Financial Markets and types of securities
The call provision in some bond indentures allows A. The issuer to exercise an option to redeem the bonds. B. The issuer to pay a premium in order to prevent bondholders from redeeming bonds. C. The bondholder to redeem the bond early by paying a call premium. D. The bondholder to exchange the bond, at no additional cost, for common shares.
Answer A is correct. A call provision allows the bond issuer to exercise an option to redeem the bonds earlier than the specified maturity date
Which one of the following statements is true when comparing bond financing alternatives? A. A call provision is generally considered detrimental to the investor. B. A convertible bond must be converted to common stock prior to its maturity. C. A call premium requires the investor to pay an amount greater than par at the time of purchase. D. A bond with a call provision typically has a lower yield to maturity than a similar bond without a call provision
Answer A is correct. A callable bond can be recalled by the issuer prior to maturity. A call provision is detrimental to the investor because the issuer can recall the bond when market interest rates decline. It is usually exercised only when a company wishes to refinance high-interest debt.
If the interest rate on newly issued bonds increases due to expected inflation, which one of the following will most likely occur? A. The price of common stocks will fall. B. The price of existing bonds will likely increase. C. The price of preferred shares will likely increase. D. The required return on common stocks will decrease.
Answer A is correct. Higher interest rates on bonds will lead to an increased demand for bond investments, which subsequently decreases the demand for common stock. Also, companies will pay more in interest and will thus have less money for dividends. Both of these factors cause the price of the common stocks to fall.
Which one of the options below best describes a public offering where there is less price uncertainty due to the existence of a benchmark price? A. A subsequent or secondary offering. B. Shelf registration. C. An initial public offering. D. A red herring registration.
Answer A is correct. Later issues of stock by the same company are subsequent offerings. Secondary markets provide for the trading of previously issued securities. The sale of the stock in the primary market can be used as a benchmark because the same type of securities were already issued in this market.
Which one of the following describes a disadvantage to a firm that issues preferred stock? A.Preferred stock is usually sold on a higher yield basis than bonds. B.Most preferred stock is owned by corporate investors. C.Preferred stock typically has no maturity date. D.Preferred stock dividends are legal obligations of the corporation.
Answer A is correct. Preferred stock must usually be sold on a higher yield basis than bonds because preferred stock stands behind bonds in priority at liquidation. An incentive must therefore be added to induce investors to purchase preferred stock. Since preferred stock is a riskier investment than bonds, investors demand a risk premium.
Confidential negotiations between Company A and Company B were completed this morning. It was decided that in 1 week, it will be publicly announced that Company A will acquire Company B for a cash offer of a 30% premium over Company B's current market price. If the stock price of Company B does not react at all today but rises by 30% with the public announcement next week, this implies that the market is A. Semi-strong form efficient but is not strong form efficient. B. Strong form efficient but is not semi-strong form efficient. C. Strong form efficient but is not weak form efficient. D. Weak form efficient but is not semi-strong form efficient.
Answer A is correct. Semi-strong form implies that all publicly available information is reflected in security prices. The 30% increase at the declaration of the merger shows that this is the case. Strong form implies that all public and private information is reflected in security prices. Since the stock price did not change when the deal occurred privately, this is not strong form efficient.
The risk to which all investment securities are subject is known as A. Systematic risk. B. Unsystematic risk. C. Diversifiable risk. D. Credit risk.
Answer A is correct. Systematic risk, also called market risk, is the risk faced by all firms. Changes in the economy as a whole, such as the business cycle, affect all players in the market. For this reason, systematic risk is sometimes referred to as undiversifiable risk. Since all investment securities are affected, this risk cannot be offset through portfolio diversification.
Systematic risk explains why A. Stock values tend to move in the same direction. B. Diversification reduces overall risk. C. Stock values move in different directions. D. Diversification increases overall risk.
