Question 1

By issuing preferred stock, and thus forfeiting bankruptcy rights from the use of debt, the venture and its investors can benefit by committing to an internal reorganization as opposed to bankruptcy reorganization.

Accepted Answer

By issuing preferred stock, the venture and its investors can benefit by committing to an internal reorganization as opposed to bankruptcy reorganization, as preferred stockholders have priority in receiving dividends and assets over common stockholders during liquidation. Additionally, preferred stock does not have the same debt obligations as a loan or bond and therefore does not provide the same bankruptcy rights.

Question 2

Convertible debt is debt that converts into preferred stock.

Accepted Answer

Convertible debt typically converts into common stock, not preferred stock, upon certain conditions being met.

Question 3

An option granting the right to sell a stock at $10 when that stock currently has a market price of $8 is "in the money."

Accepted Answer

An option granting the right to sell a stock at a price higher than the current market price is considered "in the money," because the holder can sell the stock at the option's strike price ($10) which is higher than the market price ($8), thus realizing an immediate profit.

Question 4

An option is a right to buy or sell additional shares of stock.

Accepted Answer

An option is a contract that gives the holder the right but not the obligation to buy or sell a certain number of shares of stock at a predetermined price within a certain period of time.

Question 5

If a share of preferred stock has a $10 par value, and the stock has a 2:1 conversion ratio, then the conversion price would be $5.

Accepted Answer

The conversion price is calculated by dividing the par value of the preferred stock by the conversion ratio, so $10 par value divided by 2:1 conversion ratio equals $5 conversion price.

Question 6

An American-style option is an option that can be exercised only at the expiration date.

Accepted Answer

An American-style option can be exercised at any time before the expiration date, while a European-style option can only be exercised at the expiration date.

Question 7

Common stock represents the least senior claim on a venture's assets.

Accepted Answer

Common stockholders have the least priority in receiving assets in the event of liquidation or bankruptcy, after all the creditors and preferred stockholders have been paid.

Question 8

A warrant is a type of call option.

Accepted Answer

A warrant is a type of financial derivative that gives the holder the right but not the obligation to buy shares of a company at a certain price before a certain date. This is similar to a call option, which also gives the holder the right but not the obligation to buy shares at a certain price before a certain date. Therefore, a warrant is a type of call option.

Question 9

Preferred stock is the equity claim senior to common stock and providing preference on dividends but not liquidation proceeds.

Accepted Answer

Preferred stock is senior to common stock in both dividends and liquidation proceeds, meaning preferred shareholders have priority over common shareholders for dividend payments and assets in the event of liquidation.

Question 10

A European-style option may only be exercised on a specific date.

Accepted Answer

A European-style option can only be exercised on a specific date, known as the expiration date, whereas an American-style option can be exercised at any time before the expiration date.

Question 11

Convertible notes are debt allowing for conversion into stock at a price set by a future financing round.

Accepted Answer

Convertible notes are a popular form of financing for startups, where investors provide a loan that can be converted into equity at a later date, usually at the company's next financing round. The conversion price is typically set at a discount to the valuation of the later funding round, incentivizing early investors to provide capital while taking less dilution than they would by purchasing equity outright.

Question 12

For American and Bermudan embedded options, the exercise price can change over time as specified in the security agreement.

Accepted Answer

The exercise price for American and Bermudan embedded options can change over time as specified in the security agreement. This is known as a dynamic or floating strike price.

Question 13

Convertible preferred stockholders have the right to convert a preferred share into a specified number of common shares at any time after the expiration date.

Accepted Answer

Convertible preferred stockholders have the right to convert their shares into a specified number of common shares, but this can typically be done at any time after the conversion feature becomes effective, not necessarily after an expiration date.

Question 14

For preferred noncumulative stock, all previously unpaid preferred dividends must be paid before any common stock dividend is paid.

Accepted Answer

For noncumulative preferred stock, if dividends are not declared in a given year, they do not accumulate, and shareholders are not entitled to receive missed payments in the future before common stock dividends can be paid.

Question 15

Convertible debt is debt with the option to exchange it into nonconvertible or straight debt.

Accepted Answer

Convertible debt gives the holder the option to convert it into a predetermined number of shares of the issuer's common stock, not into nonconvertible or straight debt.

Question 16

A call option is the obligation to purchase a specific asset at a predetermined price.

Accepted Answer

A call option is the right, but not the obligation, to purchase a specific asset at a predetermined price.

Question 17

Options generally have no effect on the value of a venture capital investment.

Accepted Answer

Options can have an effect on the value of a venture capital investment as they can provide additional rights or benefits to the holder, which can impact the overall valuation of the company. For example, if an option gives the holder the right to purchase shares at a discounted price, this can affect the dilution of existing shareholders and potentially decrease the overall value of the investment.

Question 18

If a call option can be bought for $12 and the stock's market value is $12, it's said to be "at the money."

Accepted Answer

An option is said to be at the money when the strike price of the option is equal to the current market price of the underlying security. In this case, the call option with a strike price of $12 and a market value of $12 is at the money.

Question 19

A preemptive right is a right for existing owners to buy sufficient shares to preserve their ownership share.

Accepted Answer

A preemptive right allows existing shareholders to purchase enough additional shares to maintain their percentage of ownership before they are offered to the public. This is a common protection for existing shareholders in the event that the company issues new shares to raise capital.

Question 20

An option not currently worth exercising is said to be "out of the money."

Accepted Answer

When the strike price of an option is not favorable compared to the current market price of the underlying asset, the option is considered "out of the money." Therefore, it is not worth exercising at the current time.

Quiz 14: Security Structures and Determining Enterprise Values