chapter 1 investment security

Question 1

corps sell __ stock to investors to raise money in order to begin or expand a business

Answer 1

common

Question 2

as owners, common stockholders have an __ position in the corp, and the common stock is called an __ security

Answer 2

equity

Question 3

the total number of shares that the corp’s charter permits it to issue is the __ stock

Answer 3

authorized

Question 4

a stock that’s actually distributed to investors out of the authorized shares is called _ stock

Answer 4

issued

Question 5

the balance of the stock that is authorized but not distributed to shareholders is _ stock

Answer 5

unissued

Question 6

__ is stock that the company has issued and then repurchased from investors

Answer 6

treasury stock

Question 7

stock that remains in the hands of investors is called __ stock

Answer 7

outstanding

Question 8

__ stock is issued stock less treasury stock

Answer 8

outstanding

Question 9

at the time a corp is authorized to issue common stock, it sets a __ for each share

Answer 9

par value

Question 10

par value has no relation to _ value

Answer 10

market

Question 11

the amount received in excess of par value is called the __

Answer 11

capital surplus

Question 12

the __ in a corp is the value of its assets minus its liabilities

Answer 12

stockholders’ equity

Question 13

the __ is equivalent to the company’s book value

Answer 13

stockholders’ equity

Question 14

the __ is the residual amount that remains to be distributed to the stockholders after payment of all debts

Answer 14

stockholders’ equity

Question 15

__ is the estimated amount that the corp’s assets would bring in the event the corp stopped doing business, sold its assets and paid its debits

Answer 15

book value

Question 16

__ is a measure of a company’s net worth if it ceases to operate

Answer 16

book value

Question 17

__ is the current price a person will pay to purchase a business or buy shares of the company’s stock on the open market

Answer 17

market value

Question 18

the market value for a stock is usually _ than its book value

Answer 18

higher

Question 19

corps usually pay dividends in _

Answer 19

cash

Question 20

a __ may consist of a distribution of the company’s products, or sometimes it is a distribution of stock in another company, such as a subsidiary

Answer 20

property dividend

Question 21

a __ is a distribution of additional shares of the company’s own stock

Answer 21

stock dividend

Question 22

stock dividends (DO / DO NOT) require shareholder approval

Answer 22

do not

Question 23

All of the following are components of Stockholder’s Equity EXCEPT:

A. Common at Par
B. Common Dividends
C. Capital Surplus
D. Earned Surplus

Answer 23

B. Common Dividends

Question 24

A customer has invested for a number of years in the ZZBOTTOM Company. He understands that his common stock makes him an owner and has asked for an explanation of the owner’s equity line in ZZBOTTOM’s financial statement. You may tell the customer that the owner’s equity is:

A. a guaranteed return to the shareholders if the company liquidates
B. the residual value left in the company after it pays all debts and claims
C. a “theoretical” value that has no practical meaning D. a value set by the exchange on which ZZBOTTOM’s stock trades

Answer 24

B. the residual value left in the company after it pays all debts and claims

Question 25

Which of the following statements best describes the market value of common stock?

A. Market value is measured by the company’s net worth.
B. Market value is determined by the company’s financial statements
C. Market value is based on investor expectations for the company’s earnings
D. Market value is an arbitrary price placed on the stock for marketing purposes

Answer 25

C. Market value is based on investor expectations for the company’s earnings

Question 26

stock split (DOES / DOES NOT) require shareholder approval

Answer 26

DOES

Question 27

when a corp declares a 3-for-1 __, each shareholder receives 2 new shares for each share previously held

Answer 27

stock split

Question 28

a corp will usually decide on a __ to make the stock affordable to more investors

Answer 28

stock split

Question 29

a company may declare a __ when its share price drops too low

Answer 29

reverse stock split

Question 30

if a corp wants to issue more shares of common stock, the investors who already own its common stock have the right to buy the new shares first. this right is known as _

Answer 30

preemptive right

Question 31

the offer of stock to existing shareholders is a __

Answer 31

rights offering

Question 32

common stockholders have _ rights

Answer 32

voting

Question 33

stockholders need not attend the annual meeting in order to vote; instead they can vote by mail through the use of written ballots called _

Answer 33

proxies

Question 34

a _ appoints an agent to act for the stockholder at the annual meeting and gives directions for voting the shares

Answer 34

proxy

Question 35

if the by-laws state that each share of common stock is entitled to one vote for each seat of the board of directors, the corp has adopted __

Answer 35

statutory voting

Question 36

with __ voting, a stockholder who owns a majority of the corp’s shares can elect all of the directors on the board

Answer 36

statutory

Question 37

Which of the following statements concerning statutory voting is correct?