Answer A is correct. Systematic risk, also called market risk, is the risk faced by all firms. Changes in the economy as a whole, such as the business cycle, affect all players in the market. Since all firms are affected by systematic risk, all of their stock values move somewhat in the same direction.
A stock began the year with a stock price of $60 per share. In the middle of the year, it had a 3-for-2 stock split. The stock ended the year with a price of $50 per share. No dividends were paid. What total return did investors earn on the stock during this year? A. 25% B. 15% C. -20% D. 30%
Answer A is correct. The 3-for-2 stock split would revalue the beginning of the year stock price. There are now three shares at x stock price for every two at $60: 3x = 2 × $60 3x =$120 x =$40 The stock appreciated $10 to $50 by year end. Therefore, the return was 25% ($10 increase ÷ $40 beginning of year stock price).
Which of the following classes of securities are listed in order from lowest risk/opportunity for return to highest risk/opportunity for return? A. U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock. B. Preferred stock; common stock; corporate mortgage bonds; corporate debentures. C. Corporate income bonds; corporate mortgage bonds; convertible preferred stock; subordinated debentures. D. Common stock; corporate first mortgage bonds; corporate second mortgage bonds; corporate income bonds.
Answer A is correct. The general principle is that risk and return are directly correlated. U.S. Treasury securities are backed by the full faith and credit of the federal government and are therefore the least risky form of investment. However, their return is correspondingly lower. Corporate first mortgage bonds are less risky than income bonds or stock because they are secured by specific property. In the event of default, the bondholders can have the property sold to satisfy their claims. Holders of first mortgages have rights paramount to those of any other parties, such as holders of second mortgages. Income bonds pay interest only in the event the corporation earns income. Thus, holders of income bonds have less risk than shareholders because meeting the condition makes payment of interest mandatory. Preferred shareholders receive dividends only if they are declared, and the directors usually have complete discretion in this matter. Also, shareholders have claims junior to those of debtholders if the enterprise is liquidated.
Which one of the following statements concerning debt instruments is correct? A. For long-term bonds, price sensitivity to a given change in interest rates is greater the longer the maturity of the bond. B. A bond with 1 year to maturity would have more interest rate risk than a bond with 15 years to maturity. C. A 25-year bond with a coupon rate of 9% and 1 year to maturity has more interest rate risk than a 10-year bond with a 9% coupon issued by the same firm with 1 year to maturity. D. The coupon rate and yield of an outstanding long-term bond will change over time as economic factors change.
Answer A is correct. The longer a bond's term, the more time there is for interest rate volatility to affect a bond's price, and thus the more sensitive is its price to interest rate changes.
An investor is currently holding income bonds, debentures, subordinated debentures, and first-mortgage bonds. Which of these securities traditionally is considered to have the least risk? A. Subordinated debentures. B. First-mortgage bonds. C. Debentures. D. Income bonds.
Answer B is correct. A mortgage bond is secured with specific fixed assets, usually real property. Thus, under the rights enumerated in the bond indenture, creditors will be able to receive payments from liquidation of the property in case of default. In a bankruptcy proceeding, these amounts are paid before any transfers are made to other creditors, including those preferences. Hence, mortgage bonds are less risky than the others listed.
From an investor's viewpoint, the least risky type of bond in which to invest is a(n) A. Debenture bond. B. Secured bond. C. Deep discount bond. D. Income bond.
Answer B is correct. A secured bond is backed by tangible property, making it the safest type for the investor of the four listed.
Which one of the following lists properly ranks financial instruments in order from the highest risk/opportunity for return to the lowest risk/opportunity for return? A. Common stock, preferred stock, income bonds, mortgage bonds, debentures, U.S. Treasury bonds. B. Common stock, preferred stock, income bonds, debentures, mortgage bonds, U.S. Treasury bonds. C. Preferred stock, common stock, income bonds, debentures, mortgage bonds, U.S. Treasury bonds. D. Common stock, preferred stock, debentures, mortgage bonds, income bonds, U.S. Treasury bonds.
