Study your flashcards anywhere!

Download the official Cram app for free >

  • Shuffle
    Toggle On
    Toggle Off
  • Alphabetize
    Toggle On
    Toggle Off
  • Front First
    Toggle On
    Toggle Off
  • Both Sides
    Toggle On
    Toggle Off
  • Read
    Toggle On
    Toggle Off
Reading...
Front

How to study your flashcards.

Right/Left arrow keys: Navigate between flashcards.right arrow keyleft arrow key

Up/Down arrow keys: Flip the card between the front and back.down keyup key

H key: Show hint (3rd side).h key

A key: Read text to speech.a key

image

Play button

image

Play button

image

Progress

1/62

Click to flip

62 Cards in this Set

  • Front
  • Back
A company currently has $125,000,000 of 3 1/4% convertible bonds. The company is going to offer $125,000,000 of 3 1/4% nonconvertible bonds plus cash of $15,000,000 for the convertible bonds. How will this transaction, if successful, affect the company's financial status?
a. It will reduce the cash and debt position and reduce the potential dilutive effect on the common stock.
b. It will reduce the cash position and increase the debt position.
c. It will increase the cash position and reduce the potential dilutive effect on the common stock.
d. It will reduce the cash position and the potential dilutive effect on the common stock.
D
The effect of the transaction will be to reduce the cash position and the potential dilutive effect on the common stock. The company is paying out cash and is also issuing nonconvertible bonds in place of convertible bonds (which could have been converted into common stock). This would reduce the cash position and the potential dilutive effect on the common stock. (6-8)
A corporation has $125,000,000 of convertible bonds outstanding. The conversion price is $50. The corporation refunds $75,000,000 of the bonds for nonconvertible bonds. How many additional shares of common stock will be outstanding if the remaining bonds are converted?
a. 1,000,000 shares
b. 1,500,000 shares
c. 2,000,000 shares
d. 2,500,000 shares
A
After the refunding, $50,000,000 of convertible bonds will remain outstanding. If these bonds are converted, there will be an additional 1,000,000 shares of common stock outstanding ($50,000,000 of bonds divided by the conversion price of $50 equals 1,000,000 shares of common stock). (6-6)
If a corporation reports a loss, it would not have to pay interest on:
a. Mortgage bonds
b. Guaranteed bonds
c. Adjustment bonds
d. Debentures
Explanation:
C
Corporations must pay interest on debt obligations whether they have earnings in a particular year or not. One exception would be for income (adjustment) bonds, which require the payment of interest only if the corporation has earnings to pay the interest. If the corporation has no earnings in a particular year, it is not required to pay the interest on these bonds. (6-12)
Which of the following would be considered creditors of a corporation?
I. Debenture holders
II. Convertible bondholders
III. Common stockholders
IV. Preferred stockholders
a. I and II only
b. I and IV only
c. III and IV only
d. II, III, and IV only
A
Stockholders, both common and preferred, are owners of a corporation. Bondholders are creditors of a corporation; they have loaned the corporation money and received bonds as evidence of the corporation's debt to them. (6-1)
A corporate bond that has no specific collateral backing it and is guaranteed by the full faith and credit of the issuing corporation is called a(n):
a. Debenture
b. Guaranteed bond
c. Income bond
d. Equipment trust certificate
A
A corporate bond that has no specific collateral backing it and isguaranteed by the "full faith and credit" of the issuing corporation is called a debenture. A strong, financially sound, well regarded company is able to borrow money backed by its "full faith and credit" and its reputation and does not have to provide collateral as a guarantee. (6-2)
DEBENTURE (S7) : A corporate bond backed by the general credit of a company and not secured by a mortgage or lien on any specific property.
FULL FAITH AND CREDIT (S7) : A pledge by an issuer to pay interest and principal on debt securities when due.
XYZ Corporation has $20 million convertible bonds outstanding. Each bond is convertible into 20 shares of common stock.
The conversion price is:
a. $20
b. $25
c. $50
d. $100
C
To find the conversion price, divide the $1,000 par value by the 20-share conversion ratio. This equals a conversion price of $50 ($1,000 par value divided by the 20-to-1 conversion ratio = $50). (6-6)
XYZ Corporation has $20 million convertible bonds outstanding. Each bond is convertible into 20 shares of common stock.
If all the bonds were converted to common stock, how many additional shares of common stock would be outstanding?
a. 100,000
b. 200,000
c. 300,000
d. 400,000
D
$20 million par value ($1,000) bonds, which equals 20,000 bonds ($20,000,000 divided by $1,000 equals 20,000), multiplied by the 20-to-1 conversion ratio would result in 400,000 shares of additional common stock outstanding (20,000 bonds x 20 = 400,000). (6-6)
Which of the following is TRUE regarding Eurodollar bonds?
I. They are denominated in U.S. dollars only.
