Managerial Finance Chapter 6 and 7

What are zero coupon bonds?

A bond that makes no coupon payments, and thus is initially priced at a deep discount.

What is a preemptive rights? Why is this a beneficial shareholder right? Explain.

A preemptive right is the right to purchase new shares when they are offered. It is beneficial because it allows shareholders to own the same fraction of the company as before the new share offer.

Why can a firm go bankrupt if it is not paying interest on its bonds but not if it is not paying dividends?

Bankruptcy is not the same thing as business failure. Bankruptcy occurs when the firm is unable to meet its debt obligations. Since dividends are neither promised nor owed to creditors—they are payments to owners—not meeting them does not trigger bankruptcy.

Explain the differences between bonds and stocks (or debt and equity).

Debt: excess debt can lead to financial distress and bankruptcy (corp), not an ownership interest: Creditors do not have voting rights (low risk for holders) - meaning of bankruptcy - Debt is not an ownership interest in the firm. Creditors generally do not have voting power. Equity: Ownership: Stockholders vote to elect the board of directors and on other issues (rights and risk holders). -An all equity firm can not go bankrupt but it can fail (corp). - Equity represents ownership interest and it is a residual claim. This means that equity holders are paid after debt holders.

What risk do rating and agencies rate?

Firms frequently pay to have their debt rated. The debt ratings are an assessment of the credit worthiness of the corporate issuer. The definitions of credit worthiness used by Moody's and S and P are based on how likely the firm is to default and the protection creditors have in the event of a default.

What is the price of a stock that never pays any dividends? Explain.

If there is never any cash flow from the stock, the stock is worthless, and its price is zero.

How do we value a stock that does not pay dividends today but may do so in the future? What procedure do we follow?

Please distinguish a stock that never pays any dividend from one that currently does not pay any dividend. While the former is worthless, the latter has value, which we estimate based on the stock's per share earnings. We then multiply these earnings by a P/E ratio of similar company that pays dividends

What are the similarities and differences between preferred stock and debt?

Preferred stock is really debt in disguise, a kind of equity bond. Preferred Shareholders are only entitled to receive a stated dividend and if the corporation is liquidated, preferred shareholders are only entitled to the state vote of their preferred shares. Many new issues of preferred stock have had obligatory sinking funds. The existence of such a sinking fund effectively creates a final maturity because it means that the entire issue will be retired. For the earlier reasons, preferred stock seems like debt. Unpaid preferred dividends are not debts of the firm.

What are the similarities and differences between common and preferred stock?

Preferred stock is sometimes convertible into common stock and preferred stocks are often callable. Preferred stock differs from common stock because it has preference over common stock in the payment of dividends and in the distribution of corporation assets in the event of liquidation.

What is proxy voting? In practice, who does the voting for most shareholders?

Proxy voting occurs when shareholder empower others to vote on their behalf. Shareholders are most likely to transfer their voting rights to current management. In a proxy fight, they transfer their voting rights to those seeing to unseat current management.

What is the bid-ask spread?

The difference between the bid price and the asked price. It also represents the dealers profit.

What are the major positive and negative characteristics of preferred stock?

You can think of these characteristics as low risk and low return.It may be helpful to consider preferred stock as the lowest kind of debt, which means that the stock has no voting rights and a regular fixed coupon, which is called dividend.The instrument is thus relatively risk-free. As a result, it has no potential for capital gains.In liquidation, the stock has precedence over common stock.