A. Minority shareholders are unable to elect any directors to the board
B. Minority shareholders can cast all of their votes for one director
C. Majority shareholders can cast all of their votes for one director
D. Most corporations no longer use statutory voting

Answer 37

A. Minority shareholders are unable to elect any directors to the board

Question 38

most corps adopt __ voting

Answer 38

statutory

Question 39

owners of a _ of the stock are typically unable to elect even one director

Answer 39

minority

Question 40

to provide for minority representation, a company sometimes adopts a _ voting system

Answer 40

cumulative

Question 41

under _ voting, a shareholder gets one vote for each share multiplied by the number of directors being elected

Answer 41

cumulative

Question 42

All of the following statements concerning statutory voting are correct EXCEPT:

A. it encourages representation on the board of directors by owners of minority interests
B. it allows shareholders one vote per share for each director
C. it is the most common method of voting for directors used by corporations
D. it requires spreading votes over all directors standing for election

Answer 42

A. it encourages representation on the board of directors by owners of minority interests

Question 43

Statutory voting means:

A. the shareholders receive more votes per share than under cumulative voting
B. the majority shareholders can elect all of the directors
C. the shareholders may combine their votes for a favored candidate
D. shareholders must, by law, attend the annual meeting in order to

Answer 43

B. the majority shareholders can elect all of the directors

Question 44

Cumulative voting tends to favor: (choose all that apply)
I   Minority shareholders 
II   Majority shareholders 
III   Institutional investors 
IV   Smaller shareholders

Answer 44

1 & 4

Question 45

Which statement is true?

A. Proxies are ballots cast by shareholders that will attend the annual meeting
B. Proxies are ballots cast by shareholders that will not attend the annual meeting
C. Proxies can only be cast at the annual meeting for companies that use statutory voting
D. Proxies can only be cast at the annual meeting for management’s recommendations

Answer 45

B. Proxies are ballots cast by shareholders that will not attend the annual meeting

Question 46

Which statements are true about a corporation that has issued Class A and Class B common shares?
I Both share classes must trade at the same price
II Both share classes can trade at different prices
III Both share classes have the same voting rights
IV Both share classes have different voting rights

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 46

D. II and IV

Question 47

XYZZ Corporation has Class A and Class B shares outstanding. This means that:

A. Class A shares receive dividends but Class B shares do not
B. Class A shares have voting rights but Class B shares do not
C. Class A shares have different dividend rights than Class B shares
D. Class A shares have different voting rights than Class B shares

Answer 47

D. Class A shares have different voting rights than Class B shares

Question 48

Which of the following events require a vote of the common stockholders? 
I   Declaration of a stock split 
II   Declaration of a stock dividend 
III   Declaration of a cash dividend 
IV   Declaration of a merger 

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 48

B. I and IV

Question 49

All of the following statements concerning corporate dividends are true EXCEPT:

A. directors declare dividends
B. dividends are paid from the retained earnings of the company
C. the company must distribute excess earnings as dividends
D. shareholders are entitled to dividends after the board of directors has declared them.

Answer 49

C. the company must distribute excess earnings as dividends

Question 50

If a company declares and pays a 10% stock dividend, an existing shareholder with 100 shares will have: 
I   more than 100 shares 
II   less than 100 shares 
III   an increased price per share 
IV   a reduced price per share 

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 50

B. I and IV

Question 51

A corporation whose stock price has risen to an extremely high level would:
I declare a stock split
II declare a reverse stock split
III declare a stock buy-back program
IV not declare a stock buy-back program

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 51

B. I and IV

Question 52

The X Corporation stock has been trading at $1 per share recently and the exchange where the stock is trading wants to delist the stock because the price is too low. The minimum share price to remain listed is $3. To increase the price, the X Corporation may:

A. Perform a reverse split to reduce the number of shares outstanding
B. Suspend trading for a month to create investor demand for the stock
C. Split the stock three-for-one to make its price more attractive
D. Split the stock three-for-one to increase its price

Answer 52

A. Perform a reverse split to reduce the number of shares outstanding

Question 53

Mega Corporation has 10 million shares of common stock outstanding. Mega wishes to issue 2 million additional shares by issuing stock rights. How many rights must it issue?