Answer B is correct. Common shareholders are the residual owners of a corporation; they stand last in order of priority during liquidation, but they have the right to receive distribution of excess profits. Preferred shareholders stand ahead of common shareholders in case of liquidation, but their potential returns are capped by the board of directors. Income bonds, debentures, mortgage bonds, and U.S. Treasury bonds are all debt securities, meaning the issuer is legally obligated to redeem them. Because these returns are guaranteed, they are lower than those for equity investments. Income bonds pay a return only if the issuer is profitable, debentures are unsecured, mortgage bonds are secured by real property, and U.S. Treasury bonds are backed by the full faith and credit of the United States government.
All of the following are characteristics of preferred stock except that A. It may be converted into common stock. B. Its dividends are tax deductible to the issuer. C. It usually has no voting rights. D. It may be callable at the option of the corporation.
Answer B is correct. Dividends on stock, whether common or preferred, are not deductible for tax purposes.
If a bond sells at a premium, the A. Bond purchase price must be more than the fair market value of the bond. B. Nominal rate must be less than the yield rate. C. Stated coupon rate must be more than the required market rate. D. Stated coupon rate must be less than the required market rate.
Answer C is correct. If the stated, or coupon, rate of a bond is higher (lower) than the effective, or market, rate on the date of issue, the bonds sell at a premium (discount).
Prior to the introduction of the euro, a U.S. corporation was in possession of accounts receivable denominated in Deutsche marks. To what type of risk were they exposed? A. Price risk. B. Exchange-rate risk. C. Business risk. D. Liquidity risk.
Answer B is correct. Exchange-rate risk is the risk that a foreign currency transaction will be negatively exposed to fluctuations in exchange rates. Because the U.S. corporation sells goods to German customers and records accounts receivable denominated in Deutsche marks, the corporation is exposed to exchange-rate risk.
The best example of a marketable security with minimal risk would be A. Stock options of a AAA-rated company. B. The commercial paper of a AAA-rated company. C. The common stock of a AAA-rated company. D. Municipal bonds.
Answer B is correct. Of the choices given, the commercial paper of a top-rated (most creditworthy) company has the least risk. Commercial paper is preferable to stock or stock options because the latter represent only a residual equity in a corporation. Commercial paper is debt and thus has priority over stockholders' claims. Also, commercial paper is a very short-term investment. The maximum maturity allowed without SEC registration is 270 days. However, it can be sold only to sophisticated investors without registration.
Political risk may be reduced by A.Refusing to pay higher wages and higher taxes. B.Making foreign operations dependent on the domestic parent for technology, markets, and supplies. C.Financing with capital from a foreign country. D.Entering into a joint venture with another foreign company.
Answer B is correct. Political risk is the risk that a foreign government may act in a way that will reduce the value of the company's investment. Political risk may be reduced by making foreign operations dependent on the domestic parent for technology, markets, and supplies. If the foreign operations depend on the domestic parent for technology, markets, and supplies, the foreign government is less likely to have negative effects on foreign operations.
The treasurer of a major multinational company needs to borrow $50 million to finance new production facilities. The treasurer is deciding between direct financing or a public offering. All of the following statements in regard to these two alternatives are correct except that A. The rating assigned by Standard & Poor's or Moody's is critical in pricing public debt. B. Public debt tends to have higher interest rates because of its lower liquidity. C. Private debt is issued to sophisticated investors such as insurance companies. D. Public debt needs to be registered with the SEC, a time-consuming and costly process.
Answer B is correct. Public debt tends to have lower interest rates because of its higher liquidity.
The risk of a single stock is A. Interest rate risk. B. Security risk. C. Market risk. D. Portfolio risk.
Answer B is correct. Security risk is the risk of a single stock, whereas portfolio risk is its risk if it is held in a large portfolio of diversified securities. Portfolio risk therefore includes diversifiable and undiversifiable risk.
