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Exam 16: Capital Market Financing: Hybrid and Other Securities

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Question 1

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The ABC Bank enters into a credit default swap with XYZ Financial. The notional amount of the swap is $50 million. The 5-year swap is based upon a 5-year loan to LMN Corp. The size of the protection payment is 3% per year. As LMN bankrupts during the time this swap is still valid, XYZ has paid ABC $22.5 million for settlements. What is the recovery ratio on the underlying loan?

A) 60%
B) 55%
C) 45%
D) 40%

E) C) and D)
F) A) and D)

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A

Question 2

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The conversion price of a convertible security is fixed and independent of stock market conditions.

A) True
B) False

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Question 3

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Convertible bonds typically have the characteristic of being subordinated debentures.

A convertible debenture can never sell for more than its conversion value or less than its bond value.

Orient Airlines' common stock currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2017. What is the conversion value of the bond?

Curry Corporation is setting the terms on a new issue of bonds with warrants. The bonds will have a 30-year maturity and annual interest payments. Each bond will come with 20 warrants that give the holder the right to purchase one share of stock per warrant. The investment bankers estimate that each warrant will have a value of $10.00. A similar straight-debt issue would require a 10% coupon. What coupon rate should be set on the bonds-with-warrants so that the package would sell for $1,000?

The ultimate credit risk of asset-backed securities lies with the special purpose vehicle that is the central payor.

Securitization can always improve the liquidity with respect to the securitized assets.

Upstate Water Company just sold a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?

Which of the following assets cannot be used for securitization?

Credit default swaps help protection sellers transfer all interest rate risk to the protection buyers.

Which of the following statements best describes warrants?

Chocolate Factory's convertible debentures were issued at their $1,000 par value in 2007. At any time prior to maturity on February 1, 2027, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

The following data apply to Saunders Corporation's convertible bonds: -What is the bond's conversion value?

Since warrants and convertibles give holders the right to exchange for their underlying stock, they should represent the same sources of financing.

You have paid $5 to buy a warrant with an exercise price of $40. The stock is currently trading at $50. How much profit or loss would you make by exercising the warrant if one warrant entitles the owner to buy one share of stock?

Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.

Which of the following variables will decrease the protection payment for credit default swaps?

A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.

The "misused" asset securitizations, credit derivatives, and CDOs took the blame of creating the credit crisis of 2007.