be a profit of F66. $) here would be a profit of F166. ) here would be a loss of F166. D) here would be a loss of F,66. Answer: opic: aluing aluing +ptions %uestion &tatus: ew AA&$ (uidelines: (uidelines: Analytic skills ) =f an investor buys a 166ercise price of F/6 and the underlying price per share of the stock at e>piration is F,; what is the amount of profit or loss; ignoring brokerage feesH A) here would be a profit of F66. $) here would be a profit of F/66. ) here would be a loss of F/66. D) here would be a loss of F66. Answer: $ opic: aluing aluing +ptions %uestion &tatus: ew AA&$ (uidelines: (uidelines: Analytic skills /1 opyright 5 61 -earson #ducation
,) =f an investor buys a 166ercise price of F, and the underlying price per share of the stock at e>piration is F,8; what is the amount of profit or loss; ignoring brokerage feesH A) here would be a profit of F36. $) here would be a profit of F136. ) here would be a loss of F36. D) here would be a loss of F136. Answer: D opic: aluing aluing +ptions %uestion &tatus: ew AA&$ (uidelines: (uidelines: Analytic skills /) =f an investor buys a 166ercise e> ercise price of F13 and the underlying price per share of the stock at e>piration is F1,; what is the amount of profit or loss; ignoring brokerage feesH A) here would be a profit of F33. $) here would be a loss of F13. ) here would be a loss of F,3. D) here would be a loss of F33. Answer: opic: aluing aluing +ptions %uestion &tatus: ew AA&$ (uidelines: (uidelines: Analytic skills
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3) onsider the following options data:
a) Determine the amount of profit or loss associated associated with each option; ignoring brokerage fees. fees. b) Different Differentiate iate a warrant from from a right. Answer: a) all ,6 < 3) L 166 shares < 66 I F,66 profit. @arrant @arrant /4 < /6) L , shares I F1 @. F1 < F4 I F1Kwarrant profit -ut 36K166 I F.36 36 < .36 I /7.3 < /3 I .36 166) I F36 -rofit is F36. b) &tock purchase warrants give their holders the option to purchase a certain number of shares of common stock at a specified price. @arrants @arrants are *uite similar to stock rights in that they result in new e*uity capital. he right provides for the maintenance of pro rata ownership by e>isting owners; while the warrant has no such featureG rather; the warrant is generally used to make other forms of financing more attractive. he life of a right is typically only on e or two months; whereas a warrant is generally e>ercisable for a period of years. Also; rights are issued at an e>ercise price below the prevailing market price of stock; while warrants are issued above the prevailing price. @arrants @arrants are are often attached to debt or preferred stock issues as sweeteners or may be used as compensation in a merger. opic: o pic: Analy?ing +ptions; @arrants; @arrants; and !ights %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills
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4) ico Rong Rong is considering the purchase of 166 shares of isco &ystems stock at F per share. $ecause the economy is picking up; ico believes the demand for +racle's router systems will increase substantially causing the price of isco's shares to increase to F ,6 per share. As an alternative; ico is considering the purchase of a call option for 166 shares of isco at with an e>ercise price of F3. his 16 day option will cost ico F66. Assume no brokerage costs or dividends. a) @hat will ico's profit profit be on the stock transaction transaction if he decides to buy the stock and its price does increase to F,6 per share and he sellsH b) 2ow much will ico earn on the option transaction if he purchases the option and the underlying stock price rises to F,6H c) 2ow much must the stock price rise for ico to break even on the option transactionH d) $ased on parts a) and b) above; above; what should should ico doH #>plain. #>plain. Answer: a) =f ico purchases the stock stock at F and sells at F,6; he will earn a profit of F per share or F66 total. b) =f ico were to purchase the option rather than the underlying underlying stock; ico would be able to sell the stock for F,;666 166 shares L F,6 per share) after purchasing the stock for F;366 166 shares L F3 per share) earning a gross profit of F366 on the transaction. +f course; ico has to consider that the option originally cost him F66. herefore; ico's profit is only F,66. c) o break even on the option transaction; transaction; the stock price would have to rise rise to F7 per share. d) $ased on parts a) and b) above; ico should buy the stock rather than than the option. opic: o pic: Analy?ing all +ptions %uestion &tatus: !evised AA&$ (uidelines: (uidelines: Analytic skills
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