Part 7 Long-Term Financing
CHAPTER 17
INVESTMENT BANKING AND SECURITIES LAW
CHAPTER LEARNING OBJECTIVES
17.1 Explain what is meant by fiinformation asymmetries” and how these affect
17.2 Explain the purpose of securities laws and regulations in the financial
markets.
17.3 Explain what a prospectus is, what it contains, and why it is critical for initial
17.4 Outline the basic stages in taking a firm public through an initial public
17.5 Explain why continuous disclosure requirements are important for investors
and how they affect secondary offerings.
Investment Banking and Securities Law 17 – 2
MULTIPLE CHOICE QUESTIONS
1. Asymmetric information is best defined as:
a) information that is available to both parties in a deal and which can be exploited equally by
each.
b) information that is available to neither party in a deal.
c) information that is available to one party in a deal but is not available to the other.
d) any information provided by insiders of the firm.
2. Which of the following cases is not an example of asymmetric information?
a) Gus buys a used car from Artie’s Ambiguous Autos Inc., not knowing it is a lemon.
b) Gus buys a used car from Artie’s Ambiguous Autos Inc., knowing it is a lemon.
c) Gus, a small retail investor, purchases shares in Artie’s Ambiguous Autos Inc.
d) Gus, a mutual fund manager, purchases shares in Artie’s Ambiguous Autos Inc.
3. Use the following statements to answer this question:
I. Asymmetric information is not supposed to exist in efficient markets.
II. Investors protect themselves fully from asymmetric information by asking for high premiums
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
4. When does a fifinancing gap” occur?
a) When a firm raises capital in the market by selling unequal amounts of bonds and equity, and
the gap is the difference between the two amounts.
b) When firms are unable to find investors to purchase their securities.
c) When there is a period of time occurring between cash outflows from a project and the cash
inflows from the project financing.
d) Each of the above is an example of a financing gap.
5. The bonds must have been issued in ______ form, if coupons representing interest payments
are to be physically attached to the security and it is the bondholder’s responsibility to submit
the coupons for payment,
a) registered
b) consolidated
c) bearer
d) booked
6. To which of the following does Gresham’s Law apply?
a) The used car market
b) Counterfeit money in circulation
c) Capital markets
d) Gresham’s Law is applicable to all of the above.
7. When interest payments are made by mailing a cheque to the officially listed owner, the
bonds must have been issued in ______ form.
a) registered
b) consolidated
c) bearer
d) booked
8. Which one of the following is an example of fraudulent activities?
a) Investing in bonds.
b) Using an accounting method that increases the earnings of the firm
c) Buying a large part of a new company and then selling it when the price increases
d) Spreading false rumours about a possible merger.
9. Sal Bender, not one of the most upstanding citizens, has just been arrested for financial
fraud, after he cooked up a get-rich-quick scheme that enticed people to purchase $10 million
worth of his interest-bearing bonds. He had promised the investors quarterly coupon payments
of $50 each, and that he would return the face value of $1,000 at maturity in five years. The
current market interest rate is 7%. His scheme was successful initially, but within four months, it
blew up in his face when the police came for him at his beach house in Barbados. Based on
your knowledge of bonds, what was the biggest flaw in Sal’s scheme?
a) Offering such a high yield to maturity compared to the current market rate tipped off the
authorities.
b) Making quarterly payments instead of semi-annual payments increased the upfront costs.
c) Using interest-bearing instead of zero-coupon bonds required him to make coupon payments.
d) There was no flaw in Sal’s plan – he was just unlucky and got caught.
17 – 5 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
10. The attractiveness of a Ponzi pyramid scheme consists of:
a) selling stocks with very high volatility to investors.
b) convincing investors to invest in assets from which they will never receive a return.
c) attracting investors by giving them a high return using new subscribers’ money.
d) convincing investors to invest and then declaring bankruptcy.
11. Suppose that the current market interest rate is 12% for non-fraudulent bonds, and that one
in six bonds are fraudulent in a given market. What would the interest rate be if a fraud premium
is introduced, assuming (1) a one-year investment horizon and (2) the market does not require a
risk premium?
a) 68.0%
b) 40.0%
c) 34.4%
d) 10.0%
12. Due diligence refers to:
a) the process of auditing the financial statements.
b) the process of checking securities offered to the public to ensure they are legitimate.
c) the process of convincing investors to invest in assets.
d) none of the above.
Investment Banking and Securities Law 17 – 6
13. Which of the following potentially result from investors losing faith in the capital market?
a) Increased off-shore investing
b) Increased investing in real assets like houses and gold
c) The complete collapse of public capital markets
d) All of these are potential consequences of the loss of investor faith in the capital market.
14. Which of the following is not a mechanism designed to maintain investor confidence in
capital markets?
a) Corporate law
b) Securities legislation
c) Due diligence
d) Due process
15. Which of the following is a fraudulent activity?
I. Selling stocks on an institution where there is zero external activity.
II. Selling penny stocks as blue chip stocks
a) I and II are fraudulent.
b) I and II are not fraudulent.
c) I is fraudulent and II is not fraudulent.
d) I is not fraudulent and II is fraudulent.
