Series 7 - Through Debt
If LMN, Inc. has filed for bankruptcy, in what order would interested parties be paid? Holders of secured debt. Holders of subordinated debentures. General creditors. Preferred stockholders.
A) 4, 1, 2, 3. B) 1, 3, 2, 4. C) 3, 1, 2, 4. D) 1, 2, 3, 4.
If all of the following bonds mature on September 1, 2020, which would have the highest price? A) 6-1/4% coupon at 6.10 B) 5-½% coupon at 5.50 C) 5-¾% coupon at 5.85 D) 6-¾% coupon at 6.80
Answer: A A bond that is trading at a premium has a yield to maturity that is lower than its coupon rate. Of the choices given, only the 6-1/4% coupon with a 6.10 yield to maturity is trading at a premium. The other bonds shown are either trading at a discount (their yield to maturity is higher than the coupon rate) or at par (their yield to maturity is equal to the coupon rate).
All of the following statements describe stock rights EXCEPT: A) they are most commonly offered with debentures to make the offering more attractive. B) they are short-term instruments that become worthless after the expiration date. C) they are issued by a corporation. D) they are traded in the secondary market.
Answer: A A corporation issues rights to existing shareholders to allow them to purchase enough stock, within a short period and at less than current market price, to maintain their proportionate interest in the company. Rights need not be exercised but may be traded in the secondary market. Warrants, not rights, are often issued with debentures to sweeten the offering.
A Notice of Defeasance informs bondholders that: A) the funds for the principal and the interest are in escrow. B) the purpose of the issue has been defeated and the bonds are called. C) the facility has been condemned and the bonds have been called. D) the interest and the principal will not be paid.
Answer: A A defeased issue is one in which the issuer placed U.S. government securities in the bank as collateral for the old issue.
You have a client who is about to retire and wants to rearrange his portfolio in order to have predictable income. Which of the following would NOT be a good investment vehicle? A) Income bonds. B) U.S. Treasury note. C) AA rated IDB. D) AA rated debenture.
Answer: A Income bonds, also known as adjustment bonds, are issued when a company is reorganizing and coming out of bankruptcy. Income bonds pay interest only if the company has enough income to meet the interest payment. As a result, these bonds normally trade flat, without accrued interest. Therefore, they are not suitable for customers seeking income.
Bond trust indentures are required for: A) corporate debt securities. B) municipal general obligation bonds. C) municipal revenue bonds. D) Treasury securities.
Answer: A Municipal and government bonds are exempt from the trust indenture requirement of the Trust Indenture Act of 1939. Revenue bonds are frequently issued with a trust indenture, but no legal requirement to do so exists. The Trust Indenture Act of 1939 requires that corporate bond issues of $5 million or more sold interstate must be issued with a trust indenture.
All of the following will affect the marketability of a block of corporate bonds EXCEPT: A) rating. B) bond denominations. C) block size. D) maturity.
Answer: B Block size is a key factor. Maturity is also important-shorter maturities tend to be more marketable than longer maturities. Also, the higher the rating, the more marketable the block. Bond denominations are not relevant.
All of the following statements regarding discount bonds are correct EXCEPT: A) their discounted price can indicate that the issuer's credit rating has fallen. B) they are more likely to be called than comparable premium bonds. C) at maturity they will be valued at par. D) their discounted price can indicate that interest rates have risen.
Answer: B Bonds trading at a premium have higher coupons than current interest rates and therefore are more likely to be called. Bonds trading at a discount have coupons that are lower than current interest rates and therefore less likely to be called. If rates rise, prices fall. If a bond's rating falls, it will be less attractive to investors and its price will fall as well. All bonds move toward par value as they get closer to maturity.
Which of the following taxes does NOT impact the holder of an ADR? A) Foreign income tax. B) Excise tax. C) Federal income tax. D) State income tax.
Answer: B Dividends on ADRs are subject to both federal and state income tax. In addition, the country of origin will frequently levy a tax which may be used as a credit on the investor's federal income tax return.
If ABC Corporation reports a loss for the year, it is obligated to pay interest on all of the following EXCEPT: A) convertible bonds. B) adjustment bonds. C) variable rate bonds. D) nonconvertible bonds.
