Question

A corporation has issued $100 par, 8% cumulative convertible preferred stock, callable at par. The preferred is convertible into 1.4 shares of common stock. Currently, the preferred stock is trading at $102 while the common stock is trading at $75.50. The corporation calls the preferred stock at par plus accrued dividends of $2 per share. If a customer buys 100 preferred shares, converts, and then sells the common stock in the market, the profit is (ignoring commissions):_________
a. tender offer
b. forced conversion
c. advance refunding
d. simultaneous transaction

Answer 1

a. The profit the investor made when he sold the common stock shares in the market is $370.

b. The investor sold the 140 common stock shares through a. tender offer.

A tender offer is made when the investor is approached by another investor in the open market to buy the 140 common stock shares.  In this instance, the shares are sold at the prevailing market price.

Data and Calculations:

Par value of cumulative convertible preferred stock = $100

Dividend rate per year = 8%

Current price of preferred stock = $102

Number of shares of preferred stock bought = 100

Total cost of purchase = $10,200 (100 x $102)

Sales price of common stock = $75.50

Number of common stock shares converted = 140 (100 x 1.4)

Sales proceeds from sale of common stock = $10,570 ($75.50 x 140)

Profit made by investor = $370 ($10,570 - $10,200)

Thus, the sale of the common stock shares was not by forced conversion, advance refunding, simultaneous transaction, but by a tender offer.

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