1) A warrant bestows on its owner the:
A) obligation to sell securities directly to the issuer at a fixed price for a stated period of time.
B) right to purchase securities directly from the issuer at a fixed price for a stated period of time.
C) obligation to purchase securities directly from the issuer at a fixed price for a stated period of
time.
D) right to sell securities directly to the issuer at a fixed price for a stated period of time.
E) right to sell securities directly to the issuer at the prior day's closing price for a stated period
of time.
Answer: B
2) Warrants are most often issued in combination with new:
A) publicly placed shares of common stock.
B) privately placed shares of common stock.
C) publicly placed bonds.
D) privately placed bonds.
E) shares of preferred stock.
Answer: D
3) The lower limit of a warrant's value is defined as:
A) zero.
B) MIN(0, Exercise price − Stock price).
C) MAX(0, Stock price − Exercise price).
D) MAX(0, Exercise price − Stock price).
E) MIN(0, Stock price − Exercise price).
Answer: C
4) The upper limit of a warrant's value is best defined as the:
A) exercise price.
B) MAX(0, Stock price − Exercise price).
C) underlying stock price.
5) Which one of the following is least apt to affect the value of a warrant?
A) Exercise price
B) Underlying stock price
C) Risk-free interest rate
D) Variance of underlying stock returns
E) Market rate of return
Answer: E
6) Bright View Windows issued warrants with an exercise price of $17. Bright View's common
stock currently sells for $16 per share. The warrants are:
A) in the money.
B) out of the money.
C) valuable.
D) not very valuable.
E) both in the money and valuable.
7) Which one of these features applies to call options but not to warrants?
A) Market value that changes
B) Value based on underlying asset
C) Absolute minimum value of zero
D) Issued by individuals
E) Exercise price
8) Which one of the following occurs whenever a warrant is exercised?
A) The issuer receives the greater of the exercise price or the stock price
B) The number of shares outstanding increases
C) Currently outstanding shares are exchanged between individual shareholders
D) A new warrant is issued to replace the exercised warrant
E) The issuer pays the lower of the exercise price or the stock price
9) Warrants generally:
A) cannot be detached.
B) expire within 30 days.
C) remain attached to their original security until the expiration date.
D) increase in value when the underlying stock price decreases.
E) have longer maturity periods than calls.
10) Concerning warrants and call options, which one of the following statements generally is
correct?
A) The issue procedures for both are quite similar.
B) When a call option is exercised, the firm must issue new stock.
C) When a warrant is exercised, existing stock changes hands.
D) Exercise of a call option does not affect share value but warrant exercise does.
E) The issuance of a call option generally decreases share value.
11) Which one of the following would harm the financial position of a warrant holder?
A) A 3-for-1 stock split
B) A 20 percent stock dividend
C) A large cash dividend
D) A listing of the warrants on the NYSE
E) A reverse stock split
12) The gain from exercising a warrant is ________ the gain from exercising a comparable call
option.
A) less than
B) generally greater than
C) always greater than
D) equal to
E) either equal to or greater than
Answer: A
13) The exercise of warrants creates new shares which:
A) increases the total number of shares but does not affect share value.
B) increases the total number of shares and can reduce the per share value.
C) does not change the number of shares outstanding, similar to options.
D) increases share value because cash is paid into the firm at the time of warrant exercise.
E) increases the number of shares outstanding while maintaining the current price per share.
14) The gain on a call is computed as:
A) [Firm's value net of debt + Exercise price(Nw)]/(N + Nw).
B) [Firm's value net of debt + Exercise price(Nw)]/N.
C) Firm's value net of debt/N − Exercise price.
D) Firm's value net of debt/(N + Nw) − Exercise price.
E) (Firm's value net of debt − Exercise price)/N.
15) The gain on a warrant is computed as:
A) {[Firm's value net of debt + Exercise price(Nw)]/(N + Nw)} − Exercise price.
B) [Firm's value net of debt + Exercise price(Nw)]/N − Exercise price.
E) (Firm's value net of debt − Exercise price)/(N + Nw).
