978-1285429649 Test Bank Chapter 2 Part 1

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subject Textbook Principles of Finance 6th Edition
subject Authors Eugene F. Brigham, Scott Besley
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Principles of Finance, 6e
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1. Which of the following events would make it more likely that a company would choose to call its outstanding callable
bonds?
a.
A reduction in market interest rates.
b.
The company's bonds are downgraded.
c.
An increase in the call premium.
d.
Answers a and b are both correct.
e.
Answers a, b, and c are all correct.
ANSWER:
a
RATIONALE:
Statement b is false because a bond downgrade generally raises the cost of issuing new
debt. Therefore, the callable bonds would not be called. Statement c is false since the
call premium, the cost paid in excess of par, increases the cost of calling debt.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-01 - Stocks and Bonds
Time Estimate-a - 5 min.
TOPICS:
Callable Bonds
2. Other things held constant, if a bond indenture contains a call provision, the yield to maturity that would exist without
such a call provision will generally be ____ the YTM with it.
a.
Higher than
b.
Lower than
c.
The same as
d.
Either higher or lower, depending on the level of call premium, than
e.
Unrelated to
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
3. Of the following provisions that might be found in a bond indenture, which would tend to reduce the coupon interest
rate on the bond in question?
a.
A subordination clause in a debenture.
b.
A call provision.
c.
A convertible feature.
d.
Having relatively few restrictive covenants.
e.
All of the above.
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ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
4. The terms and conditions to which a bond is subject are set forth in its
a.
Debenture.
b.
Underwriting agreement.
c.
Indenture.
d.
Restrictive covenants.
e.
Call provision.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
5. All of the following may serve to reduce the coupon rate that would otherwise be required on a bond issued at par,
except a
a.
Sinking fund.
b.
Restrictive covenant.
c.
Call provision.
d.
Change in rating from Aa to Aaa.
e.
None of the above (all may reduce the required coupon rate).
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
6. Which of the following factors does not influence a firm's long-term financing decisions?
a.
Its target capital structure.
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b.
Maturity matching considerations.
c.
Comparative costs of financing alternatives.
d.
Availability of collateral.
e.
All of the above factors may influence a firm's long-term financing decisions.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-03 - Capital Budgeting and Cost of Capital
Time Estimate-a - 5 min.
TOPICS:
Long-Term Financing
7. Common equity refers to the sum of which of the following balance sheet accounts?
a.
Common stock and retained earnings
b.
Book value, retained earnings, and common stock
c.
Common stock, additional paid-in capital, retained earnings
d.
Either answer a or c above could be correct depending on whether the firm has "par" or "no par" stock.
e.
Both b and c are correct since additional paid-in capital is equivalent to book value.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
8. The preemptive right is important to shareholders because it
a.
Allows management to sell additional shares below the current market price.
b.
Protects the current shareholders against dilution of ownership interests.
c.
Is included in every corporate charter.
d.
Will result in higher dividends per share.
e.
The preemptive right is not important to shareholders.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
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9. Companies can issue different classes of common stock. Which of the following statements concerning stock classes is
correct?
a.
All common stocks fall into one of three classes: A, B, and C.
b.
Most firms have several classes of common stock outstanding.
c.
All common stock, regardless of class, must have voting rights.
d.
All common stock, regardless of class, must have the same dividend privileges.
e.
None of the above statements is necessarily true.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
10. Which of the following statements is correct?
a.
One danger a family-owned business faces when it goes public is the loss of absolute voting control of the
company, because there is no way to keep new stockholders from voting.
b.
The market is less active for small companies' shares, so these stocks must be included on the SEC's list in
order to inform investors of their existence. Therefore, "listed shares" as the term is generally used refers to
shares of smaller as opposed to larger companies.
c.
Before a company can offer a new issue of common stock to the public, it must get approval from the SEC for
the price at which the stock can be sold. If the SEC thinks the proposed price is too high, then the company's
prospectus is rejected and the stock cannot be sold.
d.
The preemptive right refers to stockholders' right to elect a company's board of directors.
e.
Each of the above statements is false.
ANSWER:
e
RATIONALE:
Different classes of stock can be issued which can keep new stockholders from voting for
a certain number of years. Listed shares are those that are on an exchange. Exchanges
have minimum net income and share requirements; thus these companies would be large
rather than small. The SEC does not approve the price at which new securities are
offered. The preemptive right gives old stockholders the right to purchase additional
shares of common stock on a pro rata basis.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-01 - Stocks and Bonds
Time Estimate-a - 5 min.
TOPICS:
Miscellaneous
11. Which of the following statements is correct?
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a.
All common stock must have full voting rights.
b.
While firms are allowed to issue different classes of common stock, the Securities and Exchange Commission
(SEC) requires that each class have the same dividend privileges.
c.
