Unit 4: Types of Securities Flashcards
What is preferred stock?
Preferred stock is a hybrid of debt and equity. It has a fixed charge and increases leverage, but payment of dividends is not a legal obligation. It often has no voting rights.
What are the advantages of issuing preferred stock?
-Increasing the creditworthiness of the firm.
-No dilution of ownership.
-Superior earnings are usually still reserved for common shareholders.
What are the disadvantages of issuing preferred stock?
Cash dividends are not tax-deductible and are paid with after-tax income.
Dividends in arrears may create major managerial and financial problems.
What is a preferred stock call provision?
The issuer may have the right to repurchase the stock by paying a call premium.
What are the factors influencing a company’s dividend policy?
Legal restrictions
Stability of earnings
Rate of growth
Cash position
Debt agreement restrictions
Tax position of shareholders
Residual Theory of Dividends
Define stock dividend.
A stock dividend is an issuance of stock and entails the transfer of a sum from the retained earnings account to a paid-in capital account.
Define stock split.
A stock split is a transaction in which the existing shares of a company are divided into more shares so that the market price per share is reduced.
What is a reverse stock split?
Reverse stock splits reduce the number of shares outstanding, thereby increasing the price per share.
What are the motives for a share repurchase?
Mergers
To meet a need for share options
Stock dividends
Tax advantages to shareholders
Increasing EPS and other ratios
Preventing a hostile takeover
Eliminating a particular ownership interest
On what date does a cash dividend become a liability of a corporation?
A cash dividend becomes a liability of a corporation on the date of declaration.
What is a bond?
A bond is a formal contractual obligation to pay an amount of money (face amount) to the holder at a certain date, plus, in most cases, a series of cash interest payments based on a specified percentage (stated rate) of the face amount at specified intervals.
What are the advantages of issuing bonds?
Interest paid on debt is tax deductible.
Basic control of the firm is not shared with debtholders.
What are the disadvantages of issuing bonds?
Payment of interest and principal is a legal obligation.
Debt is generally riskier than issuing equity.
Potential bond covenants that limit management’s ability to operate freely.
Debt financing available to the individual firm is limited.
What is a debenture?
A debenture is an unsecured bond that is not backed by specific collateral. Debentures are riskier to investors than secured bonds.
What are the disadvantages of issuing stock?
Cash dividends are not tax deductible by the corporation.
Control of the company is diluted as stock is sold.
Earnings per share may be diluted as common stock is sold.
Underwriting costs are high.