16) The gain on a warrant compared to the gain on a similar call is expressed as:
A) (N + Nw)/N.
B) N/(N + Nw).
C) Nw/(N + Nw).
D) Nw/N.
E) 1 + (Nw/N).
17) If a corporate security can be exchanged for a fixed number of shares of stock, the security is
said to be:
A) callable.
B) convertible.
C) protected.
D) putable.
E) inflated.
18) A convertible preferred stock is similar to a convertible bond except that:
A) the conversion ratio is fixed.
B) the conversion price is fixed.
C) the time to maturity is infinite.
D) preferred stock converts to common stock while bonds convert to preferred stock.
E) preferred stock converts to bonds while bonds convert to common stock.
19) The holder of a $1,000 face value bond has the right to exchange the bond any time prior to
maturity for shares of stock priced at $50 per share. The $50 is called the:
A) conversion price.
B) stated price.
C) exercise price.
D) striking price.
E) par value.
20) Concerning convertible bonds, which one of these statements is false?
A) The value of a convertible bond can be greater than its straight bond value.
B) The value of a convertible bond may be greater than its conversion value.
C) A convertible bond can be separated into two distinct securities.
D) The coupon rate on a nonconvertible bond will generally exceed the coupon rate on an
otherwise identical convertible bond.
E) An increase in the conversion price lowers the conversion ratio.
21) A convertible bond has an option value equal to the market value of the convertible bond
minus the:
A) straight bond value.
B) conversion value.
C) conversion premium.
D) maximum of the straight bond value or conversion value.
E) minimum of the conversion value or the straight bond value.
22) A firm has experienced a significant increase in its share value. In retrospect, which one of
the following securities would generally have provided the most benefit to the firm assuming the
securities had been issued prior to the change in share value?
A) Bonds with attached warrants
B) Convertible preferred stock
C) Straight bonds
D) Convertible bonds
E) Common stock
23) A firm has experienced a significant decrease in its share value. In retrospect, which one of
24) A convertible bond:
A) generally has fewer restrictive covenants than an otherwise identical nonconvertible bond.
B) is generally issued with a higher coupon than a comparable non-convertible bond.
C) provides a greater benefit to its issuer than a straight bond if the underlying stock price rises
in the future.
D) retains its option value even after the bond matures.
E) tends to increase agency costs.
25) Convertible bonds:
A) are secured by shares of common stock.
B) require conversion on or before the bond's maturity date.
C) grant the owner the option of receiving either cash or shares of stock on conversion.
D) are generally issued by firms that have lower bond ratings than the average firm.
E) are generally granted seniority over all other bonds.
26) Assume a firm issues convertible bonds at a time when the risk of the firm is difficult to
properly assess. If the firm is subsequently determined to have low risk, then the:
A) straight bond component of the convertible bond will have high value.
B) bond should be immediately converted.
C) conversion value will always exceed the straight bond value.
D) call option of the convertible bond will have high value.
E) the firm will eliminate the conversion option.
27) Issuing convertible bonds or bonds with warrants is useful for a company of unknown risk
because:
A) risk affects the two value components of these securities in opposing ways.
B) if the firm turns out to be high risk, both the option premium and the straight bond value will
be high.
C) generally only well-established, high-grade companies issue these instruments.
D) the equity value is dependent on current risks rather than future risks.
E) these securities generally carry significant restrictive covenants.
28) Transfer or expropriation of wealth from bondholders to stockholders is less likely to occur
when:
A) subordinated straight debt is issued because the senior bondholders provide protection for the
subordinated bondholders.
B) convertible debt is issued because the equity component will reduce agency costs.
C) convertible debt is issued because the holders can more readily sue when a high-risk project is
undertaken.
D) subordinated debt is issued because monitoring is much easier when subordinated straight
debt is issued.
E) straight debt is issued because there is a clearer distinction between creditors and
shareholders.
29) Assuming market efficiency, which one of these is the least sensible explanation of why
convertibles and warrants are issued?
A) Cash flows from these securities best match the cash flows of the firm.