A corporation issued convertible bonds with a par value of $1,000. The corporation's stock is selling at $38.00 per share, and the current market price of the convertible bonds is $1,050. If the conversion ratio is 25, what will be the conversion price? A. $27.63 B. $40.00 C. $38.00 D. $42.00
Answer B is correct. The formula for conversion ratio is the par value of the convertible bond divided by the conversion price. Therefore, the conversion price can be calculated as follows: Conversion ratio = Par value of the convertible bond ÷ Conversion price 25 =$1,000 ÷ Conversion price Conversion price =$1,000 ÷ 25 = $40
The marketable securities with the least amount of default risk are A. Federal government agency securities. B. U.S. Treasury securities. C. Commercial paper. D. Repurchase agreements.
Answer B is correct. The marketable securities with the lowest default risk are those issued by the federal government because they are backed by the full faith and credit of the U.S. government and are therefore the least risky form of investment.
What variable is measured on the horizontal axis of the yield curve? A. Yield of the bonds. B. Years to maturity of the bonds. C. Par value of the bonds. D. Duration of the bonds.
Answer B is correct. The term structure of interest rates is the relationship between yield to maturity and time to maturity. The yield curve is graphed with interest rate as the vertical axis and years to maturity as the horizontal axis.
The CFO of a publicly traded company is expecting to pay a dividend next year of $1.25 and projecting that the price of the company's stock will be $45 in 1 year. The CFO has determined that the required rate of return for the company is 10%. Based on the data available, what is the value of one share of stock today? A.$46.25 B.42.05 C.$51.39 D.$45.00
Answer B is correct. The value of one share of stock today is the price of the stock at the end of the year plus the dividend received, discounted back 1 year by the required rate of return. Thus, the value of the stock at the end of the year is $46.25 ($45 plus the $1.25 dividend). This must be discounted back to today to equal $42.05 ($46.25 ÷ 1.10).
Which of the following statements is not correct with regard to initial public offerings (IPOs)? A. In a best-efforts offering, the underwriter has no obligation to purchase unsold shares. B. In an underwritten offering, the underwriter has an obligation to purchase all unsold shares. C. Best-efforts offerings provide the firm with the greater assurance that all offered shares will be sold. D. More risky stock offerings are done on a best-efforts basis.
Answer C is correct. Best-efforts offerings do not provide the firm with greater assurance that all offered shares will be sold. It is a best-efforts only offering. Thus, there can be no assurance that any or all of the shares being offered will be sold.
In practice, dividends A. Are usually changed every year to reflect earnings changes. B. Fluctuate more widely than earnings. C. Usually exhibit greater stability than earnings. D. Tend to be a lower percentage of earnings for mature firms.
Answer C is correct. Dividend policy determines the portion of net income distributed to stockholders. Corporations normally try to maintain a stable level of dividends, even though profits may fluctuate considerably, because many stockholders buy stock with the expectation of receiving a certain dividend every year. Thus, management tends not to raise dividends if the payout cannot be sustained. The desire for stability has led theorists to propound the information content or signaling hypothesis: A change in dividend policy is a signal to the market regarding management's forecast of future earnings. This stability often results in a stock that sells at a higher market price because stockholders perceive less risk in receiving their dividends.
A requirement specified in an indenture agreement that states that a company cannot acquire or sell major assets without prior creditor approval is known as a A. Warrant. B. Put option. C. Protective covenant. D. Call provision.
Answer C is correct. Restrictive covenants, also known as protective clauses, in bond indentures are intended to prevent the issuer form taking actions not in the bondholders' best interests. A trustee may be appointed to monitor compliance.
