Chapter 19 – Using Securities Markets for Financing and Investing Opportunities
While common stockholders of corporations have voting rights, preferred stockholders
generally do not.
Feedback: Preferred stock is frequently referred to as a hybrid investment in that it has
characteristics of both bonds and stocks. Normally preferred stock, like bonds, does not
include voting rights in the firm.
78. A preferred stock’s par value establishes the base used for calculating the preferred
stockholders’ dividend.
Feedback: Par value is the basis for the dividend the firm is willing to pay to preferred
stockholders.
79. A company with cash flow shortages must pay common stockholders their dividends
before paying preferred stockholders their dividends.
Feedback: This order of payment is incorrect. If dividends are declared, preferred
stockholders receive their dividends, first. Then, if the board of directors declares sufficient
money to be paid in dividends, then common stockholders will be paid a dividend.
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83. A share of preferred stock currently sells for $120. It offers the investor a dividend rate
of 8%, with a par value of $100. If the company is able to pay dividends, preferred
stockholders would receive a dividend of $9.60 per share.
Feedback: Par value is the basis for the dividend the firm is willing to pay to preferred
stockholders. In this case, 8% of $100 is an $8 dividend.
84. When acquiring funds through the sale of a bond, the business incurs a legal obligation
to pay regular interest payments.
85. A bond represents a contract of indebtedness issued by a corporation that promises
payment of a principal amount plus interest at a specified future date.
86. Interest represents the payment to bondholders for the use of their money.
87.
Chapter 19 – Using Securities Markets for Financing and Investing Opportunities
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The interest paid to bondholders represents the principal of the bond.
88. The interest rate paid to bondholders is sometimes called the coupon rate.
89. Although the interest rate is fixed when the bond is issued, the interest rate that one firm
must pay compared to another may vary depending upon risk factors such as the
reputation of the firm.
90. U.S. government bonds are considered safe investments. Therefore such government
bonds usually have a lower interest rate than corporate bonds.
91.
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The maturity date of a bond refers to the date on which the interest payment is due to be
paid.
92. The maturity date represents the date on which a corporation must pay investors the
principal (face value) of their bond.
93. Bond classifications include, but are not limited to Corporate bonds,T-bills, Treasury
bonds, Treasury notes, and Municipal bonds.
94. Standard and Poor’s and Moody’s are well-known companies that rate bonds.
95.
Chapter 19 – Using Securities Markets for Financing and Investing Opportunities
Bond interest is usually paid in two times each year, even though the interest rate that is
usually quoted is an annual rate.
96. Interest rates vary with changes in the state of the economy.
97. Bonds represent a permanent source of funding for companies. The money firms acquire
by issuing bonds does not need to be repaid.
98. In the language of bonds, the terms “principal” and “face value” are synonymous.
99. Bondholders represent creditors of a firm.
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100. As a legal contract, bonds issued by different companies carry the same level of risk.
101. Firms are at a disadvantage when issuing bonds because the interest rate that they must
pay to bondholders is not tax deductible.
102. As creditors of a firm, bondholders enjoy voting privileges for the firm’s board of
directors’ elections.
103. Both stocks and bonds represent temporary sources of funding for a firm. Eventually
they must be repaid.
104.
Chapter 19 – Using Securities Markets for Financing and Investing Opportunities
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By issuing bonds, a firm’s debt level increases which may adversely affect the firm’s
image in the financial community.
105. Debenture bonds represent bonds that are not secured by collateral.
106. A sinking fund is a reserve account where the firm will periodically deposit funds in
anticipation of repayment of a bond issue on the maturity date.
107. A callable bond allows a bondholder to exchange his/her bond for shares of common
stock in the same corporation.
108.
Chapter 19 – Using Securities Markets for Financing and Investing Opportunities
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The owner of a convertible bond can exchange the bond for a specified number of
shares of common stock in the same corporation.
109. Raising long-term funds through the sale of bonds requires the firm to make debt
repayment when and if the organization has sufficient cash flow.
Feedback: The organization issuing bonds has a contractual obligation to make regular
interest payments and to repay the principal.
110. With everything else constant, investors prefer a bond issued with a sinking fund
compared to a bond without a sinking fund.
