Question 1

The difference between the rights-on and ex-rights common stock price is equal to the value of a right.

Accepted Answer

This statement is true. The difference between the rights-on and ex-rights common stock price represents the value of a right.

Question 2

The difference between the rights-on and ex-rights price is equal to the subscription price divided by N.

Accepted Answer

The difference between the rights-on and ex-rights price is equal to the theoretical value of the subscription right divided by N, not the subscription price.

Question 3

Preferred stock generally carries a higher interest rate than debt.

Accepted Answer

Preferred stock is a form of equity, not debt, so it does not have an interest rate. However, it can have a higher dividend rate than common stock.

Question 4

The ex-rights date usually takes place after the end of the subscription period.

Accepted Answer

The ex-rights date occurs before the subscription period begins, indicating the date on which the stock begins trading without the right to receive the rights offering.

Question 5

Preferred stock dividends are a deductible expense for a corporation.

Accepted Answer

The answer of Preferred stock dividends are a deductible expense...

Question 6

Since the late 1970s preferred stock has been trading at slightly higher yields than comparable bonds.

Accepted Answer

The answer of Since the late 1970s preferred stock has...

Question 7

The aftertax cost of debt is cheaper than preferred stock to the issuing corporation.

Accepted Answer

The aftertax cost of debt is cheaper than preferred stock because interest payments on debt are tax-deductible, reducing the effective cost of debt to the issuer. Preferred stock dividends, on the other hand, are not tax-deductible.

Question 8

To the individual recipient, preferred stock dividends offer no advantage over common stock dividends.

Accepted Answer

The answer of To the individual recipient, preferred stock dividends...

Question 9

A rights offering may be of limited value to shareholders.

Accepted Answer

Rights offerings may not be attractive to shareholders if the price of the shares offered is higher than the current market price or if they do not have the financial means to exercise their rights. Additionally, the dilution of ownership may lower the value of their shares.

Question 10

To the security holder, preferred stock offers the highest risk and the lowest return.

Accepted Answer

This statement is incorrect. Preferred stock actually offers lower risk and higher returns than common stock, as it usually pays a fixed dividend and has priority over common stock in terms of receiving dividends and assets in the event of bankruptcy.

Question 11

If the market value of a stock when the shares are trading ex-rights is $57 and 9 rights are required to buy one share of stock at the subscription price of $45, then the rights are worth $1.33.

Accepted Answer

To calculate the value of one right, we can use the following formula:

Value of one right = (Market value of stock ex-rights - Subscription price) / (Number of rights required + 1)

Plugging in the given values, we get:

Value of one right = ($57 - $45) / (9 + 1) = $1.20

Therefore, each right is worth $1.20. Therefore, the statement above is false.

Question 12

Common shareholders have a residual claim to income, in other words they are last in line.

Accepted Answer

Common shareholders are the last to receive payment in case of bankruptcy or liquidation, after creditors and preferred shareholders have been paid. This is because they have a residual claim on the company's earnings, meaning that they only receive dividends and capital gains after all other obligations have been met.

Question 13

Because of tax considerations, corporations are able to issue preferred stock at a slightly lower yield than debt.

Accepted Answer

This is because preferred stock dividends are not tax-deductible for the corporation, while interest on debt is. Therefore, in order to attract investors to buy preferred stock, corporations may offer a slightly lower yield compared to the interest rate on their debt.

Question 14

Shares purchased through a rights offering may carry lower margin requirements.

Accepted Answer

This is because the shares are purchased at a discounted price, which reduces the potential for losses if the stock price were to decline. As a result, brokers may require lower margin requirements to reflect the lower risk.

Question 15

After a rights offering the common stock price will sell at the subscription price.

Accepted Answer

After a rights offering, the common stock price may sell at or around the subscription price, but it is not guaranteed to do so. The stock price may be influenced by various market factors such as supply and demand, company performance, and overall market conditions.

Question 16

Bondholders never have any control over the actions of a firm.

Accepted Answer

Bondholders can exert control over a firm through covenants in the bond agreement that may restrict certain actions of the firm, such as taking on additional debt or making large asset sales, to protect their interests.

Question 17

Participating preferred stock is advantageous to common shareholders.

Accepted Answer

The answer of Participating preferred stock is advantageous to common...

Question 18

If a company has preferred stock, it must pay the dividends on the preferred even if it shows no profit for the year.

Accepted Answer

The answer of If a company has preferred stock, it...

Question 19

A common shareholder cannot force a company into bankruptcy for eliminating the dividend.

Accepted Answer

A common shareholder does not have the power to force a company into bankruptcy for eliminating the dividend. The decision to declare or eliminate dividends is made by the company's board of directors.

Question 20

Shareholders always have preemptive rights when new issues of stock are offered.

Accepted Answer

Shareholders do not always have preemptive rights when new issues of stock are offered. The company's bylaws or charter will specify whether or not preemptive rights are granted to shareholders.

Quiz 17: Common and Preferred Stock Financing