An analyst in the accounting department gathered the following data on the stock portfolio portion of a university's endowment pool: Stock A Amount Invested: €1,000,000 Expected Return: 10% Beta: 0.80 Stock B Amount Invested: 250,000 Expected Return: 15% Beta: 1.40 Stock C Amount Invested: 3,000,000 Expected Return: 8% Beta: 0.95 Stock D Amount Invested:450,000 Expected Return: 12% Beta: 1.50 Stock E Amount Invested:2,500,000 Expected Return: 4% Beta: 1.00 Based on the above data, the analyst calculated the expected return on the stock portfolio to be A. 49.0% B. 9.8% C. 7.4% D. 58.6%
Answer C is correct. The expected return on the stock portfolio is calculated by dividing the return on investment by the amount invested. The return on investment is calculated as €100,000 (€1,000,000 × 10%) 37,500 (€250,000× 15%) 240,000 (€3,000,000× 8%) 54,000 (€450,000× 12%) +100,000= (€2,500,000× 4%) €531,500 The amount invested sums to €7,200,000. Thus, the expected return is 7.4% (€531,500 ÷ €7,200,000).
The residual theory of dividends argues that dividends A.Are necessary to maintain the market price of the common stock. B.Are irrelevant. C.Can be paid if there is income remaining after funding all attractive investment opportunities. D.Can be forgone unless there is an excess demand for cash dividends.
Answer C is correct. The residual theory of dividends holds that the amount (residual) of earnings paid as dividends depends on the available investment opportunities and the debt-equity ratio at which cost of capital is minimized. The rational investor should prefer reinvestment of retained earnings when the return exceeds what the investor could earn on investments of equal risk. However, the firm may prefer to pay dividends when investment opportunities are poor and the use of internal equity financing would move the firm away from its ideal capital structure.
An investment in available-for-sale securities is measured on the statement of financial position at the A. Accumulated income less accumulated dividends since acquisition. B. Cost to acquire the asset. C. Fair value. D. Par or stated value of the securities.
Answer C is correct. Under U.S. GAAP, available-for-sale securities are investments in debt securities that are not classified as held-to-maturity or trading securities and in equity securities with readily determinable fair values that are not classified as trading securities. They are measured at fair value in the balance sheet.
The risk of loss because of fluctuations in the relative value of foreign currencies is called A. Multinational beta. B. Undiversifiable risk. C. Exchange rate risk. D. Expropriation risk.
Answer C is correct. When amounts to be paid or received are denominated in a foreign currency, exchange rate fluctuations may result in exchange gains or losses. For example, if a U.S. firm has a receivable fixed in terms of units of a foreign currency, a decline in the value of that currency relative to the U.S. dollar results in a foreign exchange loss.
When determining the amount of dividends to be declared, the most important factor to consider is the A. Expectations of the shareholders. B. Future planned uses of retained earnings. C. Future planned uses of cash. D. Impact of inflation on replacement costs.
Answer C is correct. When determining the amount of dividends to be declared, the most important factor to consider is the future planned uses of cash. If the monies that would have been paid out in the form of excess dividends could provide the equity holders a higher return if employed in some productive capacity, a rational investor should not expect the excess payout.
Which one of the following is a debt instrument that generally has a maturity of 10 years or more? SubmitA. A chattel mortgage. Graded SubmitB. A financial lease. SubmitC. A note. Correct SubmitD. A bond.
Answer D is correct. A bond issue is a complex process, filled with legal and regulatory requirements. Entities rarely go to the trouble of preparing a bond issue if they expect to be able to retire the debt within 10 years.
The equity section of a Statement of Financial Position is presented below. Preferred stock, $100 par: $12,000,000 Common stock, $5 par: 10,000,000 Paid-in capital in excess of par: 18,000,000 Retained earnings: 9,000,000 Net worth: $49,000,000 The common shareholders have preemptive rights. If an additional 400,000 shares of common stock are issued at $6 per share, a current holder of 20,000 shares of common stock must be given the option to buy A. 1,000 additional shares. B. 3,774 additional shares. C. 3,333 additional shares. D. 4,000 additional shares.