II. They are denominated in foreign currencies only.
III. They are only traded outside of the U.S.
IV. They are traded in the U.S. and international markets.
a. I and III
b. I and IV
c. II and III
d. II and IV
B
Eurodollar bonds are issued by both U.S. and foreign companies and are denominated in U.S. dollars. Eurodollar bonds are actively traded in the U.S. Since the issuance of Eurodollar bonds does not comply with U.S. securities laws, they cannot be purchased as new issues in the U.S. (6-12)
A bond is convertible at $40 and is selling in the market for 120. If the stock has a current market price of $50, the parity price for the bond would be:
a. $960
b. $1,200
c. $1,250
d. $1,500
C
It is necessary to find the conversion ratio to solve this problem. The bond is convertible at $40. $1,000 divided by $40 equals the conversion ratio of 25 shares of stock to one bond, or 25 to 1. To find the parity price of the bond, multiply the market price of the stock of $50 by the conversion ratio of 25 ($50 x 25 = $1,250). This means that the bond must sell for $1,250 to be equal in value to the stock when the stock has a market value of $50 per share. (6-7)
CONVERSION RATIO (S7) : The number of shares of stock into which a convertible security may be converted. The conversion ratio equals the par value of the convertible security divided by the conversion price.
If a corporation went bankrupt, any remaining assets would be distributed in which of the following orders of priority?
I. Common stockholders
II. Mortgage bondholders
III. Convertible bondholders
IV. Unpaid workers
a. IV, II, III, and I
b. IV, III, II, and I
c. II, III, I, and IV
d. III, II, IV, and I
A
If a corporation should go bankrupt, first salaries and wages are paid to unpaid workers. The assets would then be distributed to the secured bondholders (e.g., mortgage bonds), debenture holders (who are unsecured bondholders but still creditors such as the convertible bondholders), and common stockholders (who are equity owners, not creditors). Preferred stockholders (who are also equity owners) would be paid prior to common stockholders. (6-3)
The Barge Towing Corporation has announced in a tombstone ad that it will issue $5,000,000 of 10% convertible subordinated debenture bonds convertible into common stock at $10.50. The bonds will mature in November 2020 and are being issued at a $1,000 par value.
The bonds are secured by:
a. The barges and equipment of the Barge Towing Corporation
b. The common stock of the Barge Towing Corporation
c. The underwriter of the Barge Towing Corporation
d. The "full faith and credit" and no specific collateral of the Barge Towing Corporation
Explanation:
D
The tombstone ad states the bonds to be issued are subordinated debenture bonds, which are unsecured bonds. The bonds are secured by the "full faith and credit" and no specific collateral of the Barge Towing Corporation. (6-2)
DEBENTURE (S7) : A corporate bond backed by the general credit of a company and not secured by a mortgage or lien on any specific property.
The Barge Towing Corporation has announced in a tombstone ad that it will issue $5,000,000 of 10% convertible subordinated debenture bonds convertible into common stock at $10.50. The bonds will mature in November 2020 and are being issued at a $1,000 par value.
The conversion ratio of the bonds is approximately:
a. 75 to 1
b. 85 to 1
c. 95 to 1
d. 100 to 1
C
The conversion price is given as $10.50. To find the conversion ratio, divide the par value ($1,000) of the bond by the conversion price of $10.50. This equals a conversion ratio of 95 to 1 ($1,000 divided by $10.50 equals 95). (6-6)
The Barge Towing Corporation has announced in a tombstone ad that it will issue $5,000,000 of 10% convertible subordinated debenture bonds convertible into common stock at $10.50. The bonds will mature in November 2020 and are being issued at a $1,000 par value.
If the bonds were subsequently trading in the market at $1,020, the market price of the common stock, to be on parity with the bond, would have to be:
a. $9.54
b. $10.20
c. $10.74
d. $12.04
C
To find parity (equality in dollar value) for the stock, divide the market price of the bond by the conversion ratio. The market price of the bond is 102 ($1,020) and the conversion ratio is 95 to 1. Therefore, $1,020 divided by 95 would equal approximately $10.74. This would be the parity price for the stock. (6-7)
Which statement best describes an indenture?
a. It is a written agreement between an option buyer and the option writer.
b. It is a written agreement between the brokerage firm and its customers allowing the customers to buy securities on credit.
c. It is a contract between the issuer of bonds and the trustee for the benefit of the holder of the bonds.
d. It is found on every stock certificate.
C
An indenture is a written contract between the issuer of bonds and the trustee under which bonds and debentures are issued. Listed in the indenture are: the maturity date, the coupon rate, and other terms for the benefit of the bondholder. (6-1)
Which of the following statements concerning convertible bonds are true?
I. Coupon rates are usually lower than nonconvertible bonds.
II. Convertible bondholders are creditors of the corporation.
