Series 7 Unit 4 Review

An investor purchased five bonds at 97⁵⁄₈ and sold them two years later at 102¼. This resulted in a gain of A) $49.63. B) $46.25. C) $231.25. D) $248.13.

C) $231.25. 97⁵⁄₈=$976.25 x5 = $4,881.25. 102¼ = 1022.50 x5 = $5,112.50. - $4,81.25 CG = $231.25. LO 4.d

A convertible bond has a conversion price of $50 per share. If the market value of the bond rises to a 10-point premium over par, which of the following statements is true? A) The conversion ratio is 22:1 with parity price of the common stock at $60. B) The conversion ratio is 20:1 with parity price of the common stock at $55. C) The conversion ratio is 22:1 with parity price of the common stock at $55. D) The conversion ratio is 20:1 with parity price of the common stock at $60.

Regardless of the price of the bond, the conversion ratio will always be 20:1 because $1,000 divided by $50 is 20. Parity means equal. Therefore if the bond is at a 10% premium ($1,100), the parity value of the stock will be $55 ($1,100 ÷ 20). LO 4.d

Libby sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an 7¼% coupon, are convertible into common stock at $10.50, and are being issued to the public at 100. The proceeds of the issue will be used specifically for purchasing new Southwest barges. Libby's concerns about the issue could include which of the following? A) She should not be concerned, as the bonds will be first in liquidation. B) The new barges might sink, and the collateral would be gone. C) The company might demand that she accept common stock for her bond. D) The issue may have a junior claim to another security issue.

The word subordinated is the key to the question. A subordinated bond has other debt holders ahead of it in the event of liquidation. The barges do not serve as collateral, as the bonds are identified as debentures, and having to convert to common stock is not a threat because she is the one that will, if she desires, exercise the conversion privilege. LO 4.b

When analyzing a convertible debt security, it is most likely the issue is A) a debenture. B) a convertible preferred stock. C) a zero-coupon security. D) a bond.

A) a debenture. L.O 4.c

You have a client who is about to retire and wants to rearrange his portfolio to have predictable income. Which of the following would not be a good investment vehicle? A)Income bonds B)AA-rated debenture C)U.S. Treasury note D)AA-rated IDB

A)Income bonds L.O 4.a

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 1000/40=25 1150/25=46 LO 4.d

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) 500,000 C) 600,000 D) 1,000,000

($1,000 ÷ $40). ($20,000,000 ÷ $1,000)= 500,000 additional shares (20,000 × 25) will be outstanding if all the bonds are converted. LO 4.c

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) $920 C) $910 D) $850

($1,000÷$25=40) (40 × $23 = $920). LO 4.d

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) $12. B) $14. C) $18. D) $16.

($100 ÷ $20 = 5). Parity price of the common stock is computed by dividing the market price of the convertible by the conversion ratio ($80 ÷ 5 = $16). $16 − 2 = $14. LO 4.d

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)$22.50. B)$25.00. C)$36.00. D)$100.00.

1000/25=40 900/40=22.50 L.O 4.d

An investor purchased a corporate zero-coupon bond on the offering at a price of 51. The bond matures in 17 years and has a yield to maturity of 4.04%. Seven years later, the bond is sold at a price of 73 ¾. What are the tax consequences of the sale? A) Loss of $262.50 B) Gain of $25.76 C) No gain or loss until maturity D) Gain of 227.50

B) Gain of $25.76 490 (1,000 − 510) 28.82 (490 ÷ 17 yr) 201.74 (7 × $28.82) 510+ 201.74= 711.74 73 ¾ = 737.50 737.50-711.74 = 25.76 L.O 4.e

One of your customers owns five JLO 5s of 2042. The debentures have a conversion price of $15. When the market price of the convertible is 80, the parity price of the stock is A)$18.00. B)$12.00. C)$15.00. D)$5.33.

B)$12.00. 1000/15=66.66 800/66.66=12.00 or 15 x .20 = 3 L.O 4.d

Which of the following statements regarding convertible bonds is not true? A) Convertible bondholders are creditors of the corporation. B) Coupon rates are usually lower than nonconvertible bond rates of the same issuer. C) Coupon rates are usually higher than nonconvertible bond rates of the same issuer. D) If there is no advantage to converting the bonds into common stock, they would sell at a price based on their market value without the convertible feature.

C) Coupon rates are usually higher than non convertible bond rates of the same issuer. L.O 4.c

What is the order of liquidation in the event of a corporate bankruptcy? A) Common stock, preferred stock, general creditors, senior notes B) General creditors, senior notes, preferred stock, common stock C) Senior bonds, general creditors, preferred stock, common stock D) Senior bonds, preferred stock, subordinated debt, common stock

C) Senior bonds, general creditors, preferred stock, common stock L.O 4.b

An investor purchased a new issue corporate zero-coupon bond for $600. The bond has a maturity of 20 years. Six years later, the investor sells the bond for $700. For tax purposes, this would result in A) a capital loss of $280. B) a capital gain of $20. C) a capital loss of $20. D) a capital gain of $100.

C) a capital loss of $20. 1000-600=400 400/20=20 20x6=120 600+120=720 -700 CL = (20) L.O 4.e

Which of the following statements regarding corporate zero coupon bonds are true? I. Interest is paid semiannually. II. The discount is in lieu of periodic interest payments. III. The discount must be accreted and is taxed annually. IV. The discount must be accreted annually with taxation deferred until maturity. A)II and IV B) I and III C) I and IV D) II and III

D) II and III L.O 4.a

Which the following statements concerning taxes on corporate bonds is true? A)Bonds are always considered long term so it is impossible to have short term capital gains when purchasing bonds. B)Bonds held to maturity can only have long-term capital gains. C)Short term capital gains on bonds derive from the interest income because the interest is always paid out twice in a year. D)Interest income from a corporate bond is taxed based upon ordinary income rates only.

D) Interest income from a corporate bond is taxed based upon ordinary income rates only. L.O 4.e

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 $400 long-term capital gain. B)there is a $360 long-term capital gain and $40 in ordinary income. C)$400 is reported as ordinary income. D)there is no reported capital gain.

D) no reported capital gain. L.O 4.e

The STU Corporation has issued common stock, preferred stock, promissory notes, and mortgage bonds. Should STU enter bankruptcy proceedings, the order of payment against claims would be A) the mortgage bonds, the preferred stock, the common stock, and the promissory notes. B) the preferred stock, the common stock, the mortgage bonds, and the promissory notes. C) the promissory notes, the mortgage bonds, the preferred stock, and the common stock. D) the mortgage bonds, the promissory notes, the preferred stock, and the common stock.

In a bankruptcy, secured creditors, such as those with a mortgage against real property, have the first priority. They are followed by unsecured creditors, such as holders of promissory notes, with stockholders coming last. Preferred stock is preferred over common stock in both liquidation priority and payment of dividends. LO 4.b