Mixed/Difficult

Question 1

Convertible bond

Answer 1

• Convertible bond:
• yields interest payments, but can be converted into a predetermined number of common stock
• can be done at certain times during the bond’s life
• Warrants:
• Similar to options, but generally issued by company itself, not a third party, and traded over-the-counter more often than on an exchange
• Investors cannot write warrants like they can options
• Unlike options, warrants are dilutive

Question 2

Types Of Warrants

Answer 2

• Traditional warrants: Issued with bonds (warrant-linked bonds), as a sweetener - are often detachable, can also be issued in conjunction with preferred stock
• Wedded or wedding warrants are not detachable, and the investor must surrender the bond or preferred stock the warrant is “wedded” to in order to exercise it
• Covered warrants are issued by financial institutions rather than companies, so no new stock is issued when covered warrants are exercised.

Question 3

Black-Scholes model

Answer 3

• 5 input variables: strike price of an option, current stock price, time to expiration, risk-free rate, and volatility
• Standard BSM model only used for European options, as American options could be exercised before the expiration date
• Developed in 1973 by Fischer Black, Robert Merton, and Myron Scholes
• Black-Scholes Assumptions: No dividends, markets are random, no transaction costs and rf rate & volatility are known and constant

Question 4

Debenture

Answer 4

• Type of bond or other debt instrument that is unsecured by collateral
• Rely on the creditworthiness and reputation of the issuer for support
• Used by corporations and governments and usually has a term greater than 10 years

Question 5

Price to Tangible Book Value (PTBV)

Answer 5

The tangible book value number includes all physical assets but excludes intangible assets such as goodwill, patents, intellectual property, and trademarks.

Question 6

Capitalization rate

Answer 6

The capitalization rate is calculated by dividing a property’s net operating income by the current market value. This ratio, expressed as a percentage, is an estimation of an investor’s potential return on a real estate investment.

Question 7

Zero-beta portfolio

Answer 7

A zero-beta portfolio is a portfolio constructed to have zero systematic risk, or in other words, a beta of zero. A zero-beta portfolio would have the same expected return as the risk-free rate.