III. It is possible that a convertible bond will sell at a price based solely on its inherent value as a bond.
a. I and II only
b. I and III only
c. II and III only
d. I, II, and III
C
Convertible bonds give holders the ability to convert their bonds into shares of common stock of the same issuer at a set price (conversion price) at their discretion. This feature links these types of bonds to the equity markets and the price of a convertible bond is affected by the price of the underlying stock. However, if the price of the underlying stock declines to the point where there is no advantage to the conversion feature, the bond may sell at a price based on its inherent value as a bond, disregarding the convertible feature.
Moreover, since a convertible is a bond first, anyone who holds one is a creditor of the issuer. Also, since the conversion feature is a benefit to the bondholder, convertible bonds will have a lower coupon than similar nonconvertible bonds. (6-8)
A bond secured by other bonds and securities is referred to as a:
a. Debenture bond
b. Guaranteed bond
c. Mortgage bond
d. Collateral trust bond
D
A bond secured by other bonds and securities is called a collateral trust bond. (6-2)
A convertible debenture is convertible at $25. It has a nondilutive feature in its indenture. If a stock dividend is distributed, which of the following will be true?
I. The conversion price will be reduced.
II. The conversion price will be increased.
III. The conversion ratio will be reduced.
IV. The conversion ratio will be increased.
a. I and III
b. I and IV
c. II and III
d. II and IV
Explanation:
B
A nondilutive feature means that if there is a stock split or stock dividend, the bond's conversion features must be adjusted. The bondholder would receive more shares upon conversion because the conversion ratio would be increased. The conversion price would be reduced to permit this increase in the conversion ratio. (6-6)
Wholesale corporate bond quotes can be found in the:
a. Pink sheets
b. White sheets
c. Green sheets
d. Yellow sheets
D
Wholesale corporate bond quotes can be found in the yellow sheets. (6-13)
A holder of XYZ Corporation's convertible debentures would be considered:
a. A creditor of XYZ Corporation
b. A common stockholder of XYZ Corporation
c. A preferred stockholder of XYZ Corporation
d. An equity owner of XYZ Corporation
A
A holder of the convertible debentures (unsecured bonds) is a creditor of XYZ Corporation. The holder of the bonds would become a common stockholder if he decided to convert the bonds into common stock. (6-6)
XYZ convertible debentures are convertible into 20 shares of XYZ Corporation common stock. If the bonds were selling in the market at $960, what would the common stock have to be selling for to be on parity?
a. $25
b. $45
c. $48
d. $50
C
To find the stock's parity price, divide the current market price of the bond ($960) by the conversion rate (20 shares). This equals $48. (6-7)
A guaranteed bond is:
a. Insured
b. One that has a mandatory sinking fund
c. Backed by a pledge of another corporation to pay principal and interest
d. Backed by a pledge of a federal agency to pay principal
C
The definition of a guaranteed bond is a corporate bond guaranteed by a corporation other than the issuer. (6-3)
If a corporation is in a liquidation, the holder of a subordinated debenture would be paid:
a. Before bank loans and before accounts payable
b. Before bank loans and after accounts payable
c. After bank loans and before accounts payable
d. After bank loans and after accounts payable
D
In a liquidation of a corporation, the subordinated debenture holders would be paid after bank loans and after accounts payable or other creditors. The subordinated debenture holders are paid after everyone except preferred and common stockholders. (6-3)
A bond is convertible at $25. The conversion ratio is 40 to 1. The common stock is selling at $25.50. The bond is called at 106. What should the investor do?
a. Convert the bond into the common stock
b. Convert the stock into one bond
c. Let the bond be called
d. Convert the bond into the common stock and let the stock be redeemed
C
If the bond is called, the amount received would be $1,060. If the bond is converted, the investor would receive 40 shares of common stock (the conversion ratio is 40). The investor may sell those shares at $25.50 or $1,020. Since the investor would receive $1,060 if the bond is called, the investor should let the bond be called. Choice (B) cannot be done because you cannot convert common stock into one bond. (6-6)
Prices for Wednesday, February 13th
Sales High Low Close Net Chg.
XYZ Corp 8s09 1 61 5/8 61 5/8 61 5/8 --
ABC Corp 8 1/2s17 CV 2 75 74 1/4 75 +1 1/2
What does "8s09" mean?
a. 800 bonds at 109
b. 8.09% bonds
c. 8% bonds due 2009
d. 8% bonds at 109
C
The coupon (interest rate) and maturity of the bond is shown as 8s09. This means that the bond offers an 8% coupon and matures in 2009. (6-13)
Prices for Wednesday, February 13th
Sales High Low Close Net Chg.
XYZ Corp 8s09 1 61 5/8 61 5/8 61 5/8 --
ABC Corp 8 1/2s17 CV 2 75 74 1/4 75 +1 1/2
What did the customer pay to purchase the XYZ Corp bond?
a. $61.58
b. $61.625
c. $615.80
d. $616.25
D
