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55) Explain the main differences between debt and equity.
Answer: ∙ Debt generally does not provide any voting rights nor company ownership. Equity does. ∙ Interest expense is generally at least partially tax deductible, dividends paid are not. ∙ Unpaid debt is a liability of the firm and can force the firm to liquidate or reorganize. Unpaid dividends are not a liability of the firm unless declared. ∙ Interest and dividends are often treated differently for tax purposes. ∙ Dividends paid to corporate shareholders are at least partially tax exempt, interest is not. Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Capital structure Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
56) Identify three key duties of a bond trustee.
Answer: ∙ Ensure the bond indenture provisions are obeyed ∙ Manage the sinking fund ∙ Represent the bondholders if the company defaults on its payments Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Indenture provisions Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
13) Different classes of stock usually are issued to: A) allow a certain group to maintain ownership control while reducing that group's equity position. B) reduce the firm's dividend obligation. C) fool investors. D) extract perquisites from one class of shareholders without the other class of shareholders knowing. E) distinguish the time periods in which the various shares were issued.
Answer: A Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Classes of stock Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
11) If a group other than current management solicits the authority to vote shares as part of their effort to replace the current management team, a ________ is said to occur. A) proxy fight B) stockholder derivative action C) tender offer D) vote of confidence E) seniority turnover
Answer: A Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder voting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
9) There are three directors' seats up for election. If you own 1,000 shares of stock and have been granted a total of 3,000 votes to cast in a single election, then the firm uses the voting procedure referred to as: A) cumulative voting. B) absolute priority voting. C) sequential voting. D) straight voting. E) market share voting.
Answer: A Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder voting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
30) Which one of these is a positive covenant? A) The firm must maintain a current ratio of 1.2 or better. B) The firm will not issue any debt with higher seniority. C) The firm cannot be acquired in a friendly takeover. D) No dividend increases will be allowed. E) The market debt-equity ratio cannot exceed .60.
Answer: A Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Indenture provisions Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
32) Which type of bond grants the bond holder the right to force the bond's issuer to repay the bond at a stated price given that a certain situation(s) occurs? A) Put bond B) Cat bond C) NoNo bond D) Income bond E) Warrant bond
Answer: A Difficulty: 1 Easy Section: 15.3 Some Different Types of Bonds Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
33) Bonds with attached warrants are frequently issued: A) with very low coupons. B) at a greatly discounted price. C) with an attached share of preferred stock. D) with a share purchase price set equal to the market price at time of share purchase. E) with an attached share of common stock.
Answer: A Difficulty: 1 Easy Section: 15.3 Some Different Types of Bonds Topic: Warrants Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
44) Recently, U.S. nonfinancial corporations have been: A) net repurchasers of stock. B) issuing new shares of stock in record numbers. C) primarily relying on external debt. D) paying off external debt at a record pace. E) net issuers of stock.
Answer: A Difficulty: 1 Easy Section: 15.6 Patterns of Financing Topic: Debt financing Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation
2) A classified board is one which has: A) representation from various classes of stock. B) terms that expire at different times. C) both employee and non-employee directors. D) directors elected solely by one class of shareholders. E) directors that have been assigned differing numbers of votes per seat.
Answer: B Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Management organization and roles Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
3) Preferred stock dividends: A) become a debt of the firm if unpaid. B) can be deferred indefinitely. C) are only paid if common stock dividends are also paid. D) have priority over debt interest payments but not common stock dividends. E) are a tax-deductible business expense.
Answer: B Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Preferred stock Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
6) A grant of authority allowing someone else to vote shares of stock that you own is called a: A) power-of-share authorization. B) proxy. C) share authority grant (SAG). D) restricted conveyance. E) general right of execution.
Answer: B Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder voting Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation
17) Unsecured corporate debt is commonly referred to as: A) an indenture. B) a debenture. C) deferred debt. D) protected debt. E) collateralized debt.
