Unit 1 & 2

The board of directors of DDC omitted dividends in 2016 on their $100 par 6% noncumulative preferred stock. In 2017, a $2 preferred dividend was paid. For DDC, 2018 was a good year, and the board wishes to pay a common dividend. How much must be paid per share on the preferred for 2018 in order to pay a common dividend? A. $6 B. $16 C. $12 D. $8

$6- it's noncumulative preferred stock

General Obligation Bonds

A general obligation bond is a municipal bond backed solely by the credit and taxing power of the issuing jurisdiction rather than the revenue from a given project

NSO definition

A non-qualified stock option (NSO) is a type of employee stock option wherein you pay ordinary income tax on the difference between the grant price and the price at which you exercise the option.

creditor

A person to whom money is owed

An investor owns five DEF call options with a strike price of $40. The options are European style. If the holder exercises, the cost will be: a. $4,000 b. $20,000 c. $2,000 d. $0 because European options are exercisable only at expiration

B. $20,000 Each option contract represents 100 shares. Exercising five call options means buying 500 shares at a price of $40 each, which equals $20,000. Although it is true that European-style options are exercisable only at expiration, nothing in the question indicates the investor tried to exercise before then.

bonds selling at a discount

Bonds sell at a discount when the market interest rate exceeds the coupon rate of the bond.

One year ago, ABC Widgets, Inc. funded an expansion to its manufacturing facilities by issuing a 20-year first mortgage bond. The bond is secured by the new building and land. The bond was issuing with a 5.5% coupon and is currently rated Aa. The current market price of the bond is 105, resulting in a current yield of approximately..... a. 5.24% b. 5.50% c. 5.61% d. 4.99%

Corporate bonds are quoted as a percentage of the $1,000 par value. A market price of 105 is equal to $1,050 (105% × $1,000). Each $1,000, 5.5% bond pays $55 of interest annually ($1,000 × 5.5% = $55). Current yield equals the annual interest divided by the current price of $1,050. The calculation is $55 ÷ $1,050, which is equal to approximately 5.24%. Because the bond is at a premium, the current yield must be below the nominal yield, which removes two of the choices from consideration.

Rights Offering

Existing shareholders are given the right to buy new shares at a discount to the current market price; Dilutes ownership unless option is exercised; Sometimes the option can be sold

bonds selling at a premium

For example, a bond with a par value of $1,000 is selling at a premium when it can be bought for more than $1,000 and is selling at a discount when it can be bought for less than $1,000.

ISO definition

Incentive stock options (ISOs) are a form of equity compensation that allows you to buy company shares for a specific exercise price.

noncumulative preferred stock

Preferred stock on which the right to receive dividends is lost for any period when dividends are not declared.

Callable bonds pros and cons

Pros: - pay a higher coupon or interest rate - investor-financed debt is more flexibility for the issuer - helps companies raise capital - call features allow recall and refinancing of debt Cons: - investors must replace called bonds with lower rate products - investors cannot take advantage when market rates rise -coupon rates are higher raising the costs to the company

Julie owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date, what will she own? I. 125 shares II. 100 shares III. Cost basis of $25 IV. Cost basis of $20 a. I and IV b. II and IV c. II and III d. I and II

Remember that the ex-date is the first day on and after which a purchaser of a stock is not entitled to a previously declared dividend (cash or stock). That means the owner of the stock on and after the ex-date is the one who receives the cash or, in this case, the additional stock. The payment of a stock dividend causes the number of shares owned to increase while the cost per share decreases. The total value of the position will always remain unchanged. Julie had 100 shares at $25 per share, or $2,500, and now has 125 shares × $20 = $2,500.

Unrestricted stock

Stock that can be accepted from a supplier, used further in the manufacturing process, or sold.

Call risk premium (CRP)

The premium that debt investors add to the base rate to compensate for bearing call risk

Yankee bonds

U.S. dollar-denominated debt securities issued by foreign governments or corporations and traded in U.S. securities markets

Callable

a bond feature that allows the borrower to repay the bonds before their scheduled maturity date at a specified call price

par value

a bond's stated value, to be paid to the bondholder at maturity

Restricted stock

a special type of stock that is not transferable from the current holder to others until specific conditions are satisfied