The chart shows that only one bond traded that day. The price was 61 5/8 which would be $616.25 for the $1,000 bond. (6-13)
Prices for Wednesday, February 13th
Sales High Low Close Net Chg.
XYZ Corp 8s09 1 61 5/8 61 5/8 61 5/8 --
ABC Corp 8 1/2s17 CV 2 75 74 1/4 75 +1 1/2
What was the closing price of the ABC Corp bond on Tuesday, February 12th?
a. 73 1/2
b. 74 1/4
c. 75
d. 76 1/2
A
Net change is shown as +1 1/2. The closing price for February 13 of 75 was 1 1/2 points higher than February 12. The bond closed on February 12 at 73 1/2 (75 - 1 1/2 ). (6-13)
ABC Corporation bonds are convertible at $50. If the bonds are selling in the market for 90 ($900) and the common stock is selling for $43, which of the following two statements are true?
I. The stock is selling at a discount to parity with the bond.
II. The stock is selling at a premium to parity with the bond.
III. Liquidating the stock after converting the bond would be currently profitable.
IV. Liquidating the stock after converting the bond would not be currently profitable.
a. I and III
b. I and IV
c. II and III
d. II and IV
B
The conversion ratio, which is not given, is found by dividing the par value of the bond ($1,000) by the conversion price ($50). This equals 20 to 1 ($1,000 divided by $50 equals 20). The market price of the common stock is $43 per share. The stock is selling at a discount to parity with the bond ($43 stock x 20 shares = $860 which is below the $900 market price of the bond). If the bonds were converted and the stock was then sold at the market price, the investor would have a loss. (6-6)
A corporation would be considered in default if it did not pay interest on all of the following EXCEPT:
a. Second mortgage bond
b. Debenture
c. Subordinated debenture
d. Adjustment bond
B
Interest on an adjustment (income) bond only needs to be paid if the corporation has sufficient income. Interest on all other debt securities must be paid regardless of the corporation's income. (6-12)
All of the following are TRUE regarding convertible bonds EXCEPT:
a. The bonds can be used for collateral
b. The bonds are usually debentures
c. The coupon rate on the bonds is higher than on similar nonconvertible bonds
d. The bonds can be converted into common stock
C
The coupon rate on a convertible bond will be lower than on a similar nonconvertible bond. (6-8)
Relative to a convertible bond, which of the following would produce a desirable arbitrage situation?
a. Stock at parity with the bond
b. Stock at a premium to parity and the bond is trading at par
c. Stock at a discount to parity and the bond is trading at par
d. Yield on the bond equals the yield on the stock
B
An arbitrage situation occurs when there is a price difference in comparable securities. If stock is selling above parity, the value of the stock received from converting the bond would be more than the value of the bond. An investor could sell short the stock and buy the bond and then convert the bond and use the stock to cover the short position. (6-9)
The priority for payments when liquidating a corporation would be:
I. Secured bondholders
II. Wages to unpaid workers
III. General creditors
IV. Common stockholders
a. I, III, II, and IV
b. II, I, III, and IV
c. III, IV, I, and II
d. I, IV, III, and II
B
If there is a liquidation, not all creditors have equal status. The IRS and unpaid workers receive preferential treatment when a company is liquidated, before holders of securities of the company. Unpaid workers will be paid in full first and then the IRS. Secured creditors would be paid next, if there are any. An example of a secured creditor would be a first mortgage bondholder. Next would be the debenture holders, who are unsecured (general) creditors, who may be paid in full or receive partial payment. Finally, the preferred stockholders and then the common stockholders would have claim on the remaining assets. (6-3)
When a corporation goes bankrupt, which of the following creditors would be the last to be paid?
a. Internal Revenue Service
b. Debenture holders
c. Preferred stockholders
d. Common stockholders
B
A creditor is someone to whom the corporation owes money. A stockholder is an owner of the corporation, not a creditor. (6-1, 6-4)
If a customer's objectives are safety of principal and income, you as the account executive could suggest all of the following EXCEPT:
a. AAA rated corporate bonds
b. High-grade preferred stocks
c. High-grade mortgage bonds
d. Income bonds
D
All of the bonds and preferred stocks listed would provide safety of principal and income except income or adjustment bonds. Income bonds generally come into existence in the reorganization of a company after bankruptcy. The company is only required to pay the interest on these bonds if the company earns money. Income bonds are one of the riskiest types of bonds available. (6-12)
A corporation has issued a bond with a 5% coupon that is convertible into common stock at $40. The bond is selling at its par value.
The number of shares that would be received on conversion would be:
a. 15
b. 25
c. 30
d. 40
B
