Chapter 3 & 4

Question 1

Chapter 3 objectives

Answer 1

Understand and describe the key features and characteristics of equity securities, including ownership features, voting rights, and convertibility.

Explain the roles and responsibilities of shareholders, boards of directors, and senior managers in a corporate structure.

Differentiate between debt and equity financing and understand the implications of these financing methods for both corporations and investors.

Recognize the risks and rewards associated with investing in equity securities, including the potential for dividends and capital appreciation, as well as the risks associated with corporate bankruptcy and liquidation.

Understand specific regulations and rules, such as SEC Rule 144, that apply to equity securities and their trading.

Question 2

A corporation’s shareholders must vote for:

Cash dividends
Stock dividends
Stock splits
Stopping dividends

Answer 2

Stock splits

Question 3

Treasury stock:

Receives dividends
Was previously issued stock that has been subsequently repurchased by the corporation
Carries voting rights
Is authorized stock that’s held in the corporation’s treasury until it’s issued

Answer 3

Was previously issued stock that has been subsequently repurchased by the corporation

Question 4

What type of security gives the owner immediate control over the issuer?

Subscription warrants
Preferred stock
Convertible bonds
Common stock

Answer 4

Common stock

Question 5

If a company is utilizing statutory voting, how many votes will a common shareholder receive per vacant seat on the board?

One vote for each vacant position on the board
One vote for each director that’s present at the meeting
One vote for each share that the stockholder owns
One for each proxy that’s filed by the board of directors

Answer 5

One vote for each share that the stockholder owns

Question 6

Foreign stocks trade in U.S. markets as:

Unregistered securities
American Depositary Receipts (ADRs)
Exchange-Traded Funds (ETFs)
Closed-end mutual funds

Answer 6

American Depositary Receipts (ADRs)

Question 7

A company with 1,000,000 shares outstanding is planning to issue an additional 100,000 shares. If a rights offering is being conducted and an investor owns 20,000 shares, how many additional shares will her current ownership allow her to purchase?

0
2000
4000
20000

Answer 7

2000

Question 8

The type of preferred stock that will make up for missing (unpaid) dividends is:

Cumulative preferred stock
Participating preferred stock
Callable preferred stock
Convertible preferred stock

Answer 8

Cumulative preferred stock

Question 9

The types of stocks that are generally resistant to economic downturns are:

Defensive stocks
Growth stocks
Income stocks
Cyclical stocks

Answer 9

Defensive stocks

Question 10

An investor buys 200,000 shares of a private placement that’s sold under Regulation D. The investor is not an officer or director of the company. How many shares is the investor permitted to sell three months later?

None, since the investor failed to satisfy the minimum holding period.
All of the shares since he’s not an officer or director of the issuer.
50% of the shares since he’s not an officer or director of the issuer.
All of the shares since he purchased less than 1 million shares.

Answer 10

None, since the investor failed to satisfy the minimum holding period.

When securities are sold in a private placement under Regulation D, there’s a minimum holding period of six months for any investor. If a holding period of one year is satisfied, an investor may sell his shares without complying with the filing requirements that are established under SEC Rule 144.

Question 11

Which of the following statements is TRUE regarding warrants?

Warrants can be perpetual
Warrants receive dividends when the common stock receives dividends
Warrants are guaranteed by the Options Clearing Corporation
Warrants are only issued by blue-chip corporations

Answer 11

Warrants can be perpetual

Question 12

Preemptive rights provide which of the following benefits to their holders?

The ability to vote when they cannot attend the shareholders’ meeting.
That dividends will continue to be paid on their common stock.
Their proportionate ownership will not be diluted if additional shares are issued.
A guarantee that bonds can be purchased at a predetermined price from the issuer.

Answer 12

Their proportionate ownership will not be diluted if additional shares are issued.

Question 13

Who is responsible for interest payment and repayment of loan at maturity?

Shareholder
Investor
Borrower
Debtor

Answer 13

Borrower

Question 14

The American Utility Company of Ohio is offering $750 million of 8% bonds at a price of 99.25% of par value. An investor who buys the bonds will receive yearly interest of:

$99.25 per $1,000 of face amount
$80.00 per $1,000 of face amount
$1,000.00 per $1,000 of face amount
$750.00 per $1,000 of face amount

Answer 14

$80.00 per $1,000 of face amount

Question 15

Level debt service means that:

Interest and principal payments are equal each yeare means that:
Interest payments are equal each year
Interest payments are equal each year and all principal come due at maturity
Principal payments are equal each year

Answer 15

Interest and principal payments are equal each yeare means that:

Question 16

A bond with a 5% coupon was issued at par. Shortly thereafter, it was yielding 5.5%, but is now yielding 4.5%. The bond is now trading at:

Par
A price lower than its issue price
A discount
A premium

Answer 16

A premium

Question 17

Which of the following bonds has an interest payment which remains unchanged until maturity?