B) The firm is relatively large with a low level of financial leverage.
C) The securities are useful when it is costly to assess the risk of the issuing firm.
D) The securities may resolve agency problems associated with raising money.
E) The issuer has a low bond rating.
30) From the bondholder's point of view, the optimum time to convert a convertible bond is
when the bond's conversion value is:
A) less than the call price, but greater than the face value.
B) greater than the call price, but less than the straight debt's value.
C) equal to the face value.
D) less than the straight debt's value, but greater than the call price.
E) greater than the both the call value and straight bond value on the call date.
31) Based on empirical studies, firms tend to call convertible bonds when the conversion value
is:
A) less than the conversion price.
B) greater than the straight bond value.
C) greater than the call price.
D) less than the face value.
E) equal to the straight bond value.
32) Modern Windows issued warrants for one share per warrant with an exercise price of $21.
On May 1, the common stock is selling for $23 a share. The lower and upper limits on the
warrant value on this date are:
A) $0 and $23.
B) $0 and $21.
C) $2 and $21.
D) $2 and $23.
E) $21 and $23.
33) Outer Wear has 12,000 shares of stock outstanding. Each share has a .5 warrant attached.
These warrants expire today. The market value of the firm's assets net of its debt is $192,000.
One new share can be obtained for one warrant plus $18. Assuming all else held constant, what
would you expect the market price per share to be tomorrow morning when the stock market
opens?
A) $16.67
B) $15.33
C) $16.00
D) $18.00
E) $17.50
Explanation: Market value per share = Total value/Number of shares
Market value per share = $192,000/12,000
Market value per share = $16
Since the exercise price exceeds the market price, the warrants will not be exercised.
34) Westover Industries has 600,000 shares outstanding with a market value of $27 a share. Each
share has a .2 warrant attached. One warrant plus $25 can be exchanged for one new share of
stock. What will be the value of the firm if all the warrants are exercised? Assume all else held
constant.
A) $20.9 million
B) $19.2 million
C) $18.4 million
D) $18.9 million
E) $20.2 million
Explanation: Firm value = Original value + Exercise premium
Firm value = 600,000($27) + 600,000/5($25)
Firm value = $19,200,000, or $19.2 million
35) Westover Industries has 60,000 shares outstanding. Each share has one-third of a warrant
attached. One warrant plus $25 can be exchanged for one new share of stock. The stock is
currently selling for $27 per share. All else held constant, what will the stock price be if all the
warrants are exercised?
A) $26.38
B) $26.50
C) $25.00
D) $27.00
E) $26.67
Explanation: Price = Total value/Total shares
Price = [60,000($27) + 60,000/3($25)]/(60,000 + 60,000/3)
Price = $26.50
36) The Gallery has 150,000 shares and 150,000 warrants outstanding. One new share can be
purchased for every 10 warrants plus $25 per new share. The stock is currently selling for $28
per share. If all the warrants are exercised immediately, what would be the adjusted market price
of the stock?
A) $30.50
B) $25.13
C) $26.96
D) $28.00
E) $27.73
Explanation: Market price = Total value/Total shares
Market price = [150,000($28) + (150,000/10)($25)]/[150,000 + (150,000/10)]
Market price = $27.73
37) Eastern Shore Merchants has 75,000 shares and 50,000 warrants currently outstanding. A
warrant holder can purchase one new share of stock in exchange for four warrants plus $20. The
stock is currently selling for $20.60 per share. What would be the gain per new share from
exercising the warrants, assuming all warrants are exercised?
A) $.15
B) $.51
C) $.60
D) $2.40
E) $2.04
38) A firm has 600 shares of stock and 100 warrants outstanding. Assume the warrants are all
exercised. The market value of the firm's assets is $25,000 and the market value of its debt is
$8,000. Each warrant grants its owner the right to buy one new share at $27.50. What is the gain
on one warrant?
