Question 1

Since the issuer of zero (or low) coupon bonds can annually deduct the current year's interest accrual without having to actually pay the interest until the bond matures (or is called), its cash flow each year is increased by the amount of the tax shield provided by the interest deduction.

Accepted Answer

This is because the issuer of zero or low coupon bonds can deduct the interest accrual each year as an expense on their tax returns without having to pay the actual interest until the bond matures or is called. This results in a tax shield that increases their cash flow each year.

Question 2

Interest rate risk is the chance that interest rates will change and thereby change the required return and bond value.

Accepted Answer

Interest rate risk is a real risk faced by bond investors. When interest rates rise, bond prices fall, thus the required return for investors increases as well. When interest rates decrease, bond prices rise and the required return decreases. Therefore, changes in interest rates can have a significant impact on bond values and returns.

Question 3

A trustee is a paid party representing the bond issuer in the bond indenture.

Accepted Answer

A trustee in a bond indenture represents the interests of the bondholders, not the bond issuer, to ensure the issuer complies with the terms of the bond agreement.

Question 4

Stock rights allow stockholders to purchase additional shares of stock in direct proportion to the number of shares they own.

Accepted Answer

Stock rights give current stockholders the opportunity to purchase additional shares of stock in proportion to the number of shares they already hold. This allows stockholders to increase their ownership stake in the company.

Question 5

Two of Canada's chartered banks, the Royal Bank and CIBC, are in the top 10 banking companiesby assets in the world.

Accepted Answer

While both Royal Bank and CIBC are major banks in Canada, they do not rank in the top 10 banking companies by assets in the world. As of 2021, the top 10 banking companies by assets included institutions such as Industrial and Commercial Bank of China, China Construction Bank, and JPMorgan Chase.

Question 6

Cumulative preferred stocks are preferred stocks for which all passed (unpaid) dividends in arrears must be paid in additional shares of preferred stock prior to the payment of dividends to common stockholders.

Accepted Answer

The answer of Cumulative preferred stocks are preferred stocks for...

Question 7

One advantage of preferred stock is its ability to increase leverage, which in turn will magnify the effects of increased earnings on common stockholders' returns.

Accepted Answer

Preferred stock is often viewed as less risky than common stock and can be used to increase a company's leverage without diluting the ownership of common stockholders. This increased leverage can magnify the effects of increased earnings on common stockholders' returns.

Question 8

A share of stock is expected to pay a $4 dividend next year, and investors have expectations of a12% return. If dividends are expected to grow at 5% per year indefinitely into the future, a share ofstock is worth $57.14.

Accepted Answer

Using the dividend discount model with a 12% required return and a 5% growth rate for dividends, the calculated stock price is indeed $57.14 (Dividend / (Required Return - Growth Rate) = $4 / (0.12 - 0.05) = $57.14).

Question 9

When the required return equals the coupon interest rate, the bond's value will remain at par until it matures.

Accepted Answer

When the required return equals the coupon interest rate, the bond's yield to maturity (YTM) will equal the coupon rate. This means that the bond is priced at par value, and its value will remain at par until it matures, as there is no gain or loss to be made by buying or selling the bond.

Question 10

Yield to maturity (YTM) is the rate investors earn if they buy the bond at a specific price and hold ituntil maturity.

Accepted Answer

Yield to maturity is the total return anticipated on a bond if it is held until it matures. It takes into account both the interest earned on the bond and the difference between the price paid for the bond and the face value returned at maturity.

Question 11

Floating-rate bonds are bonds that can be redeemed at par at the option of their holder either on a specific date after the date of issue and every 1 to 5 years thereafter or when and if the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt.

Accepted Answer

Floating-rate bonds have variable interest rates that are tied to an external benchmark, such as LIBOR, and fluctuate as the benchmark rate changes. They do not have specific redemption dates or trigger events like described in the statement.

Question 12

Although Treasury bills have no risk of default or illiquidity, they do suffer from "maturity risk" - the risk that interest rates will change in the future and thereby impact longer maturities more than shorter maturities.

Accepted Answer

This statement is true. The value of a Treasury bill will decrease if interest rates rise, and the longer the maturity of the bill, the more sensitive it will be to changes in interest rates. Therefore, there is a certain level of "maturity risk" associated with Treasury bills.

Question 13

Preferred stock is often considered a quasi-debt since it yields a fixed periodic payment.

Accepted Answer

Preferred stock is a type of stock that pays a fixed dividend, similar to bond interest payments. This fixed, periodic payment makes it more similar to debt than common stock, which does not guarantee any dividend payments.

Question 14

The market price of a callable bond will not generally exceed its call price, except in the case of a convertible bond.

Accepted Answer

The market price of a callable bond typically does not exceed its call price significantly because investors anticipate that the issuer will likely call the bond if interest rates drop and the bond's price rises too much above the call price. However, a convertible bond can exceed its call price due to the added value of the conversion option into equity, which may appreciate independently of interest rate movements.

Question 15

Because most small shareholders do not attend the annual meetings to vote, they may sign a proxy statement giving their votes to another party.

Accepted Answer

This is true. Small shareholders can sign a proxy statement to give their voting rights to another party if they are not attending the annual meetings.

Question 16

Tax laws are used to accomplish economic goals such as providing incentives for corporate investment in certain types of assets.

Accepted Answer

Tax laws can be used to incentivize specific economic behaviors, such as corporate investment in targeted assets or industries.

Question 17

Increases in the basic cost of long-term funds or in the risk will raise the required return on the bond.

Accepted Answer

Increases in the basic cost of long-term funds (such as changes in interest rates) or in the risk associated with a particular bond (such as concerns about a company's financial stability) will increase the required return on the bond for investors. This is because investors will demand a higher return to compensate for the increased risk or cost of borrowing.

Question 18

There is one major bond rating agency in Canada - Moody's.

Accepted Answer

There are three major bond rating agencies in Canada - Moody's, Standard & Poor's, and DBRS.

Question 19

Call feature is a feature included in almost all corporate bonds that allows the issuer to repurchase bonds at the market price prior to maturity.

Accepted Answer

A call feature allows the issuer to repurchase bonds at a predetermined price, not the market price, prior to maturity.

Question 20

When the required return is different from the coupon interest rate and is assumed to be constant until maturity, the value of the bond will approach its par value as the passage of time moves the bond's value closer to maturity.

Accepted Answer

The answer of When the required return is different from...

Quiz 8: Valuation of Financial Securities