Question 1

From a social welfare perspective,common stock is a desirable form of financing in part because it involves no fixed charge payments.Its inclusion in a firm's capital structure makes the firm less vulnerable to the consequences of unanticipated declines in sales and earnings than if only debt were available.

Accepted Answer

Common stock does not involve fixed charge payments, which can be beneficial for a firm's financial stability in case of unexpected decreases in sales or earnings. This aligns with a social welfare perspective, which aims to promote the well-being of society as a whole.

Question 2

A Eurodollar is a U.S.dollar deposited in a bank outside the United States.

Accepted Answer

This is correct, a Eurodollar is a U.S. dollar deposited in a foreign bank outside of the United States. It is not to be confused with the Euro currency used in Europe.

Question 3

Income bonds pay interest only when the amount of the interest is actually earned by the company.Thus,these securities cannot bankrupt a company and this makes them safer than regular bonds.

Accepted Answer

This statement is incorrect. Income bonds are actually riskier than regular bonds because the interest payments are not guaranteed and depend on the company's earnings. If the company does not earn enough to pay the interest, then the bondholders may not receive any income at all. This means that income bonds can potentially bankrupt a company if it is unable to pay the interest.

Question 4

Preferred stockholders have priority over common stockholders with respect to earnings.Dividends must be paid on preferred stock before they can be paid on common stock.In exchange for this priority to dividends,preferred stockholders give up their priority claims to common stockholders in the event of bankruptcy.

Accepted Answer

Preferred stockholders have priority over common stockholders with respect to dividends, but they also typically have priority in the event of bankruptcy, not the other way around.

Question 5

As with common stock,preferred stock always has a par value,and also,like common stock,the par value is unimportant in the event of liquidation.However,the preferred stock dividend does depend on the par value and the dividend is usually stated as a percentage of par.

Accepted Answer

The answer of As with common stock,preferred stock always has...

Question 6

Convertible securities are bonds or preferred stocks that,under specified terms and conditions,can be exchanged for common stock at the option of the holder.

Accepted Answer

Convertible securities are a type of hybrid security that combines features of both debt and equity. They can be converted into common stock at the option of the holder, based on predetermined terms and conditions.

Question 7

Restrictive covenants are designed so as to protect both the bondholder and the issuer even though they may constrain the actions of the firm's managers.Such covenants are contained in the bond's indenture.

Accepted Answer

Restrictive covenants are indeed included in the bond's indenture to protect both the bondholder and the issuer, even though they may limit the managers' actions.

Question 8

"Treasury zeros" are Treasury bonds that have been split or "stripped" into a zero coupon discount Treasury certificate and a series of interest payments (the coupon payments).These bonds are safer than corporate zeros and thus,are very popular with institutional investors such as pension fund managers.

Accepted Answer

Treasury zeros are split or stripped from Treasury bonds into a zero coupon discount Treasury certificate and a series of interest payments, making them safer than corporate zeros, and popular among institutional investors such as pension fund managers.

Question 9

A convertible debenture cannot be worth more than its conversion value or less than its bond value.

Accepted Answer

A convertible debenture can be worth more than its conversion value if its market value exceeds its bond value due to factors such as changes in interest rates or the issuer's creditworthiness. Additionally, it can be worth less than its bond value if the conversion option is out of the money and the debenture is trading purely based on its bond-like characteristics.

Question 10

LIBOR is an acronym for London Interbank Offer Rate,which is an average of interest rates offered by London banks to U.S.corporations.

Accepted Answer

LIBOR is an average of interest rates offered by London banks to other banks, not specifically to U.S. corporations.

Question 11

Firms generally do not call their convertibles unless their conversion value is greater than their call price.

Accepted Answer

Firms generally call their convertibles if the conversion value is greater than the call price, since this allows them to convert the debt into equity at a potentially lower cost.

Question 12

Preferred stock can provide a financing alternative for some firms when market conditions are such that those firms can issue neither pure debt nor common stock at reasonable cost.

Accepted Answer

Preferred stock can serve as a financing option for companies who cannot issue debt or common stock at a reasonable cost due to market conditions. Preferred stock provides a fixed dividend, similar to debt, but also has equity-like characteristics, such as potential appreciation in value. This can appeal to investors who may be hesitant to invest in pure debt or common stock under certain circumstances.

Question 13

A putable bond can be redeemed at par value at the holder's option.Usually,the put option can be exercised only if the issuer takes some specific action,such as significantly increasing debt.

Accepted Answer

A putable bond can be redeemed at par value at the holder's option, but this option is typically not contingent on the issuer taking specific actions like increasing debt; it is at the discretion of the bondholder.

Question 14

An indexed bond has its value tied to an inflation index.As inflation increases the value of the bond increases and the issuer is responsible for the accumulated value which may become much greater than the original face value.

Accepted Answer

The answer of An indexed bond has its value tied...

Question 15

The interest rate paid on Eurodollar deposits depends on the particular bank's lending rate and on rates of return available on U.S.money market instruments.

Accepted Answer

The interest rate paid on Eurodollar deposits is influenced by the bank's lending rate and the rates of return on U.S. money market instruments.

Question 16

One of the disadvantages to a firm in issuing zero coupon bonds is that the tax shield associated with the bonds' appreciation cannot be claimed until the bond matures.

Accepted Answer

The tax shield associated with the interest expense of zero coupon bonds is recognized annually, even though the interest is not paid until maturity, because the issuer can deduct the imputed interest expense each year for tax purposes.

Question 17

The Eurodollar market is essentially a long-term market;most loans and deposits have maturities of longer than one year.

Accepted Answer

The Eurodollar market is primarily a short-term market, with most loans and deposits having maturities of less than one year.

Question 18

A zero coupon bond's value increases over time at a compounded (or exponential)rate,not at a constant (or linear)rate.The corporate issuer reports the annual increase as interest expense,and the owner of the bond reports the increase as interest income and pays taxes on it each year.

Accepted Answer

A zero coupon bond does not pay interest periodically, but its value increases at a compounded rate over time, which is reported as interest expense by the corporate issuer and interest income by the bond owner, subject to taxation.

Question 19

Although common stock represents a riskier investment to an individual than do bonds,in the sense of exposing the firm to the risk of bankruptcy,bonds represent a riskier method of financing to a corporation than does common stock.

Accepted Answer

Bonds represent a riskier method of financing to a corporation than common stock because they come with a fixed interest rate that must be paid regardless of the company's performance. Additionally, if the company defaults on its bond payments, it may have to declare bankruptcy. On the other hand, common stock represents ownership in the company and does not come with a fixed interest rate or maturity date. While common stockholders are exposed to the risk of bankruptcy, they also have the potential to earn higher returns if the company performs well.

Question 20

A proxy fight involves a battle by a shareholder or group of shareholders who seek to change the investment policy of the firm.If the proxy group is successful,current management retains control of the firm but the proxy group dictates what investments the firm makes.

Accepted Answer

In a proxy fight, shareholders seek to change the management of the firm itself, not just its investment policy. If successful, the proxy group can gain control over the board of directors and thus influence the company's direction, including its management and policies.

Quiz 2: Financial Assets Instruments