A variable rate bond
Zero-coupon bond
A floating rate bond
An adjustable rate bond

Answer 17

Zero-coupon bond

Question 18

A municipal bond is trading at $950, has a 4% coupon, and is callable at par. Which of the following statements about this bond is TRUE?

The YTC is equal to the nominal yield.
The investor will receive $40 per year.
The YTC is less than the nominal yield.
The YTM is less than nominal yield.

Answer 18

The investor will receive $40 per year.

Question 19

Municipal bond rating organizations are concerned primarily with the risk of:

Default
Declining purchasing power
Illiquidity
Market price fluctuations

Answer 19

Default

Question 20

A bond with which of the following features is MOST advantageous to an investor?

A bond with a put provision
A non-callable bond
A bond with an in-whole call provision
A bond with a partial call provision

Answer 20

A bond with a put provision

Question 21

What’s the price of a putable bond compared to the price of a comparable traditional bond?
It’s less than the price of a traditional bond.
It’s equal to the price of a traditional bond.
It’s greater than the price of a traditional bond.
It’s unrelated to the price of a traditional bond.

Answer 21

It’s greater than the price of a traditional bond.

Question 22

If market interest rates increase, the prices of outstanding bonds:

Will remain unchanged
Will decrease
Will revert to their call price
Will increase

Answer 22

Will decrease

Question 23

For a bond, what does a call provision describe to investors?

The coupon rate and call date
The maturity date and coupon dates
The original issue discount, if any
The call date and call price

Answer 23

The call date and call price

Question 24

An individual owns a bond at $960 and it’s convertible at $40. If he converts the bond at a time when the stock is trading at $42 per share and the bond is trading at $1,040, which of the following is TRUE?

He receives 26 shares.
He receives 24 shares.
He receives 25 shares.
He realizes a $80 gain on the conversion.

Answer 24

He receives 25 shares.

Question 25

A bond is convertible at $20. If the bond is currently priced at $960 and the underlying stock is trading at $15, how many shares will an investor receive if the bond is converted? 50 shares 40 shares 64 shares 48 shares

Answer 25

50 shares

Question 26

A bond is convertible at $25 and currently trading at $1,100. If the underlying common stock is trading at $28, how much will an investor receive if he converts the bond and immediately sells the stock? $1,232 $1,000 $1,120 $1,100

Answer 26

$1,120

Question 27

The value of the conversion feature on a convertible bond is determined by: Its maturity date Its interest rate The stock price The bond's trustee

Answer 27

The stock price

Question 28

A corporation wants to offer its shareholders the ability to obtain shares at a fixed price. Which security should the corporation issue? Futures Puts Rights Preferred Stock

Answer 28

Rights Rights (preemptive rights) are issued by corporations and offer existing shareholders the ability to purchase additional shares at a fixed price. Exchange-traded options (e.g., calls and puts) are not directly issued by an issuer as a means of raising capital. (17612)

Question 29

What type of security gives the owner immediate control over the issuer? Subscription warrants Preferred stock Convertible bonds Common stock

Answer 29

Common stock Common stock carries voting privileges and, as a result, common shareholders have control over the issuer (e.g., electing board members). Bonds and preferred stocks don't offer the ability to vote in corporate elections. Convertible bonds and warrants will only receive control over an issuer if they have been converted or exercised. (10734)

Question 30

A company in which your client owns stock is about to make a rights offering. The client informs you that he does not plan on subscribing to the offer. You would tell the client that his proportionate ownership interest in the company would: Increase Remain unchanged Depend on the market value of the stock Decrease

Answer 30

Decrease If an individual does not subscribe to additional stock in a rights offering, his proportionate ownership interest in the company will decrease. (84229)

Question 31

Which of the following statements is TRUE regarding warrants? Warrants are only issued by blue-chip corporations Warrants can be perpetual Warrants are guaranteed by the Options Clearing Corporation Warrants receive dividends when the common stock receives dividends

Answer 31

Warrants can be perpetual Warrants can be perpetual in their duration and are issued by the corporation that also issues the common stock. Warrants give the holder the ability to convert the warrant into the common stock of the same corporation at a specified price and at the holder's option. (72573)

Question 32

In a Chapter 11 bankruptcy proceeding, which of the following has the highest priority claim? Unsecured debt holders Equity holders Administrative claim holders Secured debt holders