Answer: B Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Bond terminology Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation
21) If an issuer retires a debt issue before maturity, the specific amount paid to do so is called the: A) amortized payoff. B) call price. C) sinking fund amount. D) the discount. E) par or face amount.
Answer: B Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
24) Which one of these is not included in the indenture? A) Bond seniority B) Registered owner C) Protective covenant D) Call provision E) Repayment arrangements
Answer: B Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Indenture provisions Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
28) Sinking fund arrangements are least apt to contain which one of these requirements? A) A deferred provision for the first few years B) A one-time repayment of the entire principal and interest at maturity C) A balloon payment D) Equal payments of principal over the life of the bond E) Sufficient payments over the bonds' life to retire the entire bond issue
Answer: B Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Indenture provisions Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
31) Which one of these applies to floating-rate bonds? A) Bondholders can generally redeem their bonds at par at any time. B) Coupon payments are variable while the par value is fixed. C) Interest adjustments are accrued and paid on the maturity date. D) Coupon payments are fixed but the par value is variable. E) Bondholders frequently are granted a put provision at the current market price.
Answer: B Difficulty: 1 Easy Section: 15.3 Some Different Types of Bonds Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
36) Which set of circumstances would best ensure the price of a bond with attached warrants will increase given no change in the bond's credit quality or terms? A) An increase in both the market rate of interest and the underlying stock price B) A decrease in the market rate of interest and an increase in the underlying stock price C) An increase in the market rate of interest and a decrease in the underlying stock price D) A decrease in both the market rate of interest and the underlying stock price E) A decrease in the market rate of interest with no change in the underlying stock price
Answer: B Difficulty: 1 Easy Section: 15.3 Some Different Types of Bonds Topic: Bond valuation Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
37) A revolving bank line of credit: A) generally requires the borrower to borrow the entire credit line amount at some point in time. B) generally involves a fee charged to the borrower on the unused portion of the revolver. C) may only be offered for periods of one year or less. D) is generally free of charge until money is actually borrowed. E) allows the borrower to determine the amount of credit to be granted.
Answer: B Difficulty: 1 Easy Section: 15.4 Bank Loans Topic: Debt financing Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
43) What is the predominant source of financing for positive NPV projects by U.S. nonfinancial corporations? A) Preferred stock B) Internally-generated funds C) Common stock D) Publicly-issued debt E) Privately-issued debt
Answer: B Difficulty: 1 Easy Section: 15.6 Patterns of Financing Topic: Debt financing Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation
45) Since 1975 U.S. nonfinancial corporations have tended to have debt-equity ratios that are: A) steadily rising due to the low interest rate environment. B) less than 1.0. C) averaging in the .8 to .9 range. D) relatively stable over time. E) relatively unaffected by stock market movements.
Answer: B Difficulty: 1 Easy Section: 15.7 Recent Trends in Capital Structure Topic: Capital structure Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
46) Financial economists prefer to use market values rather than book values when measuring debt ratios because market values are: A) more stable than book values. B) a better reflection of current information. C) net of taxes. D) used by Standard & Poor's to measure credit worthiness. E) most commonly required by bond covenants.
Answer: B Difficulty: 1 Easy Section: 15.7 Recent Trends in Capital Structure Topic: Long-term solvency ratios Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
8) ABC owns 15 percent of XYZ Corporation. What tax benefit does ABC derive from this situation? A) ABC receives no tax benefit but XYZ is only taxed on 30 percent of its net income. B) ABC benefits because it is able to treat any XYZ dividends it receives as interest income. C) Fifty percent of the dividends paid by XYZ to ABC is exempt from income taxes. D) ABC can exclude 30 percent of any XYZ dividends received from its taxable income. E) All dividend income ABC receives from XYZ is tax-exempt.
Answer: C Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Preferred stock Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
1) Which group has the ultimate control over a corporation? A) Bondholders B) Classified board C) Shareholders D) Directors E) Chief executive officer
Answer: C Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder rights Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
12) When shareholders are granted preemptive rights, they obtain the right: A) to elect members to the board of directors. B) to share proportionally in regular and liquidating dividends. C) of first refusal for their proportionate percentage of new shares offered. D) to receive dividends prior to any preferred shareholders. E) to resell their shares to the issuer at any time at a predetermined price.
Answer: C Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder rights Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
14) Assuming control of a corporation would be hardest to obtain if the firm uses which type of voting? A) Cumulative voting with annual elections for each seat B) Cumulative voting with an annual board C) Straight voting with a staggered board D) Cumulative voting with a staggered board E) Straight voting with annual elections for each seat
Answer: C Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder voting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
22) If a debt is subordinated, it: A) has a higher priority status than secured creditors. B) is secondary to equity. C) must give preference to the secured creditors in the event of default. D) has been issued because the company is in default. E) is treated as an equity security.
Answer: C Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
27) A blanket mortgage is securitized by: A) the sinking fund. B) the borrower's inventory. C) all the borrower's real property. D) the good faith and credit of the borrower. E) the borrower's inventories and accounts receivables.
Answer: C Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
18) Bonds that grant the issuer the right to extinguish the debt prior to maturity are referred to as which type of bond? A) Put bond B) Debenture C) Callable bond D) Subordinated bond E) Covenant bond
Answer: C Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Indenture provisions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation
19) The written agreement between a corporation and its bondholders is called the: A) collateral agreement. B) note. C) indenture. D) conveyance. E) legal understanding.
Answer: C Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Indenture provisions Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation
53) Identify the general rights that are commonly granted to common stock shareholders.
Answer: Common stock shareholders generally have the right to: ∙ share proportionally in dividends. ∙ share proportionally in assets remaining after liabilities have been paid in a liquidation. ∙ vote on stockholder matters of great importance, such as a merger or acquisition. ∙ vote to elect directors to the board. ∙ share proportionately in any new stock offering. Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder voting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
4) Firms may prefer to issue cumulative preferred stock rather than debt for which reason? A) If there is no current taxable income, preferred stock dividends are automatically voided. B) Preferred stock has no voting rights but debt does. C) Preferred dividends provide a tax shield but debt does not. D) Corporate investors can receive a tax break on dividends. E) Dividend payments are tax deductible, interest on debt is not.
Answer: D Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Preferred stock Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
10) There are three directors' seats up for election. If you own 1,000 shares of stock and you can cast 1,000 votes in each of the three elections, then the firm uses the voting procedure referred to as: A) cumulative voting. B) absolute priority voting. C) sequential voting. D) straight voting. E) market share voting.
Answer: D Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder voting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
16) Which one of the following statements is true? A) Bondholders are generally granted voting rights equal to those of common shareholders. B) Payments of both interest and dividends are tax-deductible as business expenses. C) Unpaid common stock dividends can force a firm into liquidation. D) Debt increases the possibility of financial distress. E) Debt holders have a residual claim on a firm's assets.
Answer: D Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Debt financing Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
23) The written agreement between a corporation and its bondholders might contain a prohibition against paying dividends in excess of current earnings. This prohibition is an example of a(n): A) maintenance of security provision. B) collateral restriction. C) affirmative indenture. D) negative covenant. E) put provision.
Answer: D Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Indenture provisions Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
5) Which one of the following statements about preferred stock is true? A) Unlike dividends paid on common stock, dividends paid on preferred stock are a tax-deductible expense. B) Dividends on preferred stock payable during the next twelve months are considered to be a corporate liability. C) If preferred dividends are non-cumulative, then preferred dividends not paid in a particular year will be carried forward to the next year. D) There is no significant difference in the voting rights granted to preferred and common shareholders. E) Preferred stock usually has a stated liquidating value of $100 per share.