Answer: B Even if a corporation reports a loss, the corporation is obligated to pay interest on all of its outstanding debt except for income (adjustment) bonds. Income, or adjustment bonds, require interest to be paid only if declared by the board of directors.
For reporting purposes, an order to sell 25 shares of an OTC equity security priced at $230 per share is: A) 25 odd lots. B) 25 round lots. C) 1 round lot. D) 1 odd lot.
Answer: B For OTC equity securities trading at or above $175 per share, 1 share is considered to be a round lot unit of trading. Therefore all last sale information will be disseminated for any transaction of one share or more.
MNO is planning to raise capital through an offering of 30-year bonds. Which call price would be most beneficial to MNO? A) 110. B) 102. C) 104. D) 106.
Answer: B MNO would benefit most from the ability to call bonds at the lowest possible price. The call feature enables MNO to buy the bonds before maturity to reduce their fixed interest costs. A call price of 102 requires the lowest call premium of the options shown.
Gargantuan Computers, Inc. (GCI) conducts a rights offering to its current shareholders at $50 per share, plus 1 right. If the current market price of GCI is $70, what is the value of one right before the stock trades ex-rights? A) 15 B) 10 C) 3 D) 5
Answer: B The stock is trading cum rights (before the ex-date). The formula to calculate the value of one right before the ex-date is follows: CMV − subscription price / Number of rights to purchase 1 share + 1. Therefore one right is valued at $10, computed as ($70 − $50) / 2 = $10.
If a customer sells a zero-coupon bond before maturity, gain or loss will be the difference between sales proceeds and: A) discounted value. B) accreted value. C) original cost. D) par value.
Answer: B Zero-coupon bonds must be accreted for tax purposes. Each year, the annual accretion is taxable to the holder. In addition, the customer may adjust the cost basis of the zero upward by the amount of the annual accretion.
Which of the following are characteristics of a REIT? It is traded on an exchange or over the counter. It is professionally managed. It passes through both gains and losses to investors. It is a type of limited partnership. A) II and III. B) III and IV. C) I and II. D) I and IV.
Answer: C A REIT shares some features with a limited partnership, but it is a different type of business entity. REITs are traded on exchanges and OTC and are professionally managed. Both REITs and limited partnerships provide pass-through of gains to investors, but REITs do not provide pass-through of losses.
If a stock is sold on November 30 when the record date for a dividend distribution is December 1, the seller is: entitled to the dividend if the trade is done regular way. not entitled to the dividend if the trade is done regular way. entitled to the dividend if the trade is done with cash settlement. not entitled to the dividend if the trade is done with cash settlement. A) II and III. B) II and IV. C) I and IV. D) I and III.
Answer: C Anyone who owns the stock on the record date will receive the dividend. In a regular way trade, the seller will still be owner of record on record date, as the trade will settle after the record date. In a cash settlement transaction, the buyer will be owner of record on record date.
The result of declining inflation on outstanding bonds would be: A) higher prices and higher yields. B) lower prices and lower yields. C) higher prices and lower yields. D) lower prices and higher yields.
Answer: C Declining inflation means declining interest rates. If interest rates decline, bond prices rise.
Which of the following would be considered funded debt? A) Commercial paper maturing in 270 days. B) Municipal revenue bonds maturing in 10 years. C) Corporate debt maturing in 10 years. D) U.S. Treasury bonds maturing in 20 years.
Answer: C Funded debt is simply another name for medium- to long-term corporate debt. If a corporate bond has 5 or more years to maturity, it is said to be funded debt of the issuer.
ABC Corporation has declared a record date of Thursday, May 17, for its next quarterly cash dividend. When is the last day the investor may purchase the stock regular way and receive the dividend? A) Wednesday, May 16. B) Thursday, May 17. C) Monday, May 14. D) Tuesday, May 15.
Answer: C In order to receive a cash dividend, an investor must be owner of record as of the close of business on record date. Because regular way settlement is 3 business days, the customer must purchase the stock no later than Monday, May 14.
A company with 20 million shares outstanding paid $36 million in dividends. If the current market value of the company's shares is $36, the current yield is A) 10% B) 15% C) 5% D) 2%
Answer: C The current yield formula is annual dividends per share divided by current market price. The dividends per share are $36 million / 20 million shares = $1.80 per share. Current yield is $1.80 / $36.00 = 5%.
