Bubba buys a $4 convertible preferred with a $50 par value that is exchangeable for common stock at 47.50. If the preferred stock is trading at 52 and the common stock at 51, Bubba determines that the preferred stock is:
Answer : C
underpriced and should rise quickly. The parity price for the common stock is about $49.38 - determined as:50 / 47.50 = 1.053 52 / 1.053 = 49.38
Since the common stock is trading at 51, the preferred is underpriced.
A case of leverage is:
Answer : B
borrowing at 6% and investing the funds at 10%. Leverage is all about using money obtained at a lower cost than what can be earned deploying the funds elsewhere. It is unrelated to arbitrage.
Bubba holds 200 shares of common stock in a utility company and receives rights to subscribe to an additional 100 shares at $20. The utility company is raising
$40 million of new capital.
How many rights does Bubba receive?
Answer : D
200. In an issue of rights, there is always one right per share. Bubba owns 200 shares and thus receives the same number of rights.
Bubba holds 200 shares of common stock in a utility company and receives rights to subscribe to an additional 100 shares at $20. The utility company is raising
$40 million of new capital.
How many shares of common stock for the utility company were outstanding prior to the rights offering?
Answer : B
4,000,000. Bubba owns 200 shares and receives rights for 100 more. The basis for the rights offering is therefore one new share for each two shares outstanding. The utility company is raising $40 million by selling shares at $20. Therefore, the company is selling 2,000,000 new shares. Since the ratio of existing shares to new shares is 2 to 1, there must be 4,000,000 presently outstanding shares.
Bubba owns a perpetual warrant to buy one share of Internet Corporation common stock at $30. Internet Corporation stock is trading at 41.50 and is ex-dividend today at $0.75.
What is the market value of Bubbas warrant?
Answer : D
cannot be determined. Bubba can put away the calculator. The warrant is "perpetual" so the value is not determinable from today’s price of the common stock.
The preferred stock of Greatest Technology Corporation has a $100 par and is convertible into four shares of common stock. The preferred is trading at 104.50.
The preferred is callable at 101. If the common stock price is presently 27.89, which of the following actions would be a successful arbitrage:
Answer : B
purchase the preferred stock and sell an appropriate amount of the common stock "short exempt". Arbitrage is the nearly simultaneous purchase and sale of equal securities in different markets for a profit. Selling four shares of common stock for every one share of preferred stock purchased provides a profit.
The transactions involve the same number of common shares because the preferred is convertible to common at a four to one ratio.
Commercial paper is typically issued with a maturity date not exceeding:
Answer : C
270 days. A characteristic of commercial paper is relatively short duration, normally not exceeding 270 days.
The minimum denomination for a US treasury bond is:
Answer : B
$1,000. This is the minimum denomination. Normally, US treasury bonds are in much larger denominations.
Which of the following has the least active secondary market?
Answer : D
commercial paper. The sizes of secondary markets for these securities are listed in order with treasuries first, then bankers acceptances, followed by certificates of deposit. There is only a very small secondary market for commercial paper.
Which of the following is not classified as a money market instrument?
Answer : C
American Depository Receipts. American Depository Receipts are used to facilitate transfer of ownership in foreign securities. They are not money market instruments.
Which of the following is not a characteristic of treasury bills?
Answer : D
they mature one to three years from the date of issuance. Remember the question asks what is "not" a characteristic of treasury bills. The other choices are aspects of treasury bills, which most commonly have maturities of 90 days but never longer than one year.
Which of the following price quotes is representative of a treasury bill?
Answer : C
5.78 - 5.73. Prices for treasury bills are quoted as percentage yields. A quotation in yield means the first price in the spread - the bid price - should be higher than the offer price. A higher yield means a lower price.
Bubba want to buy a CMO. In general, how often should he expect to receive interest payments?
Answer : B
every month. Collateralized Mortgage Obligations generally pay interest each month. However, some CMOs pay interest quarterly or semiannually.
A CMO is issued that has three tranches. One has an average life of 2 years. A second has an average life of 10 years. The third has an average life of 30 years.
Initially, interest payments are distributed in this order:
Answer : D
equally to all CMO holders of any tranche. All bondholders share equally in the interest payments. Only principal payments are directed to the owners in each tranche in sequential order.
Which of the following have a stated interest rate on the face of the certificates?
Answer : D
both B and C. Treasury notes and treasury bonds have stated interest rates. Treasury bills are always sold at a discount to the face amount payable at maturity.
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