Chapter 1

Question 1

What are some sources of cashflow?

Answer 1

Internal cashflow: retained earnings plus depreciation.

External cashflow: long term debt and stock.

Question 2

Discount bond

Answer 2

Bond currently trading for less than its par value because the coupon rate is lower than the prevailing interest rates.

Question 3

Premium bond

Answer 3

Bond currently trading for more than its par value because its coupon rate is higher than the interest rate.

Question 4

Indenture

Answer 4

Contract used by creditors to protect themselves.

Question 5

Interest is paid … tax

Answer 5

BEFORE!

Question 6

What does the bond indenture state?

Answer 6

The face value
The coupon rate
Type of security: classification according to collateral.

Question 7

Collateral trust bonds

Answer 7

Secured by marketable securities.

Question 8

Mortgage bonds

Answer 8

Secured by real assets.

Question 9

Debenture

Answer 9

Unsecured, not backed by real assets.

Question 10

Sinking fund

Answer 10

Used to retire bonds periodically before maturity.

Question 11

Callable bond

Answer 11

Call option to firm to retire bonds before maturity.

The purpose of this is to replace high coupon with lower rate.

Question 12

Extendible bond

Answer 12

Call option to extend the maturity, hedge against lower rate.

Question 13

Retractable bond

Answer 13

Put option, right to sell at par, hedge against higher rate.

Question 14

Convertible bond

Answer 14

Call option to convert bond into common shares, exercise only if the stock price increases.

Question 15

Bond with warrants

Answer 15

Call option to buy new shares at a fixed price.

Question 16

Covenants

Answer 16

Restrictions that limit the actions of the borrower, the purpose of it is to avoid conflicts of interests and reduce the risk of the bond.

Question 17

Loan types

Answer 17

Amortized loan
Interest only loan
Bullet loan
Collateral

Question 18

Preferred share

Answer 18

• Combines the features of a bond and equity, but has preference over common shares in terms of dividends.
• Dividend can be cumulative.
• No voting rights.

Question 19

Call provision

Answer 19

A call provision lets the company repurchase or call a bond/preferred issue at a predetermined price over a specified period.

Question 20

Bond refunding

Answer 20

Occurs when outstanding debt is replaced.

Question 21

Reasons for calling a bond

Answer 21

• Lower interest rate in the market
• Improved credit rating
• Reduce debt (better financial ratios)

Question 22

Callable bond VS non callable bond

Answer 22

• Callable bond should have a higher coupon rate than a non callable bond.
• Investors hate risk, this is the compensation (premium).

Question 23

Dividend is paid … tax

Answer 23

AFTER!

Question 24

Common equity

Answer 24

Represents the shareholder’s stake in the company.

Question 25

Rights

Answer 25

-Right to receive new shares
(called pre-emptive rights in case of issue of new shares).
-Right to receive dividend
-Right to vote to elect directors to the board.

Question 26

Straight voting

Answer 26

One vote per share for each director. (doesn’t allow minority shareholders in the election)

Question 27

Cumulative voting system

Answer 27

Use multiple votes for a single director. (allow minority to participate).

Question 28

Proxy vote

Answer 28

Allow other party to vote a share on your behalf.

Question 29

Different classes of common stock

Answer 29

• full voting shares
• no voting shares
• restricted voting shares

Question 30

Market value

Answer 30

The price of the stock multiplied by the number of shares outstanding.

Question 31

Book value

Answer 31

The sum of par value, contributed surplus, accumulated retained earnings.

Question 32

Market value should always be … than Book value

Answer 32

HIGHER!

Question 33

How could a company raise private equity financing?

Answer 33

• Securities not sold on the exchange
• Sold directly to a small number of investors
• Venture capital
• Private placement

Question 34

From private to publicly traded firm how could you raise money?

Answer 34

• Initial public offering (IPO)

- Private placement

Question 35

Firm commitment (bought deal)

Answer 35

Buy and resell securities, the dealer does not have the option to decline the issue if the selling price drops below purchase price.

Question 36

Best effort

Answer 36

The dealer does not guarantee the amount of the issue, he can return the unsold shares to the firm.

Question 37

Green shoe provision

Answer 37

It gives the dealer the option to buy additional shares from the issuer at the original offering price. ( It is an additional cost to the firm)

Question 38

The registration statement

Answer 38

Provides information about the proposed uses of the funds obtained, the firm’s history and existing plans for the future.

Question 39

Red Herring

Answer 39

Preliminary prospectus used to market the stock, this is given to potential investors.

Question 40

Underpricing

Answer 40

Selling below the true value.

Question 41

When to use underpricing?

Answer 41

For firms choosing the best effort deal.

Question 42

POP system

Answer 42

It allows large firms to register files quickly.

Question 43

Rights offering

Answer 43

One right is offered for every share owned. A rights offering gives the holder the option of buying 1 new share for N rights plus the $X (exercise price). A right is an option.

Question 44

Standby underwriting

Answer 44

the firm uses the services of an investment banker to distribute shares and eventually buy the unsold shares.