Chapter 19

Question 1

1) When a corporation has only one class of shares, which of the following is not one of the rights of shareholders?

a) To vote at any shareholder meeting of the corporation.
b) To vote at any director meeting of the corporation.
c) To receive any dividend declared by the corporation.
d) To receive any residual property of the corporation on dissolution.

Answer 1

b

Question 2

2) The following may or may not be in a list of shareholders’ rights. Choose the letter that corresponds to the correct list of rights:
1. Share in dividends 6. Examine the company records
2. Elect directors 7. Priority over unsecured junior
3. Appoint managers debt
4. Vote in general meetings 8. Issue new dividends
5. Vote in directors’ meetings 9. Declare a stock split

a) 1, 2, 3, 5, 8
b) 1, 2, 3, 5, 8, 9
c) 1, 2, 4, 6
d) 1, 2, 6, 9

Answer 2

c

Question 3

3) Which of the following statements about family trusts is true?

a) Family trusts separate ownership and control.
b) Income flows to the trust beneficiaries.
c) The trustees retain the voting power.
d) All of the above statements are not true.

Answer 3

d

Question 4

see sheet

Answer 4

see sheet

Question 5

see sheet

Answer 5

see sheet

Question 6

see sheet

Answer 6

see sheet

Question 7

7) Residual owners are:

a) Bond holders
b) Equity holders
c) Equity and preferred shareholders
d) All of the above

Answer 7

b

Question 8

8) Which of the following statements about dividends is true?

a) Dividends are paid before interest is paid
b) Dividends received by Canadian households are taxed at the marginal personal tax rate
c) Dividends are tax deductible.
d) Dividends received by one Canadian corporation from another Canadian corporation are not taxed.

Answer 8

d

Question 9

9) Use the following statements to answer this question:
I. Today, the preemptive right is always used by corporations to protect their investors from dilution.
II. A common stock has the characteristics of a call option because it has unlimited upside potential.

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

Answer 9

d

Question 10

10) Preferred shares are __________ financing.

a) a form of debt
b) a form of equity
c) a combined form of debt and equity
d) different from debt and equity

Answer 10

b

Question 11

11) In the event of liquidation, preferred shareholders rank ahead of:

a) subordinated debt holders
b) secured debt
c) common shareholders
d) debentures

Answer 11

c

Question 12

12) Which one of the following is the reason for paying a different price for different classes of shares in the case of a takeover?

a) Prices depend on the tax treatment of each class.
b) Prices depend on the dividend yield offered by the class.
c) Prices depend on the