A) $.87
B) $.79
C) $.25
D) $.38
E) $.71
Explanation: Gain = [$25,000 − 8,000 + $27.50(100)/(600 + 100)] − $27.50
Gain = $.71
39) Kida Consultants has 100,000 shares of stock outstanding. The firm's value net of debt is $2
million. Kida has 1,000 warrants outstanding with an exercise price of $18, where each warrant
entitles the holder to purchase one share of stock. Calculate the gain from exercising a single
warrant.
A) $1.87
B) $1.72
C) $1.45
E) $1.98
Explanation: Gain = {[($2,000,000 + 1,000($18)]/(100,000 + 1,000)} − $18
Gain = $1.98
40) Lefty Consultants currently has 300,000 shares of common outstanding. Firm value net of
debt is $3,450,000. The firm has warrants outstanding with an exercise price of $10. How many
warrants must the firm have issued if the gain from exercising a single warrant is $1.25? Assume
each warrant entitles its owner to one new share.
A) 24,000
B) 45,000
C) 50,000
D) 80,000
E) 60,000
41) The holders of Xenron Corporation's bonds with a face value of $1,000 can exchange each of
those bonds for 35 shares of stock. The stock is selling for $22 a share. What is the conversion
price?
A) $22.00
B) $28.57
C) $35.00
D) $1.30
E) $1.27
Explanation: Conversion price = $1,000/35
Conversion price = $28.57
42) Diamond Drill has 150,000 shares of stock outstanding at a market price of $46 a share. The
holder of a $1,000 face value bond can exchange the bond at any time for 25 shares of stock.
What is the conversion price?
A) $40
B) $46
C) $43
D) $25
E) $20
Explanation: Conversion price = $1,000/25
Conversion price = $40
43) A bond with a face value of $1,000 can be exchanged for 35 shares of stock with a current
market price of $22 per share. What would the conversion ratio and conversion price be if the
bond's issuer declared a stock split of 3-for-1?
A) 75; $7.33
B) 105; $9.52
C) 105; $22.00
D) 35; $22.00
E) 105; $7.33
Explanation: New conversion ratio = 35(3)
New conversion ratio = 105
New conversion price = $1,000/105
New conversion price = $9.52
44) A bond with a face value of $1,000 can be converted into 33 shares of stock. What is the
conversion value if the stock is selling for $29.80 a share?
A) $30.30
B) $33.33
C) $983.40
D) $1,000
E) $0
Explanation: Conversion value = $29.80(33)
Conversion value = $983.40
45) The holders of Mikayla Corporation's bond with a face value of $1,000 can exchange that
bond for 30 shares of stock. What is the conversion price if the stock is selling for $28.20 a
share?
A) $25.00
C) $35.46
D) $28.20
Explanation: Conversion price = Face value/Conversion ratio
Conversion price = $1,000/30
Conversion price = $33.33
46) The holders of Mikayla Corporation's bonds with a face value of $1,000 each can exchange a
bond for 20 shares of stock. The stock is selling for $49.40 a share. What is the conversion
premium?
A) 0 percent
B) 1.33 percent
C) 1.21 percent
D) −1.33 percent
E) 1.67 percent
Explanation: Conversion premium= [($1,000/20)/$49.40] − 1
Conversion premium = .0121, or 1.21%
47) Assume a bond had a conversion price of $40 and a conversion ratio of 25. What would be
the conversion ratio and conversion price if the bond issuer declared a stock split of 4-for-1?
A) 2.50; $400
B) 100; $10
C) 25; $40
D) 6.25; $160
E) 100; $25
Explanation: New conversion ratio = 25(4/1)
New conversion ratio = 100
New conversion price = [$40(25)]/100
New conversion price = $10
48) A convertible bond is selling for $800, matures in 10 years, has a face value of $1,000, and a
coupon rate of 10 percent. Similar nonconvertible bonds are priced to yield 14 percent. The
conversion price is $32. The stock currently sells for $31.30 a share. What is the conversion
B) 1.67 percent
C) 2.50 percent
D) 3.33 percent
E) 2.24 percent
Explanation: Conversion premium = $32/$31.30 − 1
Conversion premium = .0224, or 2.24%
49) SBX bonds have a face value of $1,000 and can be exchanged for 20 shares of stock.