The New York Stock Exchange (NYSE) allows firms with dual class stock to be listed on the exchange.
d.
In order to increase a stock's liquidity, investment bankers generally require that insiders sell some percentage
of their shares after a firm has undergone an initial public offering (IPO).
e.
When a firm raises capital, investment bankers enter into a "best efforts" arrangement which guarantees that
the securities will be sold.
ANSWER:
c
RATIONALE:
Statement c is correct. For example, General Motors has several NYSE listed common
classes. Statement a is false because not all common stock has full voting rights.
Statement b is false since classes of common can have differing dividend policies.
Statement d is false because insider sales tend to depress share prices because they are
a sign that the shares are overpriced. Statement e is false because a "best efforts"
arrangement does not guarantee that the securities will be sold.
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-3 - Comprehension
Business Program-6 - Reflective Thinking
DISC-FIN-01 - Stocks and Bonds
Time Estimate-a - 5 min.
TOPICS:
Miscellaneous
12. An option which gives the holder the right to sell a stock at a specified price at some time in the future is called a(n)
a.
Call option.
b.
Put option.
c.
Out-of-the-money option.
d.
Naked option.
e.
Covered option.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
13. Pure options are instruments that are
a.
Created by investors outside the firm.
b.
Bought and sold primarily by investors and speculators.
c.
Of greater importance to investors than to financial managers.
d.
All of the above.
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e.
None of the above.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
14. Your Aunt Agatha purchased a call option a few months ago. Today is the expiration date, so she must decide whether
to exercise the option. Which of the following statements is correct? Do not consider brokers' commissions in your
answer.
a.
Aunt Agatha doesn't need to make a decision about exercising the option today; in fact, it would be better if
she waited until after the option expires.
b.
Aunt Agatha should exercise the option if the price of the stock is less than the exercise, or strike, price.
c.
Aunt Agatha should exercise the option if the price of the stock is greater than the exercise, or strike, price.
d.
Aunt Agatha should exercise the option, regardless of the current stock price.
e.
None of the above.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
15. Which of the following are generally considered advantages of term loans over publicly issued bonds?
a.
Lower flotation costs.
b.
Speed, or how long it takes to bring the issue to market.
c.
Flexibility, or the ability to adjust the bond's terms after it has been issued.
d.
All of the above.
e.
Only answers b and c above.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
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16. Eurodebt is the term used to designate
a.
Debt sold by a foreign borrower that is denominated in the currency of the country where it is sold.
b.
European bank loans that are denominated in the new Euro currency.
c.
Debt that is denominated in a currency that is different than the currency of the country in which it is sold.
d.
Equity instruments of one country that are sold in another country.
e.
The certificates that represent ownership in foreign companies that are sold in the United States.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-04 - International Financial Management
Time Estimate-a - 5 min.
TOPICS:
International Debt Instruments
17. An American Depository Receipt (ADR) represents
a.
Debt sold by a foreign borrower that is denominated in the currency of the country where it is sold.
b.
Stock of foreign companies that is sold directly to investors in the United States.
c.
Equity instruments of one country that are sold in another country.
d.
The certificates that represent ownership in foreign companies that are sold in the United States.
e.
Certificates representing ownership in stocks of foreign companies that are held in trust by a bank located in
the country the stock is traded.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-04 - International Financial Management
Time Estimate-a - 5 min.
TOPICS:
International Debt Instruments
18. Which of the following types of debt protect a bondholder against an increase in interest rates?
a.
Floating rate debt.
b.
Bonds that are redeemable ("putable") at par at the bondholders' option.
c.
Bonds with call provisions.
d.
All of the above.
e.
Only answers a and b above.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
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TOPICS:
Types of Financing
21. A company is planning to raise $1,000,000 to finance a new plant. Which of the following statements is correct?
a.
If debt is used to raise the million dollars, the cost of the debt would be lower if the debt is in the form of a
fixed rate bond rather than a floating rate bond.
b.
If debt is used to raise the million dollars, the cost of the debt would be lower if the debt is in the form of a
bond rather than a term loan.
c.
If debt is used to raise the million dollars, but $500,000 is raised as a first mortgage bond on the new plant and
$500,000 as debentures, the interest rate on the first mortgage bond would be lower than it would be if the
entire $1 million were raised by selling first mortgage bonds.
d.
The company would be especially anxious to have a call provision included in the indenture if its management
thinks that interest rates are almost certain to rise in the foreseeable future.
e.
All of the above statements are false.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-04 - International Financial Management
Time Estimate-b - 10 min.
TOPICS:
Types of Financing
22. Which of the following statements is correct?
a.
Because bonds can generally be called only at a premium, meaning that the bondholder will enjoy a capital
gain, including a call provision (other than a sinking fund call) in the indenture increases the value of the bond
and lowers the bond's required rate of return.
b.