Answer D is correct. Common shareholders usually have preemptive rights, which means they have first right to purchase any new issues of stock in proportion to their current ownership percentages. The purpose of a preemptive right is to allow stockholders to maintain their current percentages of ownership. Given that the corporation had 2,000,000 shares outstanding ($10,000,000 ÷ $5 par), an investor with 20,000 shares has a 1% ownership. Hence, this investor must be allowed to purchase 4,000 (400,000 shares × 1%) of the additional shares.
A firm plans to issue mortgage bonds subject to an indenture. Which of the following restrictions or requirements are likely to be contained in the indenture? Receiving the trustee's permission prior to selling the property. Maintain the property in good operating condition. Insuring plant and equipment at certain minimum levels. Including a negative pledge clause. A. I and IV only. B. I, III, and IV only. C. II and III only. D. I, II, III and IV.
Answer D is correct. Mortgage bonds are pledges of certain assets for a loan. They are usually secured by real property. The bond issuer would usually (i) not be allowed to sell the secured property without receiving permission from the bond trustee, (ii) be required to maintain the property in good operating condition, (iii) insure the property against loss, and (iv) not be allowed to pledge the property as security for any other loan.
An analyst is in the process of reviewing the following information on a publicly traded toy manufacturer: Share price for the last 20 years 10-Q filings for the last 5 years 10-K filings for the last 15 years Website for the toy company The above collection of data is an example of which of the following? A. Strong form of the efficient market theory. B. Weak form of the capital asset pricing theory. C. Semi-weak form of the capital asset pricing theory. D. Semi-strong form of the efficient market theory.
Answer D is correct. Prices reflect all publicly available information, such as the share price, 10-Q filings, and 10-K filings for previous years as well as the company's website in a semi-strong efficient market.
In capital markets, the primary market is concerned with the provision of new funds for capital investments through A.New issues of bond and stock securities and exchanges of existing bond and stock securities. B.The sale of forward or future commodities contracts. C.Exchanges of existing bond and stock securities. D.New issues of bond and stock securities.
Answer D is correct. The primary market is the market for new stocks and bonds. In this market, wherein investment money flows directly to the issuer, securities are initially sold by investment bankers who purchase them from issuers and sell them through an underwriting group. Later transactions occur on securities exchanges or other markets.
One type of risk to which investment securities are subject can be offset through portfolio diversification. This type of risk is referred to as A. Undiversifiable risk. B. Market risk. C. Liquidity risk. D. Company risk.
Answer D is correct. Unsystematic risk, also called company or diversifiable risk, is the risk inherent in a particular investment security. Since individual securities are affected by the particular strengths and weaknesses of the issuer, this risk can be offset through portfolio diversification.
How would a 5% stock dividend affect a company's additional paid-in capital and retained earnings when declared? A. APIC: Increase RE: Decrease B. APIC:Increase RE: Increase C. APIC:No change RE: Decrease D. APIC:No change RE: Increase
Answer a is correct. Retained earnings is the cumulative accrual-basis income of the corporation, minus amounts paid out in cash dividends, minus amounts reclassified as additional paid-in capital from stock dividends. Thus, stock dividends increase additional paid-in capital and decrease retained earnings.
Dividends must be paid to holders of common stock before preferred shareholders can receive current or past dividends. T/F
False All past, cumulative, and current preferred dividends must be paid before any common dividends can be paid.
A financial instrument with a high level of security backing is expected to earn a higher rate of return than a similar instrument with a lower level of security backing it. T/F
False An unsecured financial instrument is much riskier than an instrument that is secured. Thus, the riskier asset earns a higher rate of return. Mortgage bonds are secured by assets, whereas common stock is completely unsecured. Accordingly, common stock will earn a higher rate of return than mortgage bonds.
