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8 Cards in this Set

  • Front
  • Back

An investor purchases an ABC Corporation convertible bond at 98 on June 18, 1997. The bond is convertible at $25 and the investor converts his bond into the stock on June 19, 1998, when the common stock is trading at $26/share. For tax purposes, these transactions will result in:



A) neither gain nor loss
B) a $40 capital loss
C) a $40 capital gain
D) a $60 capital gain

Answer: A



Converting a bond into shares of common stock does not result in tax consequences. For a taxable gain or loss to exist, the shares received as a result of the conversion must be sold.

A customer purchased 10 9% convertible debentures at 98. The bonds are callable at 101. The conversion ratio is 40. The bonds are called while the common is trading at $24 and the debenture is trading at 98. Which of the following options would be MOST beneficial to the customer?



A) Tender the bonds to the corporation
B) Convert the bonds and sell the common stock
C) Wait for a better offer from the corporation


D) Sell the bonds

Answer: A



The option most beneficial to the investor is tendering the bonds to the corporation for $10,100 (10 x 1010). If the bond were sold on the market, the investor would receive $9800 (10 x 980). If the bond were converted into common, the investor would receive 400 common shares that could be sold for their current price of $24 for a total of $9600 (parity of $960 x 10).

A 7% convertible debenture is selling at 101 and it is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. What must the market price of the debenture be to be at parity with the common?



A) $929
B) $920
C) $850
D) $910


Answer: B



To determine parity price of the bond, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1K/$25 = 40). Next, multiply the current price of the common by the conversion ratio. The result is the parity price of the bond (40 x $23 = $920).

PDQ Corporation has a 6 1/4% convertible preferred stock (conversion ratio of 4) outstanding. The stock has an antidilution covenant. If PDQ declares a 10% stock dividend, the antidilution covenant will adjust:



A) the par to $110
B) the par to $90
C) the conversion price to $27.50
D) the conversion price to $22.72

Answer: D



The stock is convertible at $25 ($100 par/4 shs). To determine the new conversion price, $100/4.4 shs = $22.72, or divide $25 by 110%.

A convertible corporate bond has been issued with an antidilution covenant. If the issuer declares a 5% stock dividend, which of the following are TRUE as of the ex-date?

1. Conversion ratio increases

2. Conversion ratio decreases

3. Conversion price increases

4. Conversion price decreases

Answer: 1 & 4

The bond will be convertible into 5% more shares, so the conversion price will decrease in proportion. If the conversion price is lowered, the conversion ratio must increase.

The market price of a convertible bond depends on all of the following EXCEPT:



A) the rating of the bond
B) the conversion prices of bonds from similar companies
C) the value of the underlying stock into which the bond can be converted
D) current interest rates

Answer: B



A convertible bond's current market price will be impacted by the value of the underlying stock into which the bond can be converted, current interest rates and the rating of the bond. Conversion prices are not set in competition, therefore the conversion prices of similar bonds would be of no concern regarding price.

An investor interested in acquiring a convertible bond as part of his investment portfolio would:



A) seek to minimize changes in the bond price during periods of steady interest rates.
B) want the safety of a fixed-income investment along with potential capital appreciation.
C) be interested in tax advantages available to convertible debt securities.
D) want the assurance of a guaranteed dividend on the underlying common stock.

Answer: B



An investor who wants the safety of a fixed-income investment with the potential for capital gains would be most interested in purchasing a convertible bond. However, because convertible bonds can be exchanged for common stock, their market price tends to be more volatile during times of steady interest rates than other fixed-income securities.

If an investor is faced with converting a bond into 20 shares of common stock with a CMV of $57.75 or allowing the bond to be called at 102, the investor is experiencing:



A) a forced conversion


B) a hedge


C) an arbitrage


D) a refunding call

Answer: A



If the value of the stock to be received on conversion exceeds the call price, this is essentially forcing the bondholder to convert.