You are considering two bonds. Both are rated double A (AA), both mature in 20 years, both have a 10
percent coupon, and both are offered to you at their $1,000 par value. However, Bond X has a sinking fund
while Bond Y does not. This probably is not an equilibrium situation, as Bond X, which has the sinking fund,
generally would be expected to have a higher yield than Bond Y.
c.
A sinking fund provides for the orderly retirement of a debt (or preferred stock) issue. Sinking funds generally
force the firm to call a percentage of the issue each year. However, the call price for sinking fund purposes is
generally higher than the call price for refunding purposes.
d.
Zero coupon bonds are bought primarily by pension funds and other tax exempt investors because they avoid
the tax that non-tax exempt investors must pay on the accrued value each year.
e.
All of the above statements are false.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
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23. Which of the following statements is correct?
a.
Once a firm declares bankruptcy, it is liquidated by the trustee, who uses the proceeds to pay bondholders,
unpaid wages, taxes, and lawyer fees.
b.
A firm with a sinking fund payment coming due would generally choose to buy back bonds in the open
market, if the price of the bond exceeds the sinking fund call price.
c.
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 riskier to investors than regular bonds.
d.
One disadvantage of zero-coupon bonds is that issuing firms cannot realize the tax savings from issuing debt
until the bonds mature.
e.
Other things held constant, callable bonds should have a lower yield to maturity than noncallable bonds.
ANSWER:
c
RATIONALE:
Statement a is false because bankrupt firms often are reorganized rather than liquidated.
Statement b is false because the firm would prefer the less expensive option of calling
the bonds⎯which in this case is the sinking fund call price. Statement d is false because
interest expense accrues for tax purposes, so firms can realize the tax savings from
issuing debt. Statement e is false because callable bonds will sell for a higher yield than
noncallable bonds, if all other things are held constant.
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-01 - Stocks and Bonds
Time Estimate-a - 5 min.
TOPICS:
Miscellaneous
24. The sale of new common stock at a price greater than par value will affect which balance sheet accounts? (Choose the
most complete answer.)
a.
Common stock, paid-in capital, retained earnings.
b.
Assets, common stock, paid-in capital.
c.
Liabilities, common equity.
d.
Common stock, retained earnings.
e.
Common stock, paid-in capital.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
25. Which of the following statements is false?
a.
When a corporation's shares are owned by a few individuals who are associated with or are the firm's
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management, we say that the firm is "closely held."
b.
A publicly owned corporation is simply a company whose shares are held by the investing public, which may
include other corporations and institutions as well as individuals.
c.
Going public establishes a true market value for the firm and ensures that a liquid market will always exist for
the firm's shares.
d.
When stock in a closely held corporation is offered to the public for the first time the transaction is called
"going public" and the market for such stock is called the new issue market.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
26. Which of the following statements concerning common stock and the investment banking process is false?
a.
The preemptive right gives each existing common stockholder the right to purchase his or her proportionate
share of a new stock issue.
b.
If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market.
c.
Listing a large firm's stock is often considered to be beneficial to stockholders because the increases in
liquidity and status probably outweigh the additional costs to the firm.
d.
Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the
business. If stockholders are dissatisfied with management's performance, an outside group may ask the
stockholders to vote for it in an effort to take control of the business. This action is called a margin call.
e.
A large issue of new stock could cause the stock price to fall. This loss is called "market pressure," and it is
treated as a flotation cost because it is a cost associated with the new issue.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
27. Which of the following statements concerning preferred stock is correct?
a.
Preferred stock generally has a higher component cost to the firm than does common stock.
b.
By law in most states, all preferred stock issues must be cumulative, meaning that the cumulative,
compounded total of all unpaid preferred dividends must be paid before dividends can be paid on the firm's
common stock.
c.
From the issuer's point of view, preferred stock is less risky than bonds.
d.
Preferred stock, because of the current tax treatment of dividends, is bought mostly by individuals in high tax
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brackets.
e.
Unlike bonds, preferred stock cannot have a convertible feature.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
28. Which of the following statements is correct?
a.
One of the advantages of common stock financing is that there is no dilution of owners' equity, as there is with
debt.
b.
If the market price of a stock falls below its book value, the firm can be liquidated, with the book value
proceeds then distributed to the shareholders. Thus, a stock's book value per share sets a floor below which the
stock's market price is unlikely to fall.
c.
The preemptive right gives a firm's preferred stockholders preference to assets over common stockholders in
the event the firm is liquidated.
d.
The steeper the demand curve for a firm's stock, the higher will be its flotation costs when it sells a new issue
of common stock, other things held constant.
e.
All of the above statements are false.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
29. Which of the following statements is correct?
a.