The conversion price is $40. To find the conversion ratio (the number of shares of common stock received if the bond is converted), divide the par value of the bond ($1,000) by the conversion price ($40). This is equal to 25 ($1,000 divided by $40 equals 25). For every bond that is converted, the investor will receive 25 shares of common stock. (6-6)
A corporation has issued a bond with a 5% coupon that is convertible into common stock at $40. The bond is selling at its par value.
If the bond increased in value by 20 points, what is parity for the stock?
a. $25
b. $40
c. $48
d. $50
C
If the bond increased by 20 points over its par value of $1,000, it would be selling for $1,200. The parity for the stock would be found by dividing the market value of the bond ($1,200) by the conversion ratio (25). This is equal to $48 ($1,200 divided by 25 equals $48). (6-7)
An investor purchasing a corporate bond regular way will have to pay the contract price plus accrued interest. Accrued interest will be calculated:
a. Up to and including the trade date
b. Up to but not including the trade date
c. Up to but not including the settlement date
d. Up to and including the settlement date
C
Accrued interest on corporate bonds is calculated from the last interest payment date up to but not including the settlement date (which is the day delivery is due). A regular-way delivery is three business days. (6-14)
American Telephone Company of Ohio is offering $50,000,000 worth of 9% bonds at a price of 99.25% of par value. The State of Ohio has a state income tax. A buyer of the bond would be:
I. Subject to state income tax
II. Exempt from state income tax
III. Subject to federal income tax
IV. Exempt from federal income tax
a. I and III
b. I and IV
c. II and III
d. II and IV
A
American Telephone Company of Ohio is a corporation. Therefore, interest paid on its debt obligations is subject to federal and state income tax. (6-15)
A tombstone ad states that Southern California Gas is issuing 8 3/4% first mortgage bonds at a price of 96.35% of their par value.
Which of the following are true?
I. The bonds are being sold to yield 9.635% annually.
II. The bonds will pay interest of $87.50 annually.
III. The bonds are subject to the Trust Indenture Act of 1939.
a. I and II only
b. I and III only
c. II and III only
d. I, II, and III
C
The rate of interest stated in the tombstone is 8 3/4%. This means the company will pay 8 3/4% of $1,000 or $87.50 per year in interest. The bonds are corporate bonds being issued by Southern California Gas Company (not the State of California) and would be subject to the Trust Indenture Act of 1939. (6-1, 5-7)
TRUST INDENTURE ACT OF 1939 (S7) : A federal law that regulates bond offerings by requiring a corporation to appoint a trustee to act for the benefit of the bondholders.
A tombstone ad states that Southern California Gas is issuing 8 3/4% first mortgage bonds at a price of 96.35% of their par value.
The payment of interest and principal on the bond is secured by:
a. The general credit of the State of California
b. The mortgages on property owned by the State of California
c. The State of California
d. A lien on property owned by Southern California Gas
D
The tombstone ad states the bonds are first mortgage bonds, which means they are secured by a lien on property owned by the Southern California Gas Company. The company is a publicly owned corporation. Therefore, the bonds are not secured by property owned by the State of California. (6-2)
An indenture of a bond has a closed-end provision. This means that:
a. Additional borrowing is prohibited if the bonds will have the same level of claim against assets
b. Additional borrowing is permitted if the bonds will have the same level of claim against assets
c. The bonds must be called before maturity
d. A sinking fund must be established
A
A closed-end provision in a bond indenture means that additional borrowing against a particular source of revenue is prohibited. An open-end provision means additional borrowing against a revenue source is permitted. (6-1)
A DEF corporation convertible bond is convertible at 40. DEF common is selling at 50. At what price should the bond be selling for it to be at a 10% premium to the common?
a. 80
b. 88
c. 125
d. 137 1/2
D
Since the bond is convertible at $40 a share, the bond can be converted into 25 shares of common stock ($1,000 par value divided by $40 per share). If the bond was converted, the total value of common stock would be $1,250 (25 shares x $50 market value). A 10% premium to the parity price would be $1,375 ([10% x $1,250] + $1,250). (6-7)
A convertible bond is convertible at $25. The bond is currently selling in the market at $960. What should the stock be selling at to be at parity with the bond?
a. $10
b. $23
c. $24
d. $25
C
The bond is convertible at $25. This means the conversion ratio is 40 to 1 ($1,000 par value divided by the conversion price of $25 equals the conversion ratio of 40 to 1). To find parity for the stock, divide the market value of the bond by the conversion ratio (market value of the bond $960, divided by the conversion ratio of 40 to 1 equals $24 parity price for the stock). (6-7)
These securities are issued by foreign governments and corporations, trade in U.S. markets, and are denominated in U.S. dollars.
(Use the following choices to answer this question.)
