Define each of the following terms. g. Sweetener

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Define each of the following terms. g. Sweetener

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Define each of the following terms.
a. Preferred stock

Define each of the following terms.
b. Cumulative dividends; arrearages

Define each of the following terms.
c. Warrant; detachable warrant

Define each of the following terms.
d. Stepped-up price

Define each of the following terms.
e. Convertible security

Define each of the following terms.
f. Conversion ratio; conversion price; conversion value

Define each of the following terms.
g. Sweetener

Explanation & AnswerSolution by a verified expert

Explanation

The preferred stock is a type of a hybrid security which acts as a common stock and a debt security at the same time. A preferred stock is shown on the equity section of the balance sheet, these stocks do not have a maturity date and their payments are made in the form of fixed rate of dividends which are not tax deductible. All these features implies that preferred stocks can be treated as common equity.
 
However, the preferred stock also acts as debt securities wherein they have a priority of payment in case of bankruptcy over common equity. The dividend payment is an obligation for the company and they don't even have voting rights, unlike common equity.

Verified Answer

A preferred stock is a type of a financial instrument which acts as common equity in terms of accounting practices, payments in the form of fixed rate of dividends. At the same time, it also acts as a debt security, wherein preference holders are given priority over common equity in case of bankruptcy, the dividend payment is an obligation for the company, upon which it does not even get any tax deduction. Preference holders do not have any voting rights. Thus, preferred stock can be treated as hybrid securities.

Explanation

Cumulative dividend is a type of protective feature accompanied with the issue of preferred stock. In case of cumulative dividends, the payment of dividend to the preferred stock is done on priority before any payment is made to the common equity. Here, it is necessary for a company to make all the prior dividend payment to the preferred stock first.
 
Arrearages are those dividends which are not yet paid by the company to the preferred stock holders and are treated as dividends in arrears.

Verified Answer

Cumulative dividend is defined as a protective feature wherein the preferred stock is paid in full (in the form of dividends) before any dividend payment is made to the common stockholders.
 
Arrearages are the dividends which are yet to be paid by the company to its preferred stock holders.

Explanation

A warrant is a type of a call option given along with debt securities or preferred stock to sell these securities in the market at lower costs. Warrants give the investors a right to purchase a certain number of company’s stock at a predetermined strike price which is generally 20% higher than the market price at the time of issue.
 
A detachable warrant is the one which, which can be sold separately without any underlying security like debt or preference shares. They are sometimes given as non-monetary incentives to the employees of the company.

Verified Answer

A document in form of a call option wherein the investor has a right to buy a certain number of company’s stock at a strike price, which is accompanied with an underlying debt or common equity is known as a warrant.
 
A warrant which can be purchased and sold without holding any debt or common equity is known as a detachable warrant.

Explanation

When there is an increase in the strike price of a warrant with the due course of time, then such a price is said to be the stepped-up price. The main purpose of such a feature is to motivate the investors to exercise their warrants before the next price rise, in order to have more returns.

Verified Answer

A stepped-up price of a warrant is a scenario wherein the strike price increases with due course of time, with a sole objective of motivating the investors to exercise the option.

Explanation

Convertible securities are those debt securities and preferred stocks which have an option to get converted into the common equity of a company at the option of the investor. Generally, investors convert their convertibles at the time when the company is performing well and the stock price is about to increase. However, unlike warrants, the issue of these securities does not result in any additional capital for the company.

Verified Answer

The securities which can be converted into common equity of a company are known as convertibles. These securities are generally the bonds and the preferred stock of the subject company.

Explanation

Conversion ratio is defined as the ratio of the number of shares a  convertible security holder will receive, when converting the convertible securities to the common stock of the company. It is computed by dividing the par value of the security by the conversion price, which is also known as share price.
 
A conversion price is the price at which the security holders of the convertible securities convertible securities into the common equity of the company. It is computed by dividing the par value of the security by the conversion ratio or the number of shares the security holder will receive, upon conversion of a single bond.
 
The conversion value is the value that the investors receive at the time of conversion of their securities into the company’s common equity. It is computed by multiplying the company’s current stock price with the conversion ratio.

Verified Answer

The number of shares, which a convertible security holder will receive upon the conversion of a single unit of security to common equity is said to be the conversion ratio.
 
The price at which the security holder converts the per unit par value of their convertible security into the company’s equity is known as the conversion price.
 
The conversion value is what the investor receives upon conversion of the convertibles into the company’s common equity.

Explanation

When a feature is accompanied with the underlying securities at the time of issue, by the company to make the underlying more appealing to the investors, then such a feature is said to be the sweetener. Since sweeteners make the underlying security more appealing, it also benefits the company by issuing such securities at a lower cost to the investors. Warrants and convertibles can act as sweeteners for the issue of underlying debt or preferred stock.
 
In case of warrants, the company provides them along with the debt issue to make it more attractive to the investor as the investor will now be able to invest in the company’s equity also. In case of convertibles, the coupon rate is lower as compared to the straight bond because the investor can convert its securities into the company’s debt in the future. Thus, warrants and convertibles act as sweeteners for the issue.

Verified Answer

A feature which makes the issue of the underlying security look profitable for the investor, is known as a sweetener. The features are known as warrants or convertible securities.

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