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Question 10
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Question 6
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Question 7
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Question 9
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Question 11
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Question 12
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Question 13
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Question 3
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Question 4
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Question 5
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Question 8
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Floating rate bond
A bond in which the interest payment changes with market conditions.
Zero-coupon rate bond
A bond that is initially sold at a deep discount from face value. The return to the investor is the difference between the investor's cost and the face value received at the end of the life of the bond.
Optimum capital structure
A capital structure that has the best possible mix of debt, preferred stock, and common equity. The optimum mix should provide the lowest possible cost of capital to the firm.
Secured debt
A general category of debt that indicates the loan was obtained by pledging assets as collateral. Secured debt has many forms and usually offers some protective features to a given class of bondholders.
Preferred stock
A hybrid security combining some of the characteristics of common stock and debt. The dividends paid are not tax-deductible expenses of the corporation, as is true of the interest paid on debt.
a)
A lump sum
Sinking fund
A method for retiring bonds in an orderly process over the life of a bond. Each year or semiannually, a corporation sets aside a sum of money equal to a certain percentage of the total issue. These funds are then used by a trustee to purchase the bonds in the open market and retire them. This method will prevent the corporation from being forced to raise a large amount of capital at maturity to retire the total bond issue.
Dividend valuation model
A model for determining the value of a share of stock by taking the present value of an expected stream of future dividends.
Capital asset pricing model
A model that relates the risk-return trade-offs of individual assets to market returns. A security is presumed to receive a risk-free rate of return plus a premium for risk.
c)
A perpetuity
b)
A premium an investor requires to compensate for the eroding effect of inflation
Risk premium
A premium associated with the special risks of an investment. Of primary interest are two types of risk, business risk and financial risk. Business risk relates to the inability of the firm to maintain its competitive position and sustain stability and growth in earnings. Financial risk relates to the inability of the firm to meet its debt obligations as they come due. The risk premium will also differ (be greater or less) for different types of investments (bonds, stocks, and the like).
Inflation premium
A premium to compensate the investor for the eroding effect of inflation on the value of the dollar.
Rights offering
A sale of new common stock through a preemptive rights offering. Usually one right will be issued for every share held. A certain number of rights may be used to buy shares of common stock from the company at a set price that is lower than the market price.
d)
All are equally risky
Majority voting
All directors must be elected by a vote of more than 50 percent. Minority shareholders are unable to achieve any representation on the board of directors.
d)
All of the above ae part of investors determining a bond's required return
d)
All would have the same risk level
b)
Allows any group with more than 50% ownership to elect all of the directors
a)
Allows bondholders to require the corporation repay the bonds before maturity
Cumulative voting
Allows shareholders more than one vote per share. They are allowed to multiply their total shares by the number of directors being elected to determine their total number of votes. This system enables minority shareholders to elect directors even though they do not have 51 percent of the vote.
c)
Allows the corporation to call in the interest payments if cash is not available
b)
Allows the corporation to repay the debt before maturity
d)
Allows those with minority ownership interests to challenge management
b)
An annuity
Perpetuity
An investment without a maturity date.
Bond ratings
Bonds are rated according to risk by Standard & Poor's and Moody's Investor Service. A bond that is rated AAA by Moody's has the lowest risk, while a bond with a C rating has the highest risk. Coupon rates are greatly influenced by a corporation's bond rating.
c)
Call feature
Financial capital
Common stock, preferred stock, bonds, and retained earnings. Financial capital appears on the corporate balance sheet under long-term liabilities and equity.
d)
Constant growth rate in dividends
b)
Conversion feature
Ke
Cost of common equity
Ke
Cost of common equity in the form of retained earnings
Kd
Cost of debt
Kn
Cost of new common stock
Kp
Cost of preferred stock
a)
Cumulative dividends
b)
Debenture
b)
Dividend at the end of the first year
Dividend yield
Dividends per share divided by market price per share. Dividend yield indicates the percentage return that a stockholder will receive on dividends alone.