Assume SBX declares a 3-for-1 stock split. What conversion price will be needed following the
stock split for the conversion value and the straight bond value to be equal assuming the bond
continually sells at par?
C) $50.00
D) $150.00
E) $66.67
Explanation: Conversion value = Straight bond value = Par value
Conversion value = $1,000
Conversion price = Conversion value/Number of shares
Conversion price = $1,000/[20(3/1)]
Conversion price = $16.67
50) A convertible bond is selling for $967, matures in 15 years, has a $1,000 face value, pays
interest semiannually, and has a coupon rate of 8 percent. Similar non-convertible bonds are
priced to yield 4.25 percent per six months. The conversion ratio is 20. The stock currently sells
for $47.50 a share. Calculate the convertible bond's option value.
A) $2.92
B) $7.27
C) $2.03
D) $8.95
E) $1.48
51) A convertible bond is selling for $1,222.70. It has 10 years to maturity, a $1,000 face value, a
coupon rate of 10 percent, and semiannual interest payments. Similar non-convertible bonds are
priced to yield 4 percent per six months. The conversion ratio is 40. The stock currently sells for
$30.13 a share. Calculate the convertible bond's option value.
A) $8.68
B) $22.70
C) $13.59
D) $17.50
E) $86.80
52) A convertible bond is valued at $1,062, has a conversion ratio of 25, and an option premium
of $3. What is the conversion value if the straight bond value is equal to the bond's par value?
A) $1,062.00
B) $1,042.36
C) $1,059.00
D) $1,042.48
E) $1,065.00
53) Cooper Industries has 400,000 shares of stock outstanding with a market price of $32 a
share. The firm also has 10,000 bonds outstanding with a face value of $1,000 and a conversion
price of $40. The bonds mature tomorrow. You currently own 25,000 shares of this stock and no
bonds. What percent ownership in the firm should you expect to have after tomorrow?
A) 3.52 percent
B) 3.85 percent
C) 4.25 percent
D) 6.25 percent
E) 3.13 percent
54) Assume Jamestown Markets has 500 shares of stock and 100 bonds outstanding. The bonds
have a face value of $1,000, are convertible into 5 shares of newly issued common stock, and
mature today. What is the value of this firm to its shareholders if the total value of the firm is
$184,500? What if the value is $225,000?
A) $0; $125,000
B) $84,500; $112,500
C) $92,250; $112,500
D) $84,500; $125,000
E) $92,250; $125,000
55) A bond with a face value of $5,000 can be exchanged for 70 shares of stock. The bond has a
coupon rate of 6.5 percent which equals the market rate of interest. Assume the option premium
is $50. What is the market value of the bond if the stock is selling for $68.90 a share and the
bond matures in exactly one year?
A) $4,744.84
B) $4,873.00
C) $5,000.00
D) $4,940.00
E) $5,050.00
56) Aztec's convertible bonds each have a face value of $1,000 and a market value of $1,041.25.
Each bond can be exchanged 25 shares of stock. The stock is selling for $41.54 a share. The
straight bond value is $1,010. What is the option value per bond?
A) $0
B) $2.75
C) $3.08
D) $38.50
E) $.11
57) A convertible bond matures in 15 years, pays annual coupons, and has a coupon rate of 8
percent. The face value is $1,000 and the conversion ratio is 40. The stock currently sells for
$22.80 a share. Similar nonconvertible bonds are priced to yield 9 percent. What is the minimal
value of the convertible bond?
A) $835.00
B) $919.39
C) $1,000.00
D) $1,070.11
E) $912.00
58) Looper Industries bonds have a face value of $1,000 and can be exchanged for 30 shares of
stock. The stock is selling for $35 a share. Looper has an outstanding call option on the bonds at
$1,040. If the bonds are called, the holders must either convert or surrender their bonds. What
should be the current market value of one of these bonds if the option premium per bond is $15?
Assume the bond coupon rate equals the market rate of interest at time of call.
A) $1,040
B) $1,065
C) $1,025
D) $1,030
E) $1,035
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