17 – 7 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
16. What does the acronym SEC stand for in regards to the financial system?
a) Security Exchange of Canada
b) Securities and Exchange Commission
c) Security Enforcement Coalition
d) Stock Exchange of Canada
17. Which of the following is not one of the major factors the OSC uses to determine whether or
not a document is really a security?
a) Whether the promoter raises money and leads the investor to expect a profit.
b) Whether there is risk involved.
c) Whether the investor has any control over how the money is spent.
d) Whether the investor is led to expect any additional pecuniary benefits.
18. In determining whether a security exists, the OSC looks at:
a) whether the promoter raises money and leads the investor to expect a profit.
b) whether the investor has any control on how the money is spent.
c) whether there is risk involved.
d) all of the above.
19. The Securities and Exchange Commission is:
a) a U.S. agency that regulates U.S securities.
b) a Canadian agency that regulates Canadian securities.
c) a North American agency that regulates the issue of securities outside the U.S.
d) none of the above.
20. Why is there a resistance to implementing a federal regulator in Canada?
a) The federal government is reluctant to intervene in the financial marketplace.
b) The provincial governments are earning prohibitive profits from having control.
c) Some provinces will have to give up control.
d) Federal laws prohibit the federal government from intervening in securities regulation.
21. Which of the following is/are the major areas in which the OSC is involved?
a) Primary and secondary market offerings
b) Activities of investment professionals
c) Takeover bids
d) All of the above areas
22. Which of the following is not an essential part of a prospectus?
a) Auditor’s report
b) A letter from the president giving broad facts about the company
c) Details of future equity issues
d) Compensation to be received by company directors and senior executives
23. Use the following statements to answer this question:
I. Risk of information asymmetry is high in an IPO because the company’s public disclosure, as
a public firm, is minimal.
II. An IPO prospectus eradicates the issue of information asymmetry completely.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
24. Which of the following is part of a prospectus?
a) Description of the proposed business activity
b) Description of the potential market
c) Description of the risk factors
d) All of the above
25. The acronym IPO stands for:
a) Initial Public Offering
b) Investment Public Offering
c) Intrinsic Put Option
d) Initial Private Offering
26. Which of the following is not true about a prospectus?
a) The investment dealer helps in the preparation of the document and is legally liable.
b) The CFO rather than CEO signs the document on behalf of the board of directors.
c) All parties involved in the process are supposed to do their best to ensure the consistency of
the information provided.
d) It should be a detailed and honest disclosure of information about the firm.
27. If you are handed a formal summary of a security that describes the costs, investment
objectives, and risks involved, what are you reading?
a) Annual report
b) Prospectus
c) Auditor report
d) Proxy statement
28. If you are reading an IPO prospectus, in which form must it be?
a) Short-form prospectus, due to the company’s shorter history
b) Long-form prospectus, due to the greater risk
c) Either short or long-form, as long as a prospectus is filed
d) A prospectus is not required for an IPO.
29. What is the exempt market?
a) The regulated market for non-registered securities that raises money from private investors.
b) The unregulated market for registered securities that raises money from private investors.
c) The regulated market for registered securities that raises money from public investors.
d) The unregulated market for non-registered securities that raises money from private
investors.
30. A prospectus is mandatory for all securities issuances except:
a) securities targeting the general public.
b) corporate bond issuances.
c) if a very small amount of money is being raised.
d) sale of a control block.
31. The Ontario Securities Commission has regulated which of the following?
a) Distribution of shares.
b) Control blocks.
c) Restricted shares.
d) All of the above.
32. What are the main differences between a prospectus and an offering memorandum?
a) A prospectus is shorter and costs less to prepare than an offering memorandum.
b) Offering memorandums are shorter and cost less to prepare than prospectuses.
c) A prospectus costs less to prepare but is longer than an offering memorandum.
d) Prospectus and offering memorandum are two different names for the same document.
33. Use the following statements to answer this question:
I. Improvements in securities laws have helped in curbing fraudulent activities.
II. Asymmetry of information is the major source of frauds in financial markets.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
34. Which of the following is not one of the bases of the three major categories of exempt
purchasers?
a) Sophistication level of the purchaser
b) Low-risk nature of the instrument
c) Dollar value of the potential issue
d) Existence of alternative source of money
35. Which of the following is not a reason for a firm to go public?
a) Founders who are no longer actively involved in the company can cash out.
b) Increased access to financing options.
c) Decreased reporting regulations for public companies.
d) Greater access to larger markets.
36. Use the following statements to answer this question:
I. One of the most frequently cited reasons of why a firm goes public is because investors want
to cash out.
II. Obtaining cheaper sources of financing over the long term is a potential reason for an IPO.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
37. What is venture capital?
a) Money raised from private investors in the exempt market.
b) Money raised from public investors in the capital market.
c) Money raised from private investors in the over-the-counter market.
d) All of the above are examples of venture capital.
38. The term fired herring” refers to the:
a) Underwriting agreement
b) Preliminary prospectus
c) Bought deal
d) IPO
39. Generally, underwriters provide which of the following services to the issuing firm?
a) Strategic business advice
b) Pricing the issue
c) Determination of the spread
d) All of the above
40. Put the following IPO process stages into chronological order: