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1. Convertible Securities
1. What is a convertible security? A convertible security is Critical Concept The owner receives a fixed rate of income from the bond or preferred stock before converting.
2. Terminology. The _____ Key Term is the number of shares of stock into which the convertible security can be converted. Key Term is the stock price multiplied by the conversion ratio. Conversion price is the par value divided by the conversion ratio. Conversion premium is the difference between the market value and the conversion value.
3. Value of the Convertible Security. Due to the fixed income portion of the security, the value does not drop as much as the value of the underlying common stock if the price goes down. If the price goes up, the owner of the convertible does not have as much upside potential. Holders of convertible securities have less downside risk and also less upside potential.
4. Advantages and Disadvantages of Convertible Securities to the Corporation. Convertible securities have a number of advantages and disadvantages to the Corporation. See Advantages and Disadvantages of Convertible Securities (73.0K)
5. Forcing Conversion. A corporation can force conversion through a call provision, much like that for a corporate bond.
6. Accounting for Convertible Securities. On the income statement, the earnings per share do not reflect the effect of convertible securities. You must calculate diluted earnings per share and compare to basic earnings per share to determine the effect of convertible securities.
2. Warrants
1. What is a warrant? A warrant is ________ Key Term. They are sometimes used to sweeten a bond offering for firms who might not otherwise have access to the capital markets. Warrants can be detached from the underlying bond issue and have value of their own. They are highly speculative securities because their value is dependent on market movements.
2. Advantages and Disadvantages of Warrants to the Corporation. See Slide Advantages and Disadvantages of Convertible Securities (73.0K)
3. Value of Warrants. The value of a warrant can be calculated as follows: See Slide 4 (56.0K)
4. Use of Warrants by Corporations. Warrants have a number of possible uses by corporations. See Slide Use of of Warrants in Corporate Finance (75.0K)
3. Derivative Securities
1. What is the definition of a derivative security? A derivative security is a security whose value is derived from the underlying stock.
2. Options. An option is a ______ Key Term. A put option gives the owner the right to sell. See Slide Options (53.0K)
3. Futures contracts. Futures contracts give the owner the right, but not the obligation, to buy or sell the underlying security or commodity at a future date. Futures contracts are frequently used for trading in commodities and interest rate securities.