Holders of each of the following are creditors except a. investors owning preferred stock b. investment companies owning corporate bonds c. corporations owning municipal bonds d. states owning U.S. government bonds

a. investors owning preferred stock

capital appreciation

an increase in the market price of shares -Owning common stock has provided investors with returns in excess of the inflation rate . Therefore, most investors with a long-term investment horizon have included common stock in their portfolios as a hedge against inflation

Which of the following statements regarding ADRs are true? I. They are issued by large domestic commercial banks. II. They are issued by foreign banks. III. They facilitate U.S. trading in foreign securities. IV. They facilitate a foreign investor who wants to trade U.S. securities.

b. I and III ADRs are issued by large domestic commercial banks to facilitate U.S. investors who want to trade in foreign securities

The residual right of common stockholders refers to their right to

claim company assets in bankruptcy after wages, taxes, creditors and preferred shareholders have been paid

negotiable jumbo CDs

issued at face value & do not have a prepayment penalty

convertible debenture

pays interest at a fixed rate and is redeemable for its face value at maturity, provided the debenture is not converted

commerical paper

short-term unsecured debt issued by large corporations

nonqualified stock options

similar to qualified options, except that they are subject to a less favorable tax rate and are not subject to the same restrictions

Money Market Instruments

treasury bills, federal funds and repurchase agreements, commercial paper, negotiable certificates of deposit, banker's acceptances

Your customer owns $100 par 5-½% callable convertible preferred stock convertible into 4 shares of common stock at $25. What should she be advised to do if the board of directors were to call all the preferred at 106 when the common stock is trading at $25.50? A) Place irrevocable instructions to convert the preferred stock into common stock and sell short the common stock immediately. B) Hold the preferred stock to continue the 5-½% yield. C) Present the preferred stock for the call because the call price is $4 above the parity price. D) Convert her preferred stock into common stock because it is selling above parity

C) Present the preferred stock for the call because the call price is $4 above the parity price.If the preferred stock is called, the client will receive $106. Tendering the preferred stock will provide the highest value. The value of converting the preferred stock into 4 shares of common is worth $102 (4 × $25.50 = $102), which is less than the call value of $106. The dividends will cease on the call date if the preferred stock is held beyond the call date.

Which of the following is correct regarding zero-coupon bonds? a. They eliminate reinvestment rate risk. b. They sell at a premium. c. They offer minimum price volatility. D. They have low interest rate risk.

C. They eliminate reinvestment risk Zero-coupon bonds are sold at a deep discount from par value and have no coupon payments. Because there is nothing to reinvest, there is no reinvestment risk. That is why many investors prefer zero-coupon bonds for specific goals, such as college education for children. The tradeoff is that no coupon also means higher interest rate risk. These bonds have maximum price volatility and respond sharply to interest rate changes.

differences between common and preferred stock

Companies either issue common, preferred stock, or both. Preferred stock ranks ahead of common shares in getting something back if the company declares bankruptcy and sells off its assets. More importantly, preferred stocks are issued with stated dividend rates. If a company is profitable, preferred shareholders collect dividends before stockholders. Additionally, preferred stocks trade more like bonds, and thus don't benefit much if the company experiences massive growth. Common shareholders, reap those benefits. Common shareholders get voting rights, while preferred share holders typically don't.

100% stock dividend

Company gives 1 new share to shareholders for every 1 share that they own

cumulative preferred stock

Preferred stock on which undeclared dividends accumulate until paid; common stockholders cannot receive dividends until cumulative dividends are paid.

Is the price of preferred stock more similar to common stock or debt instruments?

Preferred stock represents ownership in a company, but its price reacts to the market more like a bond because, with its fixed dividend payment, it is price sensitive to interest rate changes

One of the rights of those owning common stock is the opportunity to vote on issues brought up at the corporation's annual meeting. To be eligible to cast a vote, a. ownership must be established by the record date b. the company must be current on its dividends to preferred stockholders c. the stockholder must be a natural person d. the stock must be paid for in full before the annual meeting

a. ownership must be established by the record date Only stockholders who are on the company's books by the record data are eligible to vote.

Which of the following statements regarding preemptive rights is true? a. Both common and preferred stockholders have the right to a rights offering. b. Common stockholders do not have the right to subscribe to a rights offering. c. Preferred stockholders do not have the right to subscribe to a rights offering. d. Neither common nor preferred stockholders have the right to subscribe to a rights offering.

b. Common stockholders do not have the right to subscribe to a rights offering. Preferred stockholders have a preference as to liquidation and distribution of dividends, but the right to maintain a proportionate interest in the company only applies to common stock.

Julie owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date, what will she own? I. 125 shares II. 100 shares III. Cost basis of $25 IV. Cost basis of $20 a. I and II b. I and IV c. II and III d. II and IV

b. I and IV Remember that the ex-date is the first day on and after which a purchaser of a stock is not entitled to a previously declared dividend (cash or stock). That means the owner of the stock on and after the ex-date is the one who receives the cash or, in this case, the additional stock. The payment of a stock dividend causes the number of shares owned to increase while the cost per share decreases. The total value of the position will always remain unchanged. Julie had 100 shares at $25 per share, or $2,500, and now has 125 shares × $20 = $2,500.

Which of the following statements regarding a 100% stock dividend are true? I. The share price is reduced by half. II. The total market value of the outstanding stock decreases. III. The total market value of the outstanding stock may increase or decrease as a result of the split. IV. The number of shares doubles.

b. I and IV In a 100% stock dividend, the number of outstanding shares is doubled and the price is reduced by half. The total market value (market cap) of the issuer's stock remains the same.

callable bonds

bonds that the issuing company can redeem (buy back) at a stated dollar amount prior to maturity

Three years ago, an investor purchased 1,000 shares of stock in the Equity Protective Life Insurance Company (EPLIC). The purchase price was $53 per share. The current market value of EPLIC stock is $79 per share. If the investor is in the 24% federal income tax bracket, it is correct to state that A) the investor owes tax on a $26,000 long-term capital gain. B) the investor owes tax on a $26,000 short-term capital gain. C) no tax is owed by the investor. D) the investor's tax liability is $3,900.

c) no tax is owed by the investor Because the investor has not sold the EPLIC stock, the gain is unrealized. It is only when a gain (or loss) is realized that there are tax consequences. Had the stock been sold, it would have been a long-term capital gain, which is taxed at 15% rather than the investor's marginal rate.

ABC Corporation has a 10% noncumulative preferred stock outstanding at $100 par value. Two years ago, ABC omitted its preferred dividend, and last year, it paid a dividend of $5 per share. To pay a dividend to common shareholders this year, each preferred share must be paid a dividend of a. $5 b. $25 c. $10 d. $15

c. $10 This stock has a par value of $100 and a dividend rate of 10%. That means the annual dividend will be 10% of the $100 par, or $10. Because this is noncumulative preferred stock, the company must pay only this year's full stated dividend of $10 per share before paying dividends to the common shareholders. Any dividends from previous years that were not paid are ignored. If this had been a cumulative preferred stock, all of the dividends in arrears (paid unpaid) would have to be paid before the common shareholders could get a dividend. In that case, it would have been $10 for two years ago, $5 for the balance of last year's dividend, and $10 for this year's (a total of $25).

When an income-oriented investor wishes to compute the current yield of a specific investment, which one of these items would not be considered? a. interest coupon b. dividends paid c. net present value d. current market price

c. net present value The current yield of any investment is the income return (dividends on equity; interest on debt) divided by the current market price. The NPV is a tool that evaluates the reasonableness of the price of an investment.

A customer owns cumulative preferred stock (par value of $100) that pays an 8% dividend. The dividend has not been paid this year or for the two previous years. How much must the company pay the customer per share before it may pay dividends to the common stockholders? a. $8 b. $16 c. $0 d. $24

d. $24 If the company is going to pay a common stock dividend, it must pay the preferred dividends first. A cumulative preferred stockholder must also receive all dividends in arrears. There are $16 due in back dividends, in addition to $8 this year, for a total of $24.

Which of the following are characteristics of commercial paper? I. It represents a loan by the holder to the issuer. II. It is a certificate of ownership in the corporation. III. It is commonly issued to raise working capital for a corporation. IV. It is junior in preference to convertible preferred stock. a. II and IV b. I and IV c. II and III d. I and III

d. I and III Commercial paper instruments are debt securities; they represent loans to the issuing corporation by the holder. They are commonly issued to raise working capital and, as debt obligation, are senior in preference to preferred stock in claims against the issuer.

nonconvertible debentures

debt instruments issued by companies to raise capital for the long-term

Preemptive rights are

designed to prevent dilution of a shareholder's ownership in the company.

American depository receipt (ADR) definition

form of equity security that was created specifically to simplify foreign investing for American investors. An ADR is issued by an American bank or broker. It represents one or more shares of foreign-company stock held by that bank in the home stock market of the foreign company.