Answer: E Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Preferred stock Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
7) Not paying dividends on a cumulative preferred issue may result in: A) preferred dividend arrearages that can be eliminated only after all common dividends are paid. B) increased taxes based on the amount of the dividend arrearage. C) the permanent forfeiture of all unpaid past dividends but the resumption of future dividends. D) the issuer being forced into repaying all preferred shareholders the stated value of their shares. E) voting rights being granted to preferred shareholders.
Answer: E Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Preferred stock Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
15) Which one of these is not a right generally granted to shareholders? A) Right to elect individuals to the board of directors B) Right to purchase shares of any new stock issue C) Right to receive proportional dividends D) Right to vote to approve or reject a merger offer E) First right to liquidation proceeds
Answer: E Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder rights Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
25) If a bond issue is callable, the call price generally is: A) less than par value. B) variable based on the market rate of interest. C) equal to par value. D) constant over the life of the debt. E) set so it decreases as the bond approaches maturity.
Answer: E Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
26) Historically in the U.S., corporate bonds have generally been issued with a par value of: A) $100. B) $5,000. C) $500. D) $10,000. E) $1,000.
Answer: E Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
29) If a bond has a make-whole call provision, the: A) call premium can be either positive or negative. B) bond's market price will always equal its face value. C) bondholder will receive the face value amount plus interest if the bond is called. D) bondholder will receive the face value amount minus any interest paid to date if the bond is called. E) call price will increase as interest rates decrease.
Answer: E Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
20) Ideally, corporations try to create securities that have the tax benefits: A) of equity but the bankruptcy benefits of debt. B) and bankruptcy benefits of debt. C) and bankruptcy benefits of equity. D) of debt and the equity benefits of dividends. E) of debt but the bankruptcy benefits of equity.
Answer: E Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Debt financing Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
34) Which type of bond only pays coupon payments if it can do so from the income earned by the firm? A) NoNo bond B) Readi-cash bond C) Floater bond D) LIBOR-based bond E) Income bond
Answer: E Difficulty: 1 Easy Section: 15.3 Some Different Types of Bonds Topic: Bond types and features Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
38) Which one of these statements correctly applies to either a leveraged or an unleveraged syndicated loan? A) The loan will always be rated as investment grade. B) The loan may not be publicly traded. C) The loan arranger is not involved with the actual lending. D) Each bank that participates negotiates the terms for its portion of the overall loan. E) Each bank has its own loan agreement with the borrowers.
Answer: E Difficulty: 1 Easy Section: 15.4 Bank Loans Topic: Debt financing Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
42) The term financial deficit is defined as the: A) loss realized on bonds that are sold for less than their purchase price. B) amount needed to fund all interest payments on currently outstanding debt. C) total amount of cash flow required from all sources to meet the needs of the uses of cash. D) amount of cash flow that must be funded internally. E) uses of cash flow minus the cash flow available from internal sources.
Answer: E Difficulty: 1 Easy Section: 15.6 Patterns of Financing Topic: Debt financing Bloom's: Remember AACSB: Reflective Thinking Accessibility: Keyboard Navigation
54) Explain some of the means by which a select group of shareholders can retain control over a corporation while still raising equity capital outside of their group.
Answer: Some of the means include straight voting for the firm's directors, staggered terms for the directors, and various classes of stock with unequal voting rights. Difficulty: 1 Easy Section: 15.1 Some Features of Common and Preferred Stocks Topic: Shareholder voting Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
57) Bond issuers will call bonds when it is favorable for them to do so. The benefit the issuer receives is a cost to the bondholders. Explain some of the ways in which bondholders are protected from calls.
Answer: The call provision may have a deferral period which prevents the issuer from calling the bonds within the first few years following issuance. The provision may also require the issuer to pay a call premium to help offset the loss to the bondholder. Some provisions are structured as "make-whole" calls which require the issuer to pay the approximate current value of the called bond to the bondholder. Difficulty: 1 Easy Section: 15.2 Corporate Long-Term Debt Topic: Indenture provisions Bloom's: Understand AACSB: Reflective Thinking Accessibility: Keyboard Navigation