A 7% convertible debenture is selling at 101, and it is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. What must the market price of the debenture be to be at parity with the common? A) $910.00. B) $929.00. C) $920.00. D) $850.00.
Answer: C To determine the parity price of the bond, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 / $25 = 40 shares). Next, multiply the current price of the common by the conversion ratio. The result is the parity price of the bond (40 shares × $23 = $920).
The current yield on a bond with a coupon rate of 7.5% currently selling at 105-½ is approximately: A) 6.5%. B) 7.5%. C) 8%. D) 7.1%.
Answer: D A bond with a coupon rate of 7.5% pays $75 of interest annually. Current yield equals annual interest amount divided by bond market price, or $75 / $1,055 = 7.109%, or approximately 7.1%.
All of the following have been recognized by the SEC under the Credit Rating Agency Reform Act as being registered with the commission to rate debt instruments. Which of the following historically has specialized in ratings for the insurance sector? A) Moody's. B) Fitch Ratings. C) Standard & Poor's. D) A.M. Best.
Answer: D A.M. Best historically has specialized exclusively on the insurance marketplace. They issue financial strength ratings measuring insurance companies' ability to pay claims and rate financial instruments issued by insurance companies, such as bonds and notes. They can issue debt and financial strength ratings for other sectors as well, under the Credit Rating Agency Reform Act.
A holder of an ADR assumes all of the following risks EXCEPT: A) foreign currency risk. B) market risk. C) political risk. D) liquidity risk.
Answer: D An American Depository Share (ADR) represents an ownership interest in a foreign domiciled company. The shares trade on the New York Stock Exchange or in the OTC. The risk of lack of liquidity is absorbed by the presence of trading on U.S. exchanges or in the OTC market. The shares are subject to market risk, political risk, and foreign currency risk.
An investor purchases an ABC Corporation convertible bond at 98 on June 18, 1997. The bond is convertible at $25 and the investor converts his bond into the stock on June 19, 1998, when the common stock is trading at $26 per share. For tax purposes, these transactions will result in: A) a $40 capital loss. B) a $40 capital gain. C) a $60 capital gain. D) neither gain nor loss.
Answer: D Converting a bond into shares of common stock does not result in tax consequences. For a taxable gain or loss to exist, the shares received as a result of the conversion must be sold.
A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of: A) 5%. B) 7.4%. C) 7.8%. D) 5.6%
Answer: D Current yield is determined by dividing annual interest payment by the current market price of the bond ($50 / $900 = 5.6%). Years to maturity is not a factor in calculating current yield.
Which of the following statements regarding real estate investment trusts are TRUE? Hybrid REITs invest in both commercial property and residential property. Some REITs hold no real property but hold mortgages on commercial property instead. All dividend disbursements made by REITs will be recognized as qualified dividends by the IRS. Dividends are taxed at the investor's ordinary income tax rate. A) II and III B) I and IV C) I and III D) II and IV
Answer: D Equity REITs can hold residential and commercial property, mortgage REITs hold mortgages on property, and hybrid REITs do both. Dividend disbursements made by the trusts are not recognized as qualified dividends and, therefore, will be taxable to the investor at their ordinary income tax rate.
ABC, Inc. will issue new stock through a rights offering. Terms of the offering are 10 rights plus $10 to purchase one new share of stock, with any fractional shares to be considered whole shares. ABC is currently trading at $13. If your customer owns 85 shares of ABC and wishes to subscribe to the new offering, how many shares can she purchase at the subscription price and how much money will be required? A) 8 shares; $80. B) 8 shares; $90. C) 9 shares; $80. D) 9 shares; $90.
Answer: D Owning 85 shares, the customer would receive 85 rights allowing the purchase of 8.5 shares. Because fractional shares are rounded up, a total of 9 shares could be purchased. Each share requires an additional $10 to purchase, therefore if the customer wants to buy the 9 shares the customer must pay a total of $90.
The common stock of ABC Corporation currently earns $3 per share. If the price-to-earnings ratio for this stock is 14, what is the current market price? A) 17. B) 21. C) 37. D) 42.
Answer: D The price-to-earnings ratio equals the market price divided by earnings per share. The PE ratio is 14, and earnings per share is $3. Therefore, the market price is 14 × $3 = $42.
