Financial Management Ch 19 Terms

Futures Contract

A contract to buy or sell a commodity at some specified price in the future.

Step-Up in the Conversion Price

A feature that is sometimes written into the contract that allows the conversion ratio to decline in steps over time. This feature encourages early conversion when the conversion value is greater than the call price.

Convertible Security

A security that may be traded into the company for a different form or type of security. Convertible securities are usually bonds of preferred stock that may be exchanged for common stock.

In-the-Money Warrant

A warrant that has a stock price above the current exercise price.

Out-of-the-Money Warrant

A warrant that has an exercise price above the current stock price.

Warrant

An option to buy securities at a set price for a given time period. Warrants commonly have a life of one to five years or longer and a few are perpetual.

Call Option

An option to buy securities at a set price over a specified period of time.

Put Option

An option to sell securities at a set price over a specified period of time.

Intrinsic Value

As applied to a warrant, this represents the market value of common stock minus the exercise price. The difference is then multiplied by the number of shares each warrant entitles the holder to purchase.

Diluted Earnings Per Share

EPS adjusted for all potential dilution from the issuance of any new shares of common stock arising from convertible bonds, convertible preferred stock, warrants, or any other options outstanding.

Basic Earnings Per Share

Earnings per share unadjusted for dilution. It represents net income divided by shares outstanding.

Forced Conversion

Occurs when a company calls a convertible security that has a conversion value greater than the call price. Investors will take the higher of the two values and convert the security to common stock, rather than take a lower cash call price.

Conversion Price

The conversion ratio divided into the par value. The price of the common stock at which the security is convertible. An investor would usually not convert the security into common stock unless the market price were greater than the conversion price.

Conversion Value

The conversion ratio multiplied by the market price per share of common stock.

Downside Risk

The difference between the market price and the floor value.

Conversion Premium

The market price of a convertible bond or preferred stock minus the security's conversion value

Speculative Premium

The market price of the warrant minus the warrant's intrinsic value is an example of a speculative premium.

Conversion Ratio

The number of shares of common stock an investor will receive if he or she exchanges a convertible bond of convertible preferred stock for common stock.

Exercise Price

The price at which a warrant (or other similar security) allows the investor to purchase common stock.

Pure Bond Value

The value of the convertible bond if it's present value is computed at a discount rate equal to interest rates on straight bonds of equal risk, without conversion privileges.

Options

These give the owner the right but not the obligation to buy or sell an underlying security at a set price for a given time period.

Derivative Securities

These have a value derived from an underlying security such as common stock or a government bond.

Floor Value

Usually equal to the pure bond value. A convertible bond will not sell at less than its floor value even when its conversion value is below the pure bond value.

Financial Sweetener

Usually refers to equity options, such as warrants or conversion privileges, attached to a debt security. The sweetener lowers the interest cost to the corporation.