A. 2 million
B. 5 per shareholder
C. 1/5th per shareholder
D. 10 million

Answer 53

D. 10 million
Mega must issue one right per share of stock outstanding. This means that it issues 10,000,000 rights. Since it wishes to sell 2,000,000 new shares, 5 rights will be required to subscribe to each new share (10,000,000 rights / 2,000,000 new shares). Be wary not to confuse the number of SHARES it wishes to issue (Choice A) with the number of RIGHTS (Choice D) it must issue.

Question 54

A common stockholder’s right to maintain proportionate ownership in a corporation is a:

A. preemptive right
B. stock ownership right
C. anti-dilution right
D. ownership percentage right

Answer 54

A. preemptive right
The preemptive right allows current stockowners to maintain their proportionate ownership in a corporation when it issues new shares.

Question 55

The shareholder’s right to inspect records means an investor:

A. has no other source of financial information about the company
B. can obtain the names and addresses of other shareholders
C. must exercise this right to obtain a current prospectus each year
D. may request audited copies of any record at any time

Answer 55

B. can obtain the names and addresses of other shareholders

Question 56

Which statement concerning common stock owned by investors is correct?

A. Upon request from the corporation, the stockholder must sell the stock back at any time
B. The stock is easily transferable to other investors at any time
C. Investors can only sell the stock after a purchase at an increased price under the up-tick rule
D. Investors must first offer the stock to existing shareholders before offering it to outsiders

Answer 56

B. The stock is easily transferable to other investors at any time

Question 57

An investor pays $10,000 for a listed stock. If the company should go bankrupt, the investor’s maximum loss would be:

A. $10,000
B. Equal to the current value of the stock investment
C. Zero
D. In excess of $10,000

Answer 57

A. $10,000
A common stockholder can only lose the original investment and is not liable for any additional amount. Limited liability protects the investor in corporate stock.

Question 58

All of the following statements about investors who buy an issue of a corporation’s securities are true, EXCEPT:

A. In a corporate liquidation, these investors will not lose any of the funds they invested
B. In a corporate liquidation, these investors will have losses that do not exceed the amount they invested
C. Creditors may not sue investors where the assets of the corporation are not sufficient to pay claims.
D. Investors have no liability beyond the funds they invested in the corporation.

Answer 58

A. In a corporate liquidation, these investors will not lose any of the funds they invested

Question 59

On the death of a majority corporate shareholder, which of the following occur?
I The corporation must dissolve
II The corporation continues as before
III The deceased individual’s shares pass to a beneficiary by will or State law if there is no will (the individual died “intestate”)
IV The deceased individual’s shares revert back to the corporation at the market value on date of death

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 59

C. II and III

The best answer is C. The corporation has continuous life and a shareholder’s death (either minority or majority shareholder) has no impact on this. The deceased person’s shares are either passed by will or by the laws of the State if the person died without a will (died “intestate” - as in no “last will and testament”).

Question 60

All of the following statements are true regarding Treasury stock EXCEPT:

A. it does not have voting rights
B. it does not have dividend rights
C. it reduces the number of shares authorized
D. it reduces the number of shares outstanding

Answer 60

C. it reduces the number of shares authorized

The best answer is C. Treasury stock is common stock that has been issued and then was repurchased by the company, so it is no longer outstanding in the hands of the public. Treasury shares do not have voting rights, do not receive dividends and have no preemptive rights. In essence, they are issued shares that have been “retired” by the company. Note that purchases for Treasury have no effect on the company’s authorized share amount.

Question 61

Which of the following are rights of common stockholders?
I The right to vote for the board of directors
II The right to transfer shares at will
III The right to inspect corporate records
IV The right to force a company to declare dividends

A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV

Answer 61

C. I, II, III
The best answer is C. Shareholders have rights to dividends only once the board of directors declares them. They have no right to force companies to declare dividends. They do have the right to vote for the board of directors; the right to transfer shares; and the right to inspect the books and records of the company.