Feedback: A sinking fund bond requires the issuing organization to regularly set aside funds
in a reserve account in order that the firm has sufficient cash with which to repay the
principal.
111.
Chapter 19 – Using Securities Markets for Financing and Investing Opportunities
A bond sold with a sinking fund provision requires the firm to allow a stockholder to
exchange his/her bond for a specified number of shares of common stock.
Feedback: A sinking fund bond requires the issuing organization to regularly set aside funds
in a reserve account in order that the firm has sufficient cash with which to repay the
principal.
112. A company often exercises the call provision of a bond if it’s available when prevailing
interest rates fall below the interest rate currently being paid to bondholders.
Feedback: In an effort to reduce the cost of their debt capital, it would benefit a firm to call in
higher interest rate bonds and reissue new bonds at lower interest rates.
113. Taking into account the risk/return tradeoff, it would stand to reason that a secured
bond holds a lower interest rate than an unsecured bond.
Feedback: Secured bonds are backed by collateral, thus are a less risky investment than an
unsecured bond. In order for corporations to attract investors to unsecured bonds, they
generally must pay a higher interest rate.
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120. The high start-up costs of web-based businesses cause online brokers to charge higher
commissions than traditional brokerage firms.
121. Online investors expect more expert advice than investors using traditional brokerage
firms.
122. Young investors place more importance on low risk investments, while elderly investors
prefer significant growth in the value of their investments.
123. Diversification means buying several different types of investments with the funds you
have available for investment.
124.
Chapter 19 – Using Securities Markets for Financing and Investing Opportunities
For starters, investors should consider the return on investment, the liquidity and
riskiness of an investment.
Feedback: The five criteria to use when selecting an investment option are as follows: (1)
investment risk; (2) yield; (3) duration; (4) liquidity; and (5) tax consequences.
125. A well-diversified portfolio would consist of a variety of investments and even cash for
emergencies. The important thing is that the choice of investments spreads the risk.
Some investments may perform very well in any one year while others may lag. Those
performing well will balance out those that are underperforming.
Feedback: Diversification spreads the risk. If some investments in the portfolio are showing
lackluster performance, they will be balanced by those who show growth. Another term for
this strategy is asset allocation.
126. The advantage of using an online broker is that these services usually provide you with
a wealth of information and help you allocate your assets. Sometimes they even help you
create an investment plan for life!
Feedback: At this time, online brokers provide fast and efficient service, however, the service
comes with very limited assistance and low commissions.
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127. Monica met with a financial planner last week and he urged her to consider only
government bonds and mutual funds in her portfolio. Since she is in her 20’s, Monica
believes she can tolerate a little more risk. You suggest that it is a better plan to follow
the advice of the financial planner, rather than research her choices on her own.
Feedback: As a rule, younger generations may be able to tolerate fluctuations in the market,
because they have more time to recover financially.
128. Raul and his grandfather receive individualized investment advice from the same
chartered financial analyst. When comparing their customized investment
recommendations, it is likely that Raul’s strategy targets lower risk investment options
than the advice received by his grandfather.
Feedback: Generally, a young person can afford to invest in higher risk investment options
than a person nearing retirement. If the investment loses value, Raul has the time to hold on
for better times. A younger person also has the expectation of many years of income. Raul’s
grandfather, on the other hand, has expectations of a fixed income at retirement.
129.
Chapter 19 – Using Securities Markets for Financing and Investing Opportunities
Having just returned from the Iraq war, David, a young soldier has $25,000 in his
savings account. His girlfriend suggested that he talk with an investment advisor and let
his money “make more money”. David has his eye on a new Ford truck, but he knows
that his old Jeep Cherokee will probably last another four years, at which time he will
definitely need this money as a down payment or purchase of something new. David
should buy high growth stock with his funds because even though they are risky, they
also have the greatest potential of bringing in the better return on his investment.
Feedback: Although he is young and probably has time to recover from downward spirals in
the stock market, David requires liquidity, and availability in four years or less. It is best to
consider a lower yielding, but less risky investment.
130. Buying a stock makes the investor an owner in the firm.
131. An investor earns a capital gain when they sell a stock for more than they paid for it.
132. The market price and growth potential of a common stock depends heavily on the
performance of the firm in meeting its objectives.
