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3016 Words Apr 9th, 2011 13 Pages



(21.1) Preferred stock Answer: b EASY
[i]. The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

a. True b. False

(21.1) Cost of preferred stock Answer: a EASY
[ii]. Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

a. True b. False

(21.2) Warrants Answer: b EASY
[iii]. A warrant is an option, and as such it cannot be used as a "sweetener."

a. True b. False

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

(21.4) Warrants and convertibles Answer: c MEDIUM
[xix]. Which of the following statements is most CORRECT?

a. Warrants have an option feature but convertibles do not. b. One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds. c. The coupon rate on

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