Question 62

All of the following statements concerning preferred stock are correct EXCEPT:

A. dividends on preferred stock are not a legal obligation of the corporation
B. for common stockholders to receive any dividend, preferred stockholders must receive the full amount of their dividend
C. when a corporation has earnings, it may pay preferred dividends without the need for a vote of directors
D. preferred stock is an equity security like common stock

Answer 62

C. when a corporation has earnings, it may pay preferred dividends without the need for a vote of directors

The best answer is C. The board of directors must vote to declare dividends on both preferred and common stock. If the board does not vote to declare a dividend on preferred stock, it must also omit the common stock dividend for that year. The corporation cannot declare a dividend on common stock in a year in which it omits the preferred stock dividend.

Question 63

The Home Run Fund purchased 1,000 shares of IBEX 5%, $100 par preferred stock for its portfolio. If IBEX pays its full dividend this year, the Home Run Fund may expect a dividend of:

A. $500
B. $5,000
C. $50,000
D. Cannot determine from information given

Answer 63

B

The best answer is B. The Home Run Fund has 1,000 shares of IBEX preferred stock. Each share has $100 par value and pays an annual stated dividend of 5% of $100 par = $5 per share. Thus, $5 X 1,000 = $5,000.

Question 64

Preferred.Com has issued 10%, $100 par cumulative preferred stock. Two years ago, the Preferred Stock paid 7% and last year it paid 8%. This year, Preferred.Com wants to pay a dividend to its common stockholders. Before Preferred may pay this dividend, preferred shareholders may expect to receive:

A. $0
B. $5
C. $10
D. $15

Answer 64

D. $15

The best answer is D. Preferred must pay the cumulative preferred shareholders all past unpaid dividends and the current dividend before common shareholders may receive dividends. Two years ago the company paid 7% and missed 3% of the 10% dividend due. Last year the company paid 8% and missed 2% of the dividend due. This year the company must pay 10% to its preferred stockholders in order to pay the common dividend. The total preferred dividend to be paid is 3% + 2% + 10% = 15%.

Question 65

ZBZ Corporation paid $5 in dividends on its 8% cumulative preferred stock last year. If common shareholders are to receive a dividend by the end of this year, what amount of dividends must ZBZ pay the preferred shareholders?

A. $0
B. $3 per share
C. $8 per share
D. $11 per share

Answer 65

The best answer is D. ZBZ must pay the 8% cumulative preferred stock ($8 = 8% of $100 par value) dividends each year. If ZBZ does not pay the full $8, the unpaid portion will be in arrears. Before ZBZ can pay any dividends to common shareholders, it must pay all past due accumulated dividends ($3) and the current preferred dividend ($8) for a total of $11.

Question 66

A customer owns shares of common stock issued by Acme Inc. Last year, Acme paid dividends totaling $4.00 per share on its 6% cumulative preferred stock. For the customer to receive a dividend this year on his or her shares of common stock, the preferred stockholders must receive a dividend of

A. $2 per share
B. $6 per share
C. $8 per share
D. Any amount, because there is no relationship between the amounts of the dividends

Answer 66

C.

The best answer is C. Because the preferred shares are cumulative, the issuer must pay all missed and current dividends before it may declare dividends for common stock. Therefore, Acme must pay preferred stockowners the unpaid $2 from last year as well as the $6 from the current year before declaring a dividend for its common stock.

Question 67

Quincy has a 6% preferred stock in his portfolio. He has noticed several times in the past five years that this stock has paid more than the stated $6 per share. Quincy most likely has:

A. Straight preferred stock
B. Convertible preferred stock
C. Callable preferred stock
D. Participating preferred stock

Answer 67

The best answer is D. Straight preferred stock pays the stated dividend and no more, so Quincy’s preferred stock cannot be straight preferred. Convertible and callable preferred stocks are both “straight” preferred, unless stated otherwise. This question has no such statement so the preferred cannot receive additional payments. Only the participating preferred stock can receive the additional payment declared by the board of directors.

Question 68

Convertible preferred stockholders will most likely exercise their right of conversion when the price of the:

A. common stock is below the conversion price to take advantage of the good price
B. common stock is rising rapidly, to take advantage of the growth
C. common stock is falling rapidly, increasing its dividend yield
D. preferred stock has remained steady and the issuer has paid dividends regularly

Answer 68

The best answer is B.
Convertible preferred shareholders exercise their conversion right when the price of common stock is rising, so they can take advantage of the growth. Because of the increase in the common stock market price, their fixed conversion price is likely to be below the current price of the stock. The owner can exercise the conversion right and buy the stock for less than the current market value.