a. Open-end investment company shares
b. Eurodollar bonds
c. Yankee bonds
d. Repurchase agreements
C
Yankee bonds are issued by foreign corporations and governments, are dollar-denominated securities, and trade in U.S. markets. Yankee bonds are normally issued by foreign entities when conditions in the U.S. are better than in the foreign country. Eurodollar bonds are primarily issued in Europe and pay their interest in Eurodollars (dollars on deposit in banks outside the U.S.). (6-12)
A corporate bond has increased in value by 3/4 of a point. The bond has increased by:
a. $0.75 per $1,000 par value
b. $7.50 per $1,000 par value
c. $0.75 per $5,000 par value
d. $7.50 per $5,000 par value
B
One point equals $10. An increase of 3/4 of a point in a corporate bond would be $7.50 per $1,000 of par value. (6-12)
A corporation has issued debentures convertible at $50. The stock pays a 10% stock dividend. According to the nondilutive feature of the bond indenture, the new conversion price would be:
a. $19.23
b. $20.83
c. $45.00
d. $45.45
D
The new conversion price would be $45.45. When there is a stock dividend or stock split on a common stock, the conversion price of the bond has to be adjusted downward. Therefore, the number of shares received on conversion would be adjusted upward. This is due to the nondilutive feature provided in the indenture of the bond. Without this clause, investors would not buy a convertible bond because the issuer could dilute away the privilege by issuing a stock dividend or split on the stock. Prior to the dividend, the conversion price was $50, and the conversion ratio was 20 to 1 ($1,000 par value divided by $50 conversion price). With the 10% stock dividend, the new ratio is 22 to 1. Given the new conversion ratio of 22 shares the conversion would be $45.45 ($1,000/22) (6-6)
During a period of stable interest rates, which bond has the most potential to show a significant change in price?
a. 7%, 30-year U.S. Treasury Bond
b. 8%, 5-year high grade corporate bond
c. 6%, 6-month Revenue Anticipation Note
d. 7 1/2%, 10-year convertible subordinated debenture
D
If interest rates are stable, most bond prices will have little movement. However, a convertible debenture could show significant price appreciation or depreciation if the underlying equity changes in value because of the potential to convert. This keeps the bond price in the vicinity of conversion parity. Parity is achieved when the value of the bond equals the value of the common stock derived from conversion. (6-8)
XYZ Corporation has a 6 1/2% convertible bond outstanding which is convertible into 40 shares of common stock. The bond is currently selling in the market at 85 ($850) and the common stock is selling at 21. The XYZ Corporation is offering its existing bondholders a new straight (nonconvertible) bond paying 6 1/2% which matures at the same time as the convertible bond. The effect of the successful completion of the proposal would be to:
I. Reduce interest costs
II. Reduce potential dilution
III. Have no effect on interest costs
IV. Increase dilution
a. I and II
b. I and IV
c. II and III
d. III and IV
C
Prior to the refunding, if all of the bonds were converted into common stock, outstanding shares would increase causing earnings per share to decrease (dilute). The effect of the successful completion of the proposal (refunding) would be to reduce potential dilution because the conversion provision is being eliminated. There would be no reduction in interest costs since the new bonds are paying the same rate of interest as the old bonds (6 1/2%). (6-8)
Dynasty Corporation is going to acquire Regal Corporation. If a trader purchased 12,000 shares of Regal Corporation and sold short 4,000 shares of Dynasty Corporation, the trader is:
a. Creating an optional hedge
b. Engaging in a risk arbitrage
c. Creating a reverse hedge
d. Creating a bullish spread
B
When there is an acquisition or merger taking place, traders will try to take advantage of the activity between the common stocks of the two companies. The trader or risk arbitrageur will go long the company being acquired and sell short the shares of the acquiring company. This process is known as risk arbitrage. If the acquisition is successful, Regal Corporation's stock will increase and Dynasty Corporation's stock will decline. (6-9)
A corporation with an excellent earnings record has several issues of bonds outstanding. During a period of stable interest rates, which of the following bonds would be expected to fluctuate the most?
a. Mortgage bonds
b. Equipment trust bonds
c. Debenture bonds
d. Convertible bonds
D
The convertible bonds would fluctuate the most because they are convertible into common stock. The price would fluctuate with the price movements of the common stock. The fact that interest rates are stable is another reason why convertible bonds is the best answer. If the question had stated that interest rates were moving sharply upward or downward, then all other bonds would fluctuate sharply in price to bring yields in line with interest rates. However, the question asks what would happen in a period of stable interest rates. Given that statement, the best answer would be that convertible bonds would fluctuate the most. (6-8)