c)
Helps prevent hostile takeovers
b)
Inflation premium
b)
It causes the price to rise
c)
It does not impact the price
a)
Less than face value
a)
Makes it possible for a minority owner to elect some board of director members
b)
More than face value
d)
None of the above
a)
Price of the stock today
Risk-free rate of return
Rate of return on an asset that carries no risk. U.S. Treasury bills are often used to represent this measure, although longer-term government securities have also proved appropriate in some studies.
a)
Real rate of return
Common stock
Represents the ownership interest of the firm. Common stockholders have the ultimate right to control the business.
c)
Required rate of return
Kj
Required return on common stock
d)
Residual claim to income
c)
Risk premium
a)
Secured debt
Par value
Sometimes referred to as the face value or the principal value of the bond. Most bond issues have a par value of $1,000 per bond. Common and preferred stock may also have assigned par values.
c)
Subordinated debenture
Supernormal growth
Superior growth a firm may achieve during its early years, before leveling off to more normal growth. Supernormal growth is often achieved by firms in emerging industries.
Required rate of return
That rate of return that investors demand from an investment to compensate them for the amount of risk involved.
Coupon rate
The actual interest rate on the bond, usually payable in semiannual installments. The coupon rate normally stays constant during the life of the bond and indicates what the bondholder's annual dollar income will be.
Residual claim to income
The basic claim that common stockholders have to income that is not paid out to creditors or preferred stockholders. This is true regardless of whether these residual funds are paid out in dividends or retained in the corporation.
Weighted average cost of capital
The computed cost of capital determined by multiplying the cost of each item in the optimal capital structure by its weighted representation in the overall capital structure and summing up the results.
Cost of capital
The cost of alternative sources of financing to the firm.
Marginal cost of capital
The cost of the last dollar of funds raised. It is assumed that each dollar is financed in proportion to the firm's optimum capital structure.
b)
The current corporate tax rate
Maturity date
The date on which the bond is retired and the principal (par value) is repaid to the lender.
Flotation cost
The distribution cost of selling securities to the public. The cost includes the underwriter's spread and any associated fees.
a)
The market's perception of that company's risk
Price-earnings ratio
The multiplier applied to earnings per share to determine current value. The P/E ratio is influenced by the earnings and sales growth of the firm, the risk or volatility of its performance, the debt-equity structure, and other factors.
Common stock equity
The ownership interest in the firm. It may be represented by new shares or retained earnings. The same as net worth.
c)
The premium associated with special risks of a given investment
Refunding
The process of retiring an old bond issue before maturity and replacing it with a new issue. Refunding will occur when interest rates have fallen and new bonds may be sold at lower interest rates.
Real rate of return
The rate of return that an investor demands for giving up the current use of his or her funds on a noninflation-adjusted basis. It is payment for forgoing current consumption. Historically, the real rate of return demanded by investors has been of the magnitude of 2 to 3 percent.
a)
The rate of return the investor demands for giving up the current use of funds on a noninflation-adjusted basis
Yield to maturity
The required rate of return on a bond issue. It is the discount rate used in present-valuing future interest payments and the principal payment at maturity. The term is used interchangeably with market rate of interest.
Business risk
The risk related to the inability of the firm to hold its competitive position and maintain stability and growth in earnings.
Financial risk
The risk related to the inability of the firm to meet its debt obligations as they come due.
d)
The sum of the real rate of return and the inflation premium
d)
The two are not related in terms of determining price
Current yield
The yearly dollar interest or dividend payment divided by the current market price.
Call provision
Used for bonds and some preferred stock. A call allows the corporation to retire securities before maturity by forcing the bondholders to sell bonds back to it at a set price. The call provisions are included in the bond indenture.
c)
We cannot determine from just this information
d)
We cannot tell from just this if there is an impact.
c)
What the company is willing to pay
d)
What the stockholder's believe is fair