The regular way ex-dividend date for cash dividends is the: A) 2nd business day following the record date. B) 2nd business day preceding the settlement date . C) 3rd business day preceding the record date. D) 2nd business day preceding the record date.
Answer: D The regular way ex-dividend date is 2 business days before the record date.
Discretion
Authority given to someone other than an account's beneficial owner to make investment decisions for the account concerning the security, # of shares or units, whether to buy or sell. The authority to decide only timing or price does not constitute discretion.
Settlement Date T+3
Corporate Securities, Muni's, Govt Agency Securities
Western Account
Divided; Each underwriter is responsible for only for its own underwriting allocation
Settlement Same Day
Money Mkt Securities Transactions settle the same day.
The Securities Act of 1933
New Issues, Full disclosure law. Requires a registration statement and Prospectus. Audited financial statements. RAD* (Registration Statement, Audited, Delineation)
Settlement Date T+1
US Govt T-Bills, T-Notes, T-Bonds, & Options
Eastern Account
Undivided: Each underwriter is allocated a portion of the issue. Leftovers are redistributed equally among underwriters.
Mr. Brown has several stock rights. Which of the following is NOT an alternative regarding these stock rights? A) Exercising. B) Redeeming them from the issuer for cash. C) Giving the rights to his son. D) Selling at the market.
Answer: B Rights are not redeemable by the issuer. They may be sold in the secondary market or be given to someone else to exercise. If exercised, rights are exchanged for an appropriate number of shares of the underlying common stock.
Which of the following corporate bonds is backed by other securities? A) Equipment trust certificate. B) Debenture. C) Collateral trust bond. D) Mortgage bond.
Answer: C Collateral trust bonds are backed by a portfolio of other securities; mortgage bonds are backed by real estate. Equipment trust certificates are backed by equipment. Debentures are backed only by the company's promise to pay.
Which of the following regarding corporate debentures are TRUE? They are certificates of indebtedness. They give the bondholder ownership in the corporation. They are unsecured bonds issued to finance capital expenditures or to raise working capital. They are the most senior security a corporation can issue. A) II and IV. B) III and IV. C) I and III. D) I and II.
Answer: C Debentures are debt securities that represent unsecured loans of the issuer. They are senior to common and preferred stock in claims against an issuer. They are issued to finance capital expenditures or raise working capital.
In a scenario of falling interest rates and a positive yield curve, assuming all to be of equal face value which of the following bonds will appreciate the most? A) 1-year bond selling at a premium B) 1-year bond selling at a discount C) 20-year bond selling at a discount D) 20-year bond selling at a premium
Answer: C In general, prices of long-term bonds are more volatile than prices of short-term bonds. Therefore, the 20-year bonds will appreciate more than the 1-year bonds when interest rates fall. Also, prices of bonds with low coupon rates tend to be more volatile than prices of bonds with high coupon rates. A bond sells at a discount when its coupon is lower than prevailing interest rates. Because of its lower coupon, the 20-year discount bond tends to appreciate more than the 20-year premium bond.
If a customer holds certificates of beneficial interest in a REIT, each of the following statements regarding this investment is true EXCEPT: A) investors receive dividends periodically. B) the certificates are publicly traded. C) the issuer must redeem certificates on shareholder request. D) a mortgage REIT represents pooled capital for real estate financing.
Answer: C REITs are not redeemed by the issuer. REITS are publicly traded units that represent either an interest in pooled capital for real estate financing or an interest in real property and that pass through income and capital gains distributions to investors. Investors who wish to liquidate their interests must sell them in the secondary market.
ABC's stock has paid a regular dividend every quarter for the last several years. If the price of the stock has remained the same over the past year, but the dividend amount per share has increased, it may be concluded that ABC's: A) current yield per share has been unaffected. B) yield to maturity has gone up. C) current yield per share has increased. D) current yield per share has decreased.
Answer: C The current yield would have increased because current yield is the income (dividend) divided by price. A higher dividend divided by the same price results in a higher yield. Stocks do not have a yield to maturity
An investor purchases a corporate bond at par to yield 5.5% to maturity. If he sells the bond at a price equivalent to a 5% yield to maturity two years later, the investor incurs: A) tax-free income. B) a capital loss. C) a capital gain. D) no taxable result at this time.
