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FIN 540 HOMEWORK PROBLEMS 3 STR LATEST
Question -1: Which of the following statements is most CORRECT?
1. By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firm’s common stock.
2. From the issuer’s point of view, preferred stock is less risky than bonds.
3. Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally 25 years or less.
4. Unlike bonds, preferred stock cannot have a convertible feature.
5. Preferred stock generally has a higher component cost of capital to the firm than does common stock.
Question -2: Which of the following statements about convertibles is most CORRECT?
1. One advantage of convertibles over warrants is that the issuer receives additional cash money when convertibles are converted.
2. Investors are willing to accept a lower interest rate on a convertible than on otherwise similar straight debt because convertibles are less risky than straight debt.
3. At the time it is issued, a convertible’s conversion (or exercise) price is generally set equal to or below the underlying stock’s price.
4. For equilibrium to exist, the expected return on a convertible bond must normally be between the expected return on the firm’s otherwise similar straight debt and the expected return on its common stock.
5. The coupon interest rate on a firm’s convertibles is generally set higher than the market yield on its otherwise similar straight debt.
Question -3: Which of the following statements concerning warrants is correct?
1. Warrants are long-term put options that have value because holders can sell the firm’s common stock at the exercise price regardless of how low the market price drops.
2. Warrants are long-term call options that have value because holders can buy the firm’s common stock at the exercise price regardless of how high the stock’s price has risen.
3. A firm’s investors would generally prefer to see it issue bonds with warrants than straight bonds because the warrants dilute the value of new shareholders, and that value is transferred to existing shareholders.
4. A drawback to using warrants is that if the firm is very successful, investors will be less likely to exercise the warrants, and this will deprive the firm of receiving any new capital.
Bonds with warrants and convertible bonds both have option features that their holders can exercise if the underlying stock’s price increases. However, if the option is exercised, the issuing company’s debt declines if warrants were used but remain