The convertible preferred stockholder would not convert if the price of the common stock were falling because he or she could purchase the common stock for a lower price in the market.

If the price of the preferred is steady and the dividend payments are made regularly, the investor would likely hold the preferred for the benefit of regular dividends.

Question 69

Which of the following reasons make companies likely to issue convertible preferred stock?

A. The companies sell additional shares of common stock more easily
B. Exercising conversion rights dilutes the common stockholders’ ownership
C. Convertibility means preferred stockholders will accept a lower stated dividend
D. The companies receive additional capital when the shares are converted

Answer 69

The best answer is C.
Since the conversion privilege gives the holders of convertible preferred stock the right to exchange for common stock at a fixed price, this benefit becomes valuable when the common stock price rises. Holders of this type of preferred stock will readily accept a lower stated dividend rate as compared to non-convertible preferred stock to get the benefit of conversion.

Exercising conversion rights does dilute common stockholders’ positions (there are more common shares over which earnings are spread). The existing shareholders must vote to approve the issuance of convertible preferred stock, because of this potentially dilutive impact. They approve it because they feel that the company will be able to use the additional capital profitably, which will ultimately increase the common stock price. When holders of preferred stock convert to common stock, the company does not receive additional capital. The company received the capital at the point when the convertible preferred was sold to the public.

Question 70

Convertible preferred stock means the stockholder may:

A. exchange the preferred stock for common stock at a fixed price
B. exchange preferred stock for bonds
C. convert the preferred stock into cash periodically
D. convert the preferred stock into cumulative preferred

Answer 70

The best answer is A. Convertible preferred means the holder of preferred stock may exchange it, at a fixed price, for common stock of the same company. For example, the holder of $100 par preferred that is convertible at $10 per share, can convert each $100 par preferred share into $100 par/$10 conversion price = 10 common shares. Holders of convertible preferred stock cannot convert it into bonds or cumulative preferred.

Question 71

A customer owns $100 par convertible preferred stock, convertible at $25 per share. The convertible preferred is trading at $120. What is the parity price of the common stock?

A. $20
B. $25
C. $30
D. This cannot be determined

Answer 71

The best answer is C. With any conversion question, the first thing that must be computed is the conversion ratio, which is par divided by the conversion price. $100 par /$25 conversion price = 4:1 conversion ratio. This means that each convertible preferred share can be converted into 4 common shares. Since the preferred stock is now trading at $120 and it can be converted into 4 common shares, each common share must be trading at $120/4 = $30 to be at parity (“equivalent value”) with the preferred.

Question 72

Which statement concerning the voting rights of preferred stock is correct?

A. Preferred shareholders do not have voting rights
B. Preferred shareholders vote on payment of dividends
C. Preferred shareholders vote on issuance of new common stock
D. Preferred shareholders vote for the board of directors

Answer 72

The best answer is A. Preferred shareholders do not have voting rights or preemptive rights. Rather, they get a fixed dividend yield that is paid before a common dividend can be paid; and they have prior claim to corporate assets over common in a liquidation.

Question 73

For the past year, the yields on new issues of preferred stock have been falling. Which of the following statements concerning preferred stock issued last year are correct? 
I   Prices are now higher 
II   Prices are now lower 
III   Yields are now higher 
IV   Yields are now lower 

A. I & III only
B. I & IV only
C. II & III only
D. II & IV only

Answer 73

The best answer is B. If yields on new issues have fallen in the past year, market interest rates must have also been falling. When this happens people bid up the prices of current outstanding preferred stock in the market (I). As these prices rise, yields fall (IV) to the current market levels. Remember: as prices go up, yields go down.

Question 74

ABC Corporation owns 10% of the common stock of Chimney Cricket & Co. a firm specializing in chimney cleaning for residential fireplaces. ABC received $100,000 in dividends from this stock last year. When preparing its tax return:

A. ABC may exclude all $100,000 of dividends
B. ABC may exclude $70,000 of dividends
C. ABC may exclude $80,000 of dividends
D. ABC must report all $100,000 with no exclusions

Answer 74

The best answer is B. Corporations receive tax exclusions on 70% of the dividends from stocks they own in other corporations (when they own less than 20% of the stock). In this case, the exclusion is $70,000. ABC would have to own 20% or more of Chimney Cricket to exclude 80%.