Answer: C Yields fall as bond prices rise. Because the bond is trading at a higher price than when it was purchased, its yield to maturity has dropped from 5.5% to 5%. The consequence of the sale is a capital gain, because the investor sold the bond that was purchased for par at a premium.
The following is taken from the S&P Bond Guide: FLB Zr 12 87 87-½. What is the coupon rate on this bond? A) 0.12. B) 87. C) 87.5. D) No coupon.
Answer: D FLB is the issuer, Zr means zero-coupon, 12 indicates the year of maturity (2012), 87 is the bid price ($870), and 87-½ is the asked price ($875).
Investors should always be aware of taxes applicable to investments they own. Which of the following taxes might be associated with income derived from ADRs but not income from other investments? A) Federal income tax. B) State income tax. C) Excise tax. D) Foreign income tax.
Answer: D In most countries, a withholding tax on dividends is taken at the source. To the holder of an ADR, this would be a foreign income tax. The foreign income tax paid may be taken as a credit against U.S. income taxes owed.
Which of the following terms or phrases does NOT apply to REITs? A) Managed. B) Secondary market. C) Dividends taxed at full ordinary income rates. D) Redeemable.
Answer: D REITs trade in the secondary market and are not redeemable. The real estate portfolio is actively managed, and dividends paid by REITs do not meet the requirements to be taxed as qualified dividends and are, therefore, taxed as ordinary income.
Which of the following statements regarding the economics of fixed-income securities are TRUE? Short-term interest rates are more volatile than long-term rates. Long-term interest rates are more volatile than short-term rates. Short-term bond prices react more than long-term bond prices given a change in interest rates. Long-term bond prices react more than short-term bond prices given a change in interest rates. A) I and III. B) II and III. C) II and IV. D) I and IV.
Answer: D There are two separate issues in this question: the volatility of rates and volatility of bond prices. Short-term rates are more volatile than long-term rates and move more quickly than long-term rates. Often the most volatile interest rate is the federal funds rate, which is an overnight rate of interest. Given a change in rates, long-term bond prices move more than short-term bond prices because of the compounding effect over a much longer period.
A corporate bond is quoted at 102-5/8. A customer buying 10 bonds would pay: A) $10,262.50. B) $10,025.80. C) $10,258.00. D) $10,285.00.
Answer: A Par ($1,000) × 102% = $1,020. 5/8 of one bond point ($10) = .625 × $10 = $6.25. Therefore, the quote reading 102-5/8 = $1,026.25 per bond ($1,020 + $6.25). Because we are told the customer is buying 10 bonds, we multiply $1,026.25 × 10 bonds which equals the amount the customer will need to pay in order to make the entire purchase; $10,262.50.
A convertible preferred stock issue (par value $100) is selling at $125 and is convertible into 5 shares of common stock. The conversion price of the common stock is: A) 20. B) 25. C) 100. D) 1200.
Answer: A Par value divided by conversion price equals the number of shares into which the security is convertible. If this security is convertible into 5 shares, we need to know what number goes into $100 5 times. That number is $20. The current market value of the preferred stock is unnecessary information.
Which of the following is a function of a registrar? A) Accounting for the number of shares outstanding. B) Recording the names of stockholders on the corporation's books. C) Canceling old shares. D) Transferring shares into the name of a new owner.
Answer: A The registrar's function is to ensure that the number of shares outstanding does not exceed the number accounted for on the corporation's books. The transfer agent records the names of stockholders on the corporation's books, cancels old shares, and transfers shares into a new owner's name.
All of the following statements regarding a 6% municipal bond that is puttable at par are true EXCEPT the: A) owner will receive $1,000 from the issuer when the put option is exercised. B) bond is likely to trade at a discount in the secondary market when it is puttable. C) owner would likely put the bond to the issuer when interest rates are rising. D) bond may be put to the issuer at the owner's discretion.
Answer: B Once a bond becomes puttable, the holder has the right to put the bond to the issuer at par. As a result, the bond would not trade below par in the secondary market. This effectively insulates the holder from interest rate risk-the risk that rising rates will force prices down.
Consider a municipal bond issue that has been defeased. Which of the following statements is NOT true? A) The issue is no longer considered part of the issuer's outstanding debt. B) The rating on the issue decreases. C) The marketability of the issue increases. D) The issue is now backed by U.S. government securities
Answer: B Once a municipal issue has been defeased (pre-refunded), its rating increases as it is now backed by U.S. government securities held in escrow. As the rating of a bond increases, so does its marketability. Once defeased, the issue is no longer considered part of the issuer's outstanding debt (although it will remain outstanding with interest paid until called).