An XYZ Corporation convertible bond is selling in the market at $1,248.75. It is convertible at $30. XYZ common stock's market price is 37.50. The bond has been called at 103. Which of the following is the least attractive alternative for a holder of the bond?
a. Sell the bond
b. Convert to common and sell the common
c. Allow the bond to be called
d. Convert common stock to a bond
C
The holder could sell the bond and receive $1,248.75. If he converted, he would receive 33 1/3 shares ($1,000 par divided by $30 per share conversion feature) with a total value of $1,249.88 (33 1/3 times $37.50). The least attractive alternative is to allow the bond to be called and receive $1,030. (6-6)
The Trust Indenture Act of 1939 regulates:
I. A purchase of $5,000,000 of Treasury bonds
II. A private placement of $3,000,000 of corporate notes
III. A $20,000,000 sale of corporate bonds sold interstate
IV. A sale by a brokerage firm throughout the country of $25,000,000 of corporate debentures
a. I and II only
b. I and III only
c. III and IV only
d. I, II, III, and IV
C
The Trust Indenture Act of 1939 regulates the public issuance of corporate securities that are sold interstate. It does not cover U.S. government securities or private placements. A $20,000,000 sale of corporate bonds sold interstate and a sale by a brokerage firm throughout the country (also interstate) of $25,000,000 of corporate debentures would be covered under the Trust Indenture Act of 1939. (6-1)
TRUST INDENTURE ACT OF 1939 (S7) : A federal law that regulates bond offerings by requiring a corporation to appoint a trustee to act for the benefit of the bondholders.
REGULATION D OFFERING (S7) : A type of exempt offering that is sold directly to accredited investors and maximum of thirty-five nonaccredited investors. Also called Private Placement, Restricted Stock, Lettered Stock, Legend Stock.
A bond is convertible into stock at $50 per share. The market price of the stock is 65. The market price of the bond is 120. To profit from this arbitrage opportunity, an investor should:
I. Buy 5 bonds
II. Buy 100 shares of stock
III. Sell 5 bonds short
IV. Sell 100 shares of stock short
a. I and III
b. I and IV
c. II and III
d. II and IV
B
Since the bond is convertible into 20 shares of stock ($1,000 par divided by 50) and the bond is priced at 120, the parity for the stock is $60 per share ($1,200 bond price divided by 20 shares). An arbitrage situation exists because the stock is selling at a 5-point premium to parity (65 market price - 60 parity price).
An investor would profit from this situation by purchasing bonds at 120 and shorting the stock at 65. Each bond may be converted into 20 shares of stock at a cost of $60 per share. These shares may then be used to cover the short sale, establishing a 5-point profit (65 short sale price - 60 cost). (6-6)
The Trust Indenture Act of 1939 establishes:
a. A legal relationship between a municipal issuer and a trustee for the benefit of bondholders
b. A legal relationship between a corporate issuer and a trustee for the benefit of bondholders
c. The requirements for call provisions in non-exempt issues
d. Prospectus requirements
B
The Trust Indenture Act relates to the issuance of corporate debt instruments. It requires that a trustee be appointed to act in the bondholders' interest. (6-1)
An individual owns an ARF corporation 8% convertible debenture. The debenture is convertible at 20 and is currently selling in the market at 97 1/2. If ARF common stock is trading in the market at 18, at what price should the debenture sell at to be at a 10% premium to parity with the common?
a. $396
b. $900
c. $975
d. $990
D
Since the conversion price is $20 per share, the debenture can be converted into 50 shares ($1,000 par divided by $20 per share). If converted, the stock would have a total value of $900 (50 shares x $18 per share market price). To be at a 10% premium to parity, the debenture should be trading at $990 ($900 parity plus 10% of $900). (6-6)
An indenture for a corporate bond includes all of the following EXCEPT:
a. Early redemption features
b. A list of all bonds previously issued by the corporation
c. A description of any pledged collateral
d. The interest payment dates
B
A bond indenture would not contain a list of all bonds issued by the corporation. The other items are found in the indenture. (6-1)
An individual purchases $5,000 BRT Corporation 7 3/8% bonds that mature 10-1-29. The transaction was executed on Thursday, August 5, 20XX for regular-way settlement. The bonds were sold on March 10th of the following year. How much interest must the individual report for tax purposes in 20XX?
a. $52.24
b. $132.13
c. $142.38
d. $220.22
A
On October 1st, the investor will receive a semiannual interest payment of $184.37 ($5,000 x 7 3/8% divided by 2). The investor, for tax purposes, would deduct the amount of accrued interest (7 3/8% x $5,000 x 129/360 = $132.13) paid at the time of the transaction from the amount received ($184.37) on October 1st and report the difference as income earned and received ($184.37 - $132.13 = $52.24). (6-14)
Bond AlaP 10 1/2 25
Curr. Yld. 10.4
Vol. 25
Close 100 7/8
Net Chg -1/8