Answer 32

Secured debt holders In a bankruptcy proceeding, secured creditors are given the highest claim priority. For companies in the U.S., there are two types of bankruptcy proceedings—Chapter 7 and Chapter 11. Chapter 7 is when the company is going out of business and all of the assets owned by the company are sold. This type of bankruptcy is also referred to as liquidation. Chapter 11 is also referred to as reorganization because the company is not going out of business; instead, it's taking steps to come out of the proceedings in a healthier financial position. (17609)

Question 33

The most recent transaction in ABC 6.50x 2050 was at 95. This bond is trading at: Par The yield to maturity A discount A premium

Answer 33

A discount The bond's last trade was done at a price of 95 or 95% of par, which is a discount. The 6.50 represents the bond's interest rate and 2050 is the bond's maturity date. The "x" is simply a placeholder and doesn't give any information about the bond. (17615)

Question 34

The value of the conversion feature on a convertible bond is determined by: The stock price Its interest rate Its maturity date The bond's trustee

Answer 34

The stock price Convertible bonds can be converted into a pre-determined number of shares of the issuer's common stock (i.e., conversion ratio). Investors will likely convert their bonds if the price of the stock rises or is expected to rise. The other features on a bond (e.g., its maturity date or interest rate) will not have as significant an impact on the value of the conversion feature. (17415)

Question 35

If market interest rates increase, the prices of outstanding bonds: Will remain unchanged Will revert to their call price Will increase Will decrease

Answer 35

Will decrease Bonds are subject to interest-rate risk. Interest-rate risk implies that as market rates increase, investors will not be interested in purchasing existing bonds at par since they’re able to obtain higher yields by purchasing new bonds. Therefore, existing bonds will need to be offered at a discounted price in order to attract purchasers. In other words, if interest rates increase, outstanding bond prices will decrease. Conversely, if interest rates fall after a bond has been issued, the bond will likely trade at a premium to par. (37039)

Question 36

The certificate which gives a person other than the stockholder the right to vote is referred to as a: Stock power Warrant Power of attorney Proxy

Answer 36

Proxy The certificate which gives a person other than the stockholder the right to vote is referred to as a proxy. Although stockholders have the right to attend shareholder meetings in person, most do not. Instead, the stockholders sign a proxy which directs a designated person on how to vote their shares. (37020)

Question 37

If a bond is called at 103.75, how much will an investor receive? $1,037.75 $1,037.50 plus accrued interest It depends on the current market price of the bond $1,037.50

Answer 37

$1,037.50 plus accrued interest Bond prices are quoted in percentages of par. A bond with a call price of 103.75 is callable at 103.75% of par value. Since the par value for most bonds is $1,000, when this bond is called, the issuer must pay $1,037.50 ($1,000 x 103.75%) to each investor. However, if a bond is called before it matures or is sold prior to maturity, the seller is also entitled to accrued interest. (17414)

Question 38

The security with the longest expiration date would normally be a: Right Call Put Warrant

Answer 38

Warrant A warrant generally has an expiration date longer than a put, call, or right. There are some warrants which never expire. (72603)

Question 39

A company based in Europe with offices located in New Jersey would like to have its stock traded on the NYSE. This would most likely be accomplished through the issuance of: Bankers' Acceptances Yankee bonds Eurodollar bonds American Depositary Receipts

Answer 39

American Depositary Receipts American Depositary Receipts (ADRs) facilitate U.S. investment in the stock of foreign corporations. When the foreign securities are deposited in a U.S. bank based in that country, a receipt for those securities is issued and traded in the U.S. as if it were the foreign security itself. (63214)

Question 40

A corporation's shareholders must vote for: Stopping dividends Cash dividends Stock splits Stock dividends

Answer 40

Stock splits The board of directors has control over dividends but must have shareholder approval for a stock split. (72616)

Question 41

A convertible bond has a conversion price of $50 and is currently selling in the market at $1,100. The conversion ratio is: 50 22 55 20

Answer 41

20 To find the conversion ratio of a convertible bond, the bond's par value ($1,000) is divided by the conversion price ($50). In this question, the conversion ratio is 20 ($1,000 ÷ $50). To calculate the conversion ratio, the market price of the bond is irrelevant. (37049)

Question 42

For a bond, what does a call provision describe to investors? The call date and call price The maturity date and coupon dates The original issue discount, if any The coupon rate and call date

Answer 42

The call date and call price For a bond, the call provision is a part of a bond's indenture and stipulates the bond's call date and call price. (17616)

Question 43

Last year, a company failed to pay the full dividend to its preferred shareholders, but now wants to pay a cash dividend on its common shares. Which preferred stock must be paid all of the dividends in arrears before the dividend can be paid on its common shares? Convertible preferred Cumulative preferred Callable preferred Participating preferred

Answer 43

Cumulative preferred If a corporation has failed to pay dividends in full on its preferred shares, cumulative preferred stock must be paid any dividends in arrears (missing) before common shares are paid cash dividends. Participating preferred allows the holder to receive an additional amount (along with common shares) if company profits reach a certain level. Convertible preferred can be converted into common stock of the issuer, and callable preferred can be called back from the holder by the issuer. (17509)

Question 44

For a bond owner, in which of the follow situations is call protection most valuable? When bond prices are stable. When bond prices are falling. When bond prices are fluctuating. When bond prices are rising.