Auction markets and dealer markets are examples of secondary markets. Dealer markets include the New York Stock Exchange and the American Stock Exchange. T/F
False Auction markets and dealer markets are examples of secondary markets. Auction markets like the New York Stock Exchange, the American Stock Exchange, and regional exchanges conduct trading at particular physical sites.
The higher a bond's rating, the higher its interest rate will be. T/F
False Basically, there is an inverse correlation between the bond rating (based on risk) and the interest rate that is attractive to an investor. A high rating (i.e., low risk) will lead to a lower interest rate.
When an investment bank buys an entire issue of securities and then attempts to sell it to investors, this is called a best efforts sale. T/F
False Best efforts sales of securities provide no guarantee that the securities will be sold or that enough cash will be raised. An underwritten deal or a firm commitment provides a guarantee. The investment banker agrees to purchase the entire issue and resell it.
Credit risk is the risk that a security cannot be sold on short notice for its market value. T/F
False Credit risk is the risk that the issuer of a debt security will default. Liquidity risk is the risk that a security cannot be sold on short notice for its market value
By far, the greatest advantage to a corporation of issuing debt is the fact that the equity holders do not have to share basic control of the firm. T/F
False Interest paid on debt is tax deductible. This is by far the most significant advantage of debt. For a corporation facing a 40%-50% marginal tax rate, the tax savings produced by the deduction of interest can be substantial.
Assets with shorter maturities suffer from greater interest-rate risk. T/F
False Interest-rate risk is the risk of fluctuations in the value of an asset due to changes in interest rates. Therefore, in general, interest-rate risk is greater the longer the maturity of the asset.
Companies tend to pay out more in dividends in good years and cut back in years with lower earnings. T/F
False Investors value dividend stability. A company whose earnings fluctuate greatly from year to year will tend to pay out a smaller dividend during good years so that the same dividend can be paid even if profits are much lower
Most serious investors are risk neutral, meaning that their utility of a gain is equal to their disutility of a loss. T/F
False Most serious investors are risk averse. They have a diminishing marginal utility for wealth. In other words, the utility of additional increments of wealth decreases. The utility of a gain for serious investors is less than the disutility of a loss of the same amount. Due to this risk aversion, risky securities must have higher expected returns.
One disadvantage to the issuer of issuing common stock is the contractual dividend payment that must be made regularly. T/F
False One of the advantages to the issuer of common stock is the fact that common stock does not require a fixed dividend; dividends are paid from profits when available.
An advantage for a firm issuing preferred stock is that the cash dividends expense is deductible for tax purposes. T/F
False Preferred stock cash dividends are not deductible as a tax expense and are paid with taxable income. The result is a substantially greater cost relative to bonds.
Market risk is the same as unsystematic risk T/F
False Systematic risk, also called market risk, is the risk faced by all firms. Changes in the economy as a whole, such as the business cycle, affect all players in the market.
Two advantages of going public include the ability to raise additional funds and access to the company's operating data by other firms. T/F
False The ability to raise additional funds is an advantage of going public; however, access to the company's operating data by other firms is a disadvantage.
The board of directors of a corporation declares a dividend on a certain date. All holders of the company's stock as of that date are entitled to receive the dividend. T/F
False The date of declaration is the date the directors meet and formally vote to declare a dividend. On this date, the dividend becomes a liability of the corporation. The date of record is the date as of which the corporation determines the shareholders who will receive the declared dividend. Only those shareholders who own the stock on the date of record will receive the dividend. It typically falls from 2 to 6 weeks after the declaration date.
Trading securities should be reported on the balance sheet net of any unamortized premium or discount. T/F
False Trading securities should be reported on the balance sheet at fair value while held-to-maturity securities are presented net of any unamortized premium or discount.
Under the strong form of the efficient markets hypothesis (EMH), insider trading can result in abnormal returns. Under the weak form, insider trading cannot result in abnormal returns. T/F
False Under the strong form of the EMH, all public and private information is assumed to be instantaneously reflected in securities' prices; thus, insider trading cannot result in abnormal returns. Under the semistrong form of the hypothesis, all publicly available data are reflected in security prices, but private or insider data are not immediately reflected; accordingly, insider trading can result in abnormal returns.