If the demand curve for a firm's stock is relatively flat, the firm will have a more difficult time raising a large
amount of new equity funds for expansion than would be true if the demand curve were steeper.
b.
Flotation costs to raise a given amount of funds would, typically, be smaller under a best-efforts arrangement
than with an underwritten offering, and the corporation is also more certain of getting the needed funds under
a best-efforts offering. This is why best-efforts deals are most common.
c.
Par value is not necessarily the actual price at which stock is issued by the firm, but it does constitute the
maximum legal liability per share in the event of bankruptcy. Thus, if a firm sold $5 par stock to investors at
$30 per share, in the event of bankruptcy the firm would have to pay the stockholders no more than $5 per
share.
d.
The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any additional shares
sold by the firm. This right protects current stockholders against both dilution of control and dilution of value.
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e.
One of the legal rights that often goes with common stock is the preemptive right. This is the right of present
stockholders to purchase their "proportional share" of all new securities that might be issued by the firm,
including common and preferred stock, and all types of debt.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
30. Which of the following statements is correct?
a.
A floating rate bond has an advantage over a fixed rate bond because its price is more stable and this makes a
floating rate preferred bond more suitable as a liquid asset.
b.
Convertible preferred stock would likely appeal more to income-oriented investors because they can convert
their capital gains into bond income simply by converting their preferred stock into bonds.
c.
One advantage of preferred stock from an issuer's perspective is that it has a lower after-tax cost than that of
debt.
d.
One principal advantage of preferred stock is that preferred stockholders have a legal enforceable right to their
stock dividend, thus, preferred stock is generally less risky than unsecured debt.
e.
Because of the 70% dividend exclusion rule for preferred stock dividends, the higher a company's tax bracket,
the more likely it is to issue preferred stock.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
31. Which of the following statements is correct?
a.
A warrant is basically a long-term option that enables the holder to sell common stock back to the firm at an
agreed upon price, at a specified time in the future.
b.
Generally, warrants are distributed along with preferred stock in order to make the preferred stock less risky.
c.
If a company issuing coupon paying debt wanted to reduce the cash outflows associated with the coupon
payments, it could issue warrants with the debt to accomplish this.
d.
One of the disadvantages of warrants to the issuing firm is that they can be detachable and can be traded
separately from the debt with which they are issued.
e.
Warrants are attractive to investors because when they are issued with stock, investors receive dividends on
the warrants they own as well as on the underlying stock.
ANSWER:
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it, what will be the gain or loss that results from the option position that was held? Ignore taxes and commissions.
a.
$200 gain
b.
$300 loss
c.
$50 loss
d.
$450 loss
e.
None of the above.
ANSWER:
b
RATIONALE:
Loss = 100($44.50 − $45.00) −$250 = −$300
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-01 - Stocks and Bonds
Time Estimate-b - 10 min.
TOPICS:
Options
41. Sharon has a convertible bond with a face value of $1,000 that can be converted into 40 shares of common stock of
Mountain Ice Corporation. If the current price of the stock is $20, what is the conversion price of the bond?
a.
$20
b.
$50
c.
$800
d.
$500
e.
None of the above.
ANSWER:
e
RATIONALE:
Conversion price = $1,000/40 = $25
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing
Business Program-3 - Analytic
DISC-FIN-01 - Stocks and Bonds
Time Estimate-a - 5 min.
TOPICS:
Convertible Bond
42. A(n) ____ is generally obtained from a bank or insurance company and the borrower agrees to make a series of
payments consisting of interest and principal.
a.
putable bond
b.
bankers acceptance
c.
income bond
d.
term loan
e.
certificate of deposit
ANSWER:
POINTS:
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c.
the common stockholders do not vote in new directors with a clear majority.
d.
the company cannot pay its interest payments.
e.
the company has not paid the preferred dividend for a specified period.
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
46. A ____ is a financial instrument which gives the owner the right but not the obligation to sell shares of stock at a
specified price during a particular time period.
a.
convertible security
b.
call option
c.
warrant
d.
put option
e.
callable security
ANSWER:
POINTS:
DIFFICULTY:
ACCREDITING STANDARDS:
TOPICS:
47. A French firm is buying $1,000,000 of optical cable from a firm in the United States. The French firm will pay for the
cable in thirty days. To protect itself from changes in the exchange rate between the Euro and dollar, the French firm
enters into a futures contract to purchase $1,000,000 at a price of $1.25/€. How many Euros will it cost the French firm to
purchase $1,000,000 using the futures contract?
a.
€125,000,000
b.
€2,500,000
c.
€1,250,000
d.
€1,000,000
e.
€800,000
ANSWER:
e
RATIONALE:
Cost of $1,000,000 = $1,000,000/1.25$/€ = €800,000
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-1 - Analyzing

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