Bond AlldC zr29
Curr. Yld. …
Vol. 110
Close 14 1/8
Net Chg -1/2

Bond AMAX 8 1/2 25
Curr. Yld. 13.6
Vol. 3
Close 104 1/2
Net Chg +1/8

Bond ATT 5 1/2 27
Curr. Yld. 7.2
Vol. 14
Close 76
Net Chg -1 1/4

An investor purchased 10 ATT 5 1/2 27. How much interest will the investor receive each year?
a. $55
b. $97
c. $550
d. $970
C
The description ATT 5 1/2 27 represents a 5 1/2% bond maturing in 2027. The investor would receive interest equal to 5 1/2% of the face value ($10,000) each year. The investor would receive $550 (5 1/2% x $10,000). (6-13)
Bond AlaP 10 1/2 25
Curr. Yld. 10.4
Vol. 25
Close 100 7/8
Net Chg -1/8

Bond AlldC zr29
Curr. Yld. …
Vol. 110
Close 14 1/8
Net Chg -1/2

Bond AMAX 8 1/2 25
Curr. Yld. 13.6
Vol. 3
Close 104 1/2
Net Chg +1/8

Bond ATT 5 1/2 27
Curr. Yld. 7.2
Vol. 14
Close 76
Net Chg -1 1/4
An investor asks you to recommend bonds that would generate cash flow. All of the following would be suitable EXCEPT:
a. Ala P 10 1/2 25
b. AMAX 8 1/2 25
c. AlldC zr29
d. AmMed 9 1/2 21
Explanation:
C
The AlldC zr29 is a zero-coupon bond. It would not provide any cash flow since the investor would not receive any interest. (6-13)
Bond AlaP 10 1/2 25
Curr. Yld. 10.4
Vol. 25
Close 100 7/8
Net Chg -1/8

Bond AlldC zr29
Curr. Yld. …
Vol. 110
Close 14 1/8
Net Chg -1/2

Bond AmMed 9 1/2 21
Curr. Yld. CV
Vol. 15
Close 97
Net Chg +1

Bond ATT 5 1/2 27
Curr. Yld. 7.2
Vol. 14
Close 76
Net Chg -1 1/4

What was the previous day's closing for AmMed 9 1/2 21?
a. 16
b. 96
c. 97
d. 98
B
The net change for the AmMed 9 1/2 21 is +1. The closing price of 97 is therefore 1 point higher than the previous day's close. The previous day's close would be 96 (97 - 1). (6-13)
A 7% convertible bond has a conversion ratio of 40. The bond has a non-dilutive feature and the common is selling at $43 a share. If the company distributes a 10% stock dividend, which of the following is true regarding the convertible bond?
a. Conversion ratio remains at 40, but the conversion price is reduced.
b. Conversion ratio increases to 45.50 and the conversion price remains constant.
c. Conversion price decreases to $22.73 and the conversion ratio remains the same.
d. Conversion price decreases to $22.73 and the conversion ratio increases to 44.
D
A non-dilutive feature requires that the conversion features be adjusted should there be a stock split or stock dividend. The conversion ratio will be increased and the conversion price will be reduced. The new conversion ratio will be 44 [the old ratio (40) plus the old ratio times the percentage dividend (40 x 10% = 4)]. The new conversion price will be the par value of the bond divided by the new conversion ratio ($1,000 divided by 44 equals $22.73). (6-6)
Which of the following best describes Eurodollars?
a. U.S. dollars on deposit in U.S. banks
b. U.S. dollars on deposit in European banks
c. U.S. dollars on deposit in foreign banks
d. European currency on deposit in U.S. banks
C
Eurodollars are defined as U.S. dollars on deposit in foreign banks, not just in Europe. (6-12)
Eurodollar (a United States dollar deposited in a European bank and used as an international currency to finance trade)
When raising capital, which two of the following securities are required to register with the SEC under the Securities Act of 1933?
I. A REIT that will be listed on the NYSE
II. Commercial paper issued by a finance company maturing in one month
III. A Eurodollar bond issued by a U.S corporation
IV. An American Depositary Receipt issued by a British company
a. I and III
b. I and IV
c. II and III
d. II and IV
B
There is no specific exemption under the registration provisions of the Securities Act of 1933 for ADRs or REITs. They both issue shares of common stock and if sold to the public in the U.S. would require SEC registration. Corporate debt with a maturity of 270 days or less (commercial paper) is exempt from registration. Securities initially offered outside the U.S., for example Eurodollar bonds, would also be exempt from SEC registration. (6-12, 4-19, 9-19, 18-30)