A high dividend rate means a slower rate of growth. A high growth rate usually means a low dividend rate. T/F
True A high dividend rate means a slower rate of growth. A high growth rate usually means a low dividend rate.
Mortgage bonds and debenture bonds differ in that mortgage bonds are usually secured by a specific property while debenture bonds are not. T/F
True A mortgage bond is a pledge of certain assets for a loan. It is usually secured by real property as a condition of the loan. A debenture bond is a long-term bond not secured by specific property. It is a general obligation of the borrower. Only companies with the best credit ratings can issue debentures because holders will be general creditors. They will have a status inferior to that of secured parties and creditors with priorities in bankruptcy.
One motive for the acquisition of treasury stock is to fend off a hostile takeover. T/F
True Among the motives for a share repurchase are the following: mergers, share options, stock dividends, tax advantages to shareholders (e.g., favorable capital gains rates), to increase earnings per share and other ratios, to prevent a hostile takeover, or to eliminate a particular ownership interest
Under fair value accounting, available-for-sale securities are revalued, i.e., marked to market, at each balance sheet date. T/F
True Available-for-sale securities include both debt and equity investments and are accounted for in a manner similar to trading securities, i.e., revalued at each balance sheet date.
A great deal of risk is involved with equity ownership. T/F
True Equity ownership involves risk because holders of common stock are not guaranteed a return and are last in priority in a liquidation. Shareholders' capital provides the cushion for creditors if any losses occur on liquidation.
Financial intermediaries are specialized firms that help create and exchange the instruments of financial markets. Examples include commercial banks, life insurance companies, and private pension funds. T/F
True Financial intermediaries are specialized firms that help create and exchange the instruments of financial markets. Examples include commercial banks, life insurance companies, private pension funds, nonbank thrift institutions (such as S&Ls, savings banks, and credit unions), state and local pension funds, mutual funds, finance companies, casualty insurance companies, money market funds, mutual savings banks, credit unions, and investment bankers.
If the stated, or coupon, rate of a bond issue is lower than the rate prevailing in the market at the time the bonds are sold, the bonds are said to be sold at a discount. T/F
True If the bonds' stated rate is lower than the market rate, investors must be offered an incentive to buy the bonds, since the bonds' periodic interest payments are lower than those currently available in the market. In this case, the issuer receives less cash than the par value and the bonds are said to be sold at a discount.
Preferred shareholders have priority over common shareholders in the receiving of assets and earnings if the entity liquidates T/F
True If the firm goes bankrupt, the preferred shareholders have priority over common shareholders.
The negative effect of a spike in fuel prices on airlines is an example of an industry risk. T/F
True Industry risk is the risk that a change will affect securities issued by firms in a particular industry.
Financial markets may be classified as either money markets or capital markets. T/F
True Money markets trade debt securities with maturities of less than 1 year. Capital markets trade long-term debt and equity securities. The New York Stock Exchange is an example of a capital market.
Preemptive rights give common shareholders the right to purchase any additional stock issuances in proportion to their current ownership percentages. T/F
True Preemptive rights give common shareholders the right to purchase any additional stock issuances in proportion to their current ownership percentages.
Financial markets may be categorized as either primary or secondary. T/F
True Primary markets are the markets in which corporations and governmental units raise new capital by making initial offerings of their securities. The issuer receives the proceeds of sale in a primary market. Secondary markets provide for trading of previously issued securities among investors. Examples of secondary markets include auction markets and dealer markets.
In normal times, the yield curve is upward sloping T/F
True The term structure of interest rates is the relationship between yield to maturity and time to maturity. In most years, long-term rates have been higher than short-term rates, so the yield curve is usually upward sloping.