Answer 44

When bond prices are rising. Call protection prevents an issuer from calling (i.e., buying back) their bonds. If bonds are ultimately called, investors must sell their bonds back to the issuer. Bonds are most often called when their prices have risen due to declining interest rates. (17613)

Question 45

Which of the following is a characteristic of a subscription warrant? Immediate dilution of the corporation's shares Immediate forfeit of control over the company A shareholder's ability to maintain ownership during an issuance of stock Lower fixed interest expense on the issuer's bonds

Answer 45

Lower fixed interest expense on the issuer's bonds Warrants represent the right to buy shares of stock at a pre-determined price. Warrants are typically attached to bonds or preferred stock. The issuer attaches warrants to these securities in order to lower the interest or dividend rate on the new security being issued. (10733)

Question 46

Which of the following investments is the MOST suitable for a person who is interested in aggressive growth? High-rated bond Preferred stock High-yield bond fund Common stock

Answer 46

Common stock Of the choices listed, common stock has historically provided the greatest potential for growth. Bonds and preferred stock are typically suitable for investors who are seeking income. (17507)

Question 47

Preferred dividends: Must be satisfied before common dividends Must be satisfied each year Must be satisfied after common dividends Must be satisfied before bond interest payments

Answer 47

Must be satisfied before common dividends Preferred shares receive dividends before the common stock dividends can be paid. However, a company doesn't guarantee preferred dividends will be paid each year. (17411)

Question 48

Who derives the MOST benefit from a put provision attached to a bond offering? Bondholders Preferred stock holders Issuers Common stock holders

Answer 48

Bondholders A put provision allows the bondholder to redeem the bond on a specified date (or dates) prior to maturity. This provision is most likely to be utilized if market interest rates rise. (37046)

Question 49

A U.S. government bond is selling in the market at 95.28. The dollar value of this bond is: $958.75 $9,587.50 $952.80 $950.87

Answer 49

$958.75 U.S. government bonds are quoted as a percentage of par with a fraction in 32nds of a point. Therefore, a T-bond quoted at 95.28 is equal to 95 28/32. By converting the fraction to a decimal, the quote becomes which is 95.875% of the par value of $1,000. $1,000 x 95.875% = $958.75. (37032)

Question 50

XYZ corporation has 7,000,000 shares of common stock ($1 par value) authorized, of which 5,000,000 shares have been issued. There are 500,000 shares of treasury stock. The current market price of XYZ is 20. The market capitalization of XYZ common stock is: $5,000,000 $4,500,000 $100,000,000 $90,000,000

Answer 50

$90,000,000 A company's market capitalization is found by multiplying the market value by the outstanding shares. $20 market value x 4,500,000 shares outstanding = $90,000,000. (72621)

Question 51

Foreign stocks trade in U.S. markets as: American Depositary Receipts (ADRs) Unregistered securities Closed-end mutual funds Exchange-Traded Funds (ETFs)

Answer 51

American Depositary Receipts (ADRs) American Depositary Receipts are used to facilitate the trading of foreign stocks in the United States. Unregistered securities are securities sold to investors that do not require registration with the SEC (for example, a private securities offering). An exchange-traded fund (ETF) is a type of investment company that represents a basket of securities and is traded on an exchange. The basket of securities usually represents an index such as the Nasdaq 100 or the S&P 500. A closed-end mutual fund is also a type of investment company that issues a fixed number of shares. (63212)

Question 52

The call premium of a bond refers to the amount: Over par value that the issuer must pay to exercise the call privilege An investor must pay above par to buy a callable bond Added to the price at issuance to compensate for the call privilege The issuer must add to the semiannual interest payments to offset the call feature

Answer 52

Over par value that the issuer must pay to exercise the call privilege The call premium of a bond refers to the amount the issuer must pay in excess of par value to exercise the call privilege. For example, if a bond is callable at 102, it has a 2 point ($20) call premium. The issuer must pay $1,020 ($20 more than par) if it wishes to call in the bond. (84021)