Series 7: Unit 4 (Corporate Bonds)
Parity Price Steps
1. Find Conversion Ratio 2. Multiply Conversion Ratio * Price
Incandescent Bulb, Inc., recently suffered significant operating losses and is planning a bankruptcy filing. Which of the following debt issues have the most junior claim? A) Debentures B) Mortgage bonds C) Common stock D) Senior notes
A) Debentures asking about DEBT issues
A corporation with an outstanding convertible debenture issue could force conversion by A) publishing an announcement that the debenture holders have thirty days to tender their bonds at the call price. B) soliciting proxies from the common shareholders asking them to vote for mandatory conversion. C) decreasing the coupon rate on the debenture to a level where the dividend on the common stock provides a higher return. D) issuing new debentures with a higher coupon rate.
A) publishing an announcement that the debenture holders have thirty days to tender their bonds at the call price.
A customer purchases an ABC $100 par 6½% convertible preferred stock at $80. The conversion price is $20. If the common stock is trading 2 points below parity, the price of ABC common is A) $14. B) $18. C) $16. D) $12.
A)$14. 1. Conversion Ratio = (100/20) = 5 2. CS Price = (80/5) = 16 - 2 = 14
A customer owns a 7.5% ABC convertible bond currently trading at 115. The conversion price is $40. What is the parity price of the common? A) $44.00 B) $46.00 C) $28.75 D) $34.00
B) $46.00 The bond is selling at a 15% premium. To be equal to that, the stock must be selling at a 15% premium over the conversion price. $40 times 115% equals $46.
A convertible debenture has a conversion price of $40 per share. If the market value of the debenture rises to a 12.5-point premium over par, which of the following are true? Conversion ratio is 25:1 Conversion ratio is 28:1 Parity price of the common stock is $42 Parity price of the common stock is $45 A) II and III B) I and IV C) II and IV D) I and III
B) I and IV
PDQ Corporation has a 6.25% $100 par value 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 $90. B) the conversion price to approximately $22.73. C) the conversion price to approximately $27.50. D) the par to $110.
B) the conversion price to approximately $22.73. conversion price = 25
An investor purchases a bond on its initial public offering. Even though the bond has a maturity value of $1,000 in 10 years, the offering price is only $600. If this investor holds the bond until it matures, A) there is a $360 long-term capital gain and $40 in ordinary income. B) there is no reported capital gain. C) $400 is reported as ordinary income. D) there is a $400 long-term capital gain.
B) there is no reported capital gain. Phantom income taxed until maturity, when basis is fully realized.
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 is the parity price of the debenture? A) $929 B) $910 C) $920 D) $850
C) $920 1. Conversion Ratio: (1000/25) = 40 2. CS Price * Conv. Ratio = 23*40 = 920
MNOP Corporation's 4% bond is currently trading at 98⅝. That would be the price of A) $980.625. B) $98.625. C) $986.25. D) $985.80.
C) $986.25.
ABC Company issued $20 million of convertible bonds with a coupon of 5% and a current market value of 120. The conversion price is $40. If all the bonds are converted, how many additional shares of common stock will ABC have outstanding? A) 400,000 B) 1,000,000 C) 500,000 D) 600,000
C) 500,000 1. Each Bond will convert to (1,000/40) = 25 shares of common stock 2. The company issued (20,000,000/1,000) = 20,000 bonds 3. There will be (20,000*25) = 500,000 additional shares
There are many reasons to invest in a convertible bond. Which of the following is a reason to invest in a convertible bond? A) Convertible bonds can be called in early if interest rates fall, allowing you to receive your principal back faster than waiting for the bond to mature. B) Convertible bonds provide interest income that is stable, and the bonds are more marketable than nonconvertible bonds of the company that pay higher stated yields if you are seeking income. C) In a bearish equity market, convertible bonds would at least provide income and allow you to benefit from upside market movement if the equity market turns bullish later. D) In a bearish equity market, convertible bonds provide growth potential in the underlying stock, and it might actually be cheaper to obtain the stock by converting the bond into stock rather than paying commissions when buying the common stock in the market.
C) In a bearish equity market, convertible bonds would at least provide income and allow you to benefit from upside market movement if the equity market turns bullish later.
Betco Corporation had insufficient liquidity to meet its outstanding debt and was subsequently forced into bankruptcy. There were numerous lawsuits from all of the various creditors and investors against the corporation. Finally, a court settlement was reached to dissolve the company and use the remaining assets to pay off the creditors. Who most likely has the highest priority of getting paid? A) The senior executives of the corporation because being senior executives gives them the most senior claim to corporate assets B) Investors holding guaranteed bonds because guaranteed bonds provide an ironclad guarantee that the investors always get back the principal amount invested C) The attorneys representing the plaintiffs in the lawsuits against the bankrupt company D) The secured creditors because secured debt is always the most senior security
C) The attorneys representing the plaintiffs in the lawsuits against the bankrupt company when legal issues involve judicial suits, those involved in resolving the bankruptcy would not work on the case unless they would get paid. As a result, the courts usually require administrative expenses to be paid prior to even the secured creditors.
An investor owns a convertible debenture with a conversion price of $10. If a 10% stock dividend is paid on the company's common stock, which of the following is true? A) The conversion price will be adjusted to $11.00. B) The investor will receive 10 shares of the common stock. C) The conversion price will be adjusted to $9.09. D) The investor will receive 1 share of the common stock.
C) The conversion price will be adjusted to $9.09. With a conversion price of $10, the investor was able to convert into 100 shares ($1,000 divided by $10). After the 10% stock dividend, the investor must be able to convert into 10% more shares (110 shares). To get 110 shares from a $1,000 principal, the price must be reduced. The computation is $1,000 divided by 110. That equals $9.09 per share.
An investor needing current income should not receive a recommendation to purchase A) callable bonds. B) convertible bonds. C) zero-coupon bonds. D) income (adjustment) bonds.
C) zero-coupon bonds.
ABC Company issues a 10% bond due in 10 years. The bond is convertible into ABC common stock at a conversion price of $25 per share. The ABC bond is quoted at 90. Parity of the common stock is A) $100.00. B) $25.00. C) $36.00. D) $22.50.
D) $22.50. 25*.9 = 22.50
A customer purchased an ABC $3 convertible preferred stock at $60. The par value is $50 and the conversion price is $5. If the common stock is trading a half point below parity, the price of ABC common is A) $9.50. B) $4.50. C) $2.50. D) $5.50.
D) $5.50. The conversion ratio is computed by dividing par value by the conversion price ($50 par ÷ $5 = 10). Parity price of the common stock is computed by dividing the market price of the convertible by the conversion ratio ($60 ÷ 10 = $6). $6 − 0.50 = $5.50.
Which of the following would be the most likely unsuitable recommendation for a client whose objective is steady income? A) A U.S. Treasury bond B) A bank CD C) A subordinated debenture D) An income bond
D) An income bond Income bonds only pay interest when issuer's income allows it