Question 75

All of the following statements concerning preferred stock are correct EXCEPT:

A. in a dissolution, preferred stock is “senior” to common stock
B. preferred stock can be convertible to common stock
C. payments to preferred stockholders are subject to the approval of the Board of Directors
D. the yield on preferred stock will vary depending on the earnings of the corporation

Answer 75

The best answer is D. The yield on preferred stock is fixed at a percentage of the par value, and the rate does not depend on the earnings of the corporation. Rather, the yield to move based on movements in market interest rates. Payments to preferred stockholders are not legal obligations; rather, the Board of Directors determines whether to pay them or not. Preferred stock is a “senior” security over common stock, and it can be convertible.

Question 76

Corporate bonds appear on the issuer’s balance sheet as:

A. Stockholders equity
B. Bondholders equity
C. Capital in excess of par
D. Debt

Answer 76

The best answer is D. Bonds are debt. Stock is equity. Therefore, the bonds will appear on the balance sheet as a debt that the corporation owes. The corporation must pay this debt in full before it may pay stockholders in liquidation. Bondholders are creditors of the company; they have no equity position.

Question 77

Which of the following is funded debt of a corporation?

A. Commercial paper
B. Long-term bonds
C. Preferred stock
D. Trade payables

Answer 77

The best answer is B. “Funded” debt is long-term debt (over five years to maturity) of a corporation. It is termed “funded” because this is a source of long-term “funding” to the issuer. Commercial paper is a short-term corporate IOU that must be repaid within 9 months or less (covered later in this chapter). Preferred stock is equity, not debt. Finally, trade payables are corporate liability that must be paid within the next 30-60 days - so they are definitely not a funded debt.

Question 78

An 8%, $1,000 par, corporate bond currently selling in the market for $800 pays which of the following? 
I   $80 of annual interest 
II   $100 of annual interest 
III   $40 per interest payment 
IV   $50 per interest payment 

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 78

The best answer is A. An 8% bond pays 8% of par ($1,000) each year. This amounts to $80 annually. Bonds pay interest semi-annually, so each payment will be $40. Note that the coupon rate is applied to the par value, not the market value, to determine the amount of interest paid.

Question 79

This year JAM Corporation is facing a shortage of cash, and the board of directors has decided not to declare dividends on its preferred or common stock. The board:

A. may avoid default by also not paying interest on its bonds
B. must pay only part of the interest due on its bonds
C. must pay the full interest due on its bonds or face default
D. must pay additional interest on its bonds this year

Answer 79

The best answer is C. Directors have no discretion concerning interest payments on bonds. They must pay the full current interest due or face default. They may not “adjust” the interest payments up or down, nor may they omit these payments as they may on both common and preferred stock.

Question 80

Which of the following statements best describes what happens on the maturity date of a bond?

A. The issuer repurchases the bond at a discount from the face value
B. The issuer repurchases the bond at a premium to the face value
C. The issuer repurchases the bond either at a premium or at a discount to face value
D. The issuer repurchases the bond for its face value

Answer 80

The best answer is D. At the maturity date, the issuer repays the full face value ($1,000) for each bond outstanding

Question 81

An issuer will most likely call its fixed income securities during periods when interest rates have:

A. Increased
B. Declined
C. Remained stable
D. Been extremely volatile

Answer 81

The best answer is B. Issuers call bonds and preferred stock when interest rates have fallen. Then the issuer can refund the issues at lower current interest rates and can save on debt service costs and dividend payments.

Question 82

Which method will most likely enable a corporation to retire its bonds for less than face value?

A. In whole call
B. Repurchase in the open market
C. Sinking fund call
D. Redemption at maturity

Answer 82

The best answer is B. When a corporation repurchases its bonds in the open market, they may be selling at a discount, and the corporation could retire the bonds for less than face value. The other methods of retiring bonds require the corporation to pay face value or more.

Question 83

If market interest rates have risen, a corporation with excess funds could retire bonds at a price that is less than par by which of the following methods?  
I   Sinking fund call 
II   In whole call 
III   Amortization 
IV   Repurchase in the open market 

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 83

The best answer is B.
Amortization is the scheduled repayment of principal at the maturity date - not prior to the maturity date.