Which of the following types of bonds would be characterized by decreasing interest costs to the issuer? A) Revenue bonds. B) Serial bonds. C) Term bonds. D) Limited tax bonds.
Answer: B Periodically, serial bonds pay off part of the principal through serial maturities. This eliminates the interest costs on the matured bonds.
All of the following are characteristics of a rights offering EXCEPT: A) the rights are marketable. B) the subscription period is up to 2 years. C) the subscription price is below the CMV. D) it is issued to current stockholders.
Answer: B Rights offerings are usually very short-lived (30 to 45 days).
A 7% bond is selling to yield 4-½%. The next time interest is paid, an investor who owns $10,000 face amount of the bonds will receive: A) $700. B) $350. C) $225. D) $450.
Answer: B The bond is a 7% bond. The total amount paid each year on 10 bonds is $700. The amount paid for a 6 month's interest is $350.
A convertible bond has a conversion price of $40 per share. If the market value of the bond rises to a 12½ point premium over par, which of the following are TRUE? Conversion ratio is 25:1. Conversion ratio is 28:1. Parity price of the common stock is $42. Parity price of the common stock is $45. A) II and IV. B) I and IV. C) I and III. D) II and III.
Answer: B The conversion ratio is computed by dividing par value by the conversion price ($1,000 par / $40 = 25). Parity price of the common stock is computed by dividing the market price of the convertible bond by the conversion ratio ($1,125 / 25 = $45). Or, 112½% × $40 = $45.
A customer purchases a 4% corporate bond yielding 5%. A year before the bond matures, new corporate bonds are issued at 3%, and the customer sells the 4% bond. Which of the following statements regarding the bond are TRUE? The customer bought it at a discount. The customer bought it at a premium. The customer sold it at a premium. The customer sold it at a discount. A) II and III. B) II and IV. C) I and III. D) I and IV.
Answer: C A 4% bond yielding 5% has a YTM of 5%. If a bond's yield to maturity is higher than its coupon (or nominal yield), the bond is selling at a discount to par. If interest rates decline, new bonds will be issued with lower coupons, and outstanding bonds with higher coupons will trade at a premium.
A corporation must have stockholder approval to: A) declare a 15% stock dividend. B) declare a cash dividend. C) issue convertible bonds. D) repurchase 100,000 shares of stock for its treasury.
Answer: C Stockholders are entitled to vote on the issuance of additional securities that would dilute shareholders' equity (the shareholder's proportionate interest). Conversion of the bonds would cause more shares to be outstanding, thus reducing the proportionate interest of current stockholders. Decisions that are made by the board of directors and do not require a stockholder vote include the repurchase of stock for its treasury, declaration of a stock dividend, and declaration of a cash dividend.
A 10-year bond, callable in 5 years at par, is sold at a discount. Rank the following yields from lowest to highest. Nominal yield. Current yield. Yield to call. Yield to maturity. A) IV, II, III, I. B) I, II, III, IV. C) I, II, IV, III. D) II, I, IV, III.
Answer: C "YMCA" The lowest of all yields for a discount bond is the nominal yield (coupon rate), which is a fixed percentage of par. The highest possible return to the owner of a bond purchased at a discount would occur if the bond were called before maturity, because less time must elapse for the investor to receive the discount.
Cash dividends from REITs are: A) taxed at a maximum rate for qualified dividends. B) taxed as long-term capital gains. C) not taxed. D) taxed as ordinary income.
Answer: D Cash dividends from REITs are taxed as ordinary income. A maximum rate for qualified dividends, which applies to qualified common stock dividends, does not apply to dividends from REITs.
Defeasement can be best described as a: A) refundment. B) matched sale. C) prerefunding. D) refinancing.
Pre-refunding involves issuing one bond to call an outstanding bond at a future date. When this is done, the money raised is held in escrow to redeem the outstanding bonds at a future call date. What was originally pledged to back the bonds is now replaced by the escrowed funds. The issuer no longer has to show these bonds as an obligation on its debt statement. This is known as defeasement. The escrowed funds are invested in U.S. government securities.
Balance of Trade Surplus/deficit
Surplus - More$ flowing in than out. Deficit - More$ flowing out than in. (May also occur when interest rates in another country are high because $ flows where it earns the highest return.)
In general, a corporation assumes the least risk when it obtains funds from: A) sale of income bonds. B) sale of preferred stock. C) a commercial bank. D) sale of debentures.
Answer: B Unlike the other choices, the sale of preferred stock does not entail the assumption of debt and is therefore the least risky. It is always riskier to borrow than it is to raise equity because equity does not have to be paid back.
For U.S. investors holding American Depositary Receipts (ADRs), dividends received are: A) subject to a foreign withholding tax. B) tax-free in the country of origin. C) tax-free in both the country of origin and in the U.S. D) taxed as a capital gain in the U.S.
Answer: A Any tax taken on dividends received from ADRs is taken in the country of origin. This is a foreign withholding tax for U.S. investors. The foreign withholding tax may later be taken as a credit against any U.S. income taxes owed by the U.S. investor.
Holders of common shares may generally vote on: A) whether the company should issue additional preferred stock. B) whether a cash dividend is to be declared. C) which member of the board of directors should be chairman. D) whether an administrative assistant should be promoted to management.
Answer: A Common shareholders must vote to approve the issuance of additional preferred stock because additional preferred shares dilutes the common shares' residual assets under a liquidation. Common shareholders do not vote to declare dividends. Board members select the chairman of the board. Shareholders do not get involved in the daily operational activity of the corporation.
Which of the following best describes book entry? A) The transfer of ownership is entered on the books of the issuer or the issuer's transfer agent. B) The transfer of ownership is entered on the books of the SRO. C) The transfer of ownership is entered on the books of the clearing agency. D) The transfer of ownership is entered only on the books of the buyer.
Answer: A For book-entry ownership, transfers of ownership are accounting functions in the records of the issuer or the issuer's transfer agent.
Libby sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an 11-1/4% coupon, are convertible into common stock at $10.50, and are being issued to the public at 100. The proceeds of the issue will be used specifically for purchasing new Southwest barges. Libby's concerns about the issue could include: A) she should not be concerned as the bonds will be first in liquidation. B) the issue may be junior-in-lien to another security issue. C) the new barges might sink, and the collateral would be gone. D) the company might demand that she accept common stock for her bond.
Answer: B The word "subordinated" is the key to the question. A subordinated bond has other debt holders ahead of it in the event of liquidation. The barges do not serve as collateral as the bonds are identified as debentures, and having to convert to common stock is not a threat since she is the one that will, if she desires, exercise the conversion privilege.
A customer buys an 8% bond on an 8.20 basis. If the bond is callable in 5 years at par and matures in 10 years, which of the following statements is TRUE? A) Nominal yield is higher than YTM. B) Nominal yield is higher than YTC. C) YTC is higher than YTM. D) YTC is lower than YTM.
Answer: C A bond with a YTM (basis) greater than its coupon is trading at a discount. When a bond is trading at a discount, the YTC is greater than the YTM. Nominal yield is lower than both YTM and YTC.
A corporate bond with a nominal yield of 6% is currently trading at a yield to maturity (YTM) of 5.8%. It would be accurate to state that this bond is trading at A) par. B) parity. C) a premium. D) a discount.
Answer: C If YTM is less than the nominal or coupon yield, the bond is trading at a premium.
If an investor is anticipating that the yield spread between U.S. government and BBB-rated corporate bonds will widen, the investor is expecting the U.S. economy to: A) remain flat over the coming months. B) experience volatility over the coming months. C) enter a recession over the coming months. D) expand over the coming months.
Answer: C If investors anticipate a recession, they tend to flee to quality. In this case, they would likely sell lower quality corporate bonds (forcing prices down and yields up) and use the proceeds to buy higher quality U.S. government bonds (forcing prices up and yields down). Thus, the yield spread would widen between corporate and government bonds. Yields on corporate bonds are higher than yields on U.S. government bonds to begin with. If yields on corporate bonds go up and yields on government bonds decline, the spread will widen.
A customer purchased 10 9% convertible debentures at 98. The bonds are callable at 101. The conversion ratio is 40. The bonds are called while the common is trading at $24 and the debenture is trading at 98. Which of the following options would be most beneficial to the customer? A) Wait for a better offer from the corporation. B) Sell the bonds. C) Tender the bonds to the corporation. D) Convert the bonds and sell the common stock.
Answer: C The option most beneficial to the investor is tendering the bond to the corporation for $10,100. If the bond were sold on the market, the investor would receive $9,800. If the bond were converted into common, the investor would receive 400 common shares that could be sold for their current price of $24 for a total of $9,600.
ABC Corporation, whose common stock is trading at $32, has issued $40 million of 8-1/8% debentures due 10-1-14. Each bond issued has a warrant attached enabling the holder to buy 4 shares of ABC common at $40 per share. If all of the warrants are exercised, ABC Corporation will receive: A) $12.8 million. B) $20 million. C) $6.4 million. D) $10 million.
Answer: C There are a total of 40,000 warrants outstanding ($40 million of debentures / $1,000 par value per bond). Each warrant entitles the holder to buy 4 shares of common stock. Therefore, if all warrants are exercised, holders will be purchasing 160,000 shares (4 × 40,000) at $40 per share. 160,000 × $40 = $6.4 million.
An inverted yield curve is the result of: A) investors moving from equities to debt instruments. B) investors moving from debt instruments to equity instruments. C) investors buying long-term bonds and selling short-term bonds. D) investors buying short-term bonds and selling long-term bonds.
Answer: C When investors believe that interest rates may decline soon, they seek to lock in the current rate of return by buying long-term bonds. Increased demand increases the price and causes the yields on long-term debt instruments to fall. In addition, selling short-term bonds depresses prices, causing yields to rise. As a result, the yield curve takes on a negative slope. Short-term yields are then higher than long-term yields, which is the definition of an inverted curve.
The last day that stocks can be bought for cash and still receive the dividend is: A) on the ex-date. B) the day after the record date. C) the business day prior to the regular way ex-date. D) the record date.
Answer: D A cash trade settles the same day. Stocks bought for cash on the record date will be entitled to the dividend under an exception to the 2-business day rule for regular way transactions.
If a bond has a basis price of 7%, which of the following would most likely be refunded? A) Coupon 6-½%, maturing in 2033, callable in 2013 at 100. B) Coupon 6-½%, maturing in 2033, callable in 2013 at 103. C) Coupon 7-½%, maturing in 2033, callable in 2013 at 103. D) Coupon 7-½%, maturing in 2033, callable in 2013 at 100.
Answer: D An issuer is most likely to refund the issue that will cost it the most money over the life of the issue. Always use the following order in making this choice: (1) highest coupon, (2) lowest call premium, (3) earliest call date, and (4) longest maturity.
One of your clients owns 2 different 6% corporate bonds maturing in 15 years. The first bond is callable in 5 years, while the second has 10 years of call protection. If interest rates begin to fall, which bond is likely to show a greater change in price? A) Bond with the 5-year call. B) Both will increase by the same amount. C) Both will decrease by the same amount. D) Bond with the 10-year call.
Answer: D As interest rates fall, the investor benefits from having the highest interest rate for as long as possible. The price change will not be the same for both bonds. The greater the call protection, the more likely a bond will appreciate if rates fall.
Which of the following statements regarding warrants are TRUE? They pay dividends. They are debt securities. They allow for the purchase of common stock at a fixed price. They are equity-equivalent securities. A) I and II B) II and III C) II and IV D) III and IV
Answer: D Holders of warrants have the right to buy stock from the issuer at a stated price for a specific time period. Warrants are considered equity-equivalent securities. They do not pay dividends which are only paid to stockholders, and the owner of the warrant does not own the stock until the warrant is exercised.
Smith and Co., Inc. has 1 million shares of common stock outstanding and plans to sell 200,000 new shares via a rights offering. Joe Wilson, a common stockholder, owns 200 shares of the company. How many rights will he receive in the mail, and how many rights will it take to purchase one of the new shares? A) 100 rights, 5 per share. B) 100 rights, 20 per share. C) 200 rights, 20 per share. D) 200 rights, 5 per share.
Answer: D Stockholders receive one right per share owned. Hence, Joe receives 200 rights. The purpose is to maintain shareholders' proportionate interest in the company. Since the number of shares outstanding will increase by 20%, Joe needs to purchase 40 new shares (200 / 40 = 5 rights per share)