If an issuer wishes to redeem its bonds prior to maturity, it must either call them or buy them back from bondholders in the open market. Any possible call provisions are spelled out in the bond contract. An “in whole” call is the standard call option given to an issuer to retire the bonds prior to maturity if market interest rates drop. It cannot call some of the bonds - it must call the entire issue, usually paying a call premium. In contrast, a “sinking fund” call will retire part of the issue periodically. The issuer is required to deposit extra funding into a sinking fund each year, and the trustee calls bonds (at par) with those funds by random selection. If the market price of the issue has fallen (because interest rates have risen), alternately, the trustee can retire those bonds by buying them in the market. Finally, the issuer can always buy back its bonds in the open market to retire them prior to maturity. If market rates have risen, the buy-back price will be less than par.

Question 84

For which of the following bonds will the owner’s name and address appear on a bond certificate?

A. Bearer bonds
B. Book entry bonds
C. Registered bonds
D. Coupon bonds

Answer 84

The best answer is C. With registered bonds, the owner’s name and address will appear on an engraved bond certificate. Bearer and coupon bonds are the same thing - they are certificates in the name of the “bearer” and whoever holds them is considered to be the owner. With book-entry bonds, there are no more physical certificates. The transfer agent keeps the record of the book-entry owner.

Question 85

Which of the following statements concerning mortgage bonds are correct?
I Mortgage bonds are secured
II Mortgage bonds are unsecured
III Mortgage bonds pledge the company’s land and buildings as collateral.
IV Mortgage bonds pledge the company’s wholly owned subsidiary as collateral.

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 85

The best answer is A. A mortgage bond is a secured bond where the issuer pledges its property, plant and equipment (it gives a mortgage on these assets) as collateral for the bond issue. This reduces the issuer’s interest cost. Utilities are large issuers of mortgage bonds, since pledging this collateral reduces the issuer’s interest rate.

Question 86

Which of the following statements concerning equipment trust certificates are correct?
I Equipment Trust Certificates are secured
II Equipment Trust Certificates are unsecured
III Equipment Trust Certificates pledge a company’s rolling stock as collateral
IV Equipment Trust Certificates pledge the shares of a company’s wholly owned subsidiary as collateral.

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 86

The best answer is A. Equipment trust certificates first started as a way of financing railroads, where the railroad cars (rolling stock) were the collateral for the bond issue. They are now also used by airlines and trucking companies to finance the purchase of airplanes and long distance trucks. The trains, planes and trucks are the collateral securing the issue and this reduces the issuer’s interest cost.

Question 87

Which of the following statements concerning collateral trust certificates are correct?
I Collateral Trust Certificates are secured
II Collateral Trust Certificates are unsecured
III Collateral Trust Certificates pledge a company’s rolling stock as collateral
IV Collateral Trust Certificates pledge the shares of a company’s wholly owned subsidiary as collateral.

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 87

The best answer is B. Collateral trust certificates pledge shares owned by the company (usually of a wholly owned subsidiary) as collateral for a bond issue. This is the security for the issue. Equipment trust certificates pledge a company’s moveable equipment as collateral for a bond issue. Mortgage bonds pledge a company’s land and buildings as collateral for a bond issue.

Question 88

When a corporation issues debentures, the collateral is:

A. the corporation’s land and buildings
B. all corporate assets
C. the corporation’s promise to pay
D. all tangible corporate assets

Answer 88

The best answer is C. Debentures, by definition, are unsecured debt. They have no “collateral” backing. They are only backed by the corporation’s promise to pay, so debentures are “promissory notes.”

Question 89

A company’s capitalization consists of:

30-Year Debentures: $20,000,000 
Preferred Stock: $10,000,000 
Common at Par: $1,000,000 
Capital in Excess of Par: $9,000,000 
Retained Earnings: $20,000,000 

The company’s total long term capital is:

A. $1,000,000
B. $10,000,000
C. $30,000,000
D. $60,000,000

Answer 89

The best answer is D.
Capitalization of a company includes common equity, preferred stock and bonds.

Common stockholder’s equity has 3 components - Common at Par; Capital in Excess of Par; and Retained Earnings.

Common Equity is $1,000,000 + $9,000,000 + $20,000,000 = $30,000,000.

Total long term capital is: $30,000,000 common equity + $10,000,000 preferred equity + $20,000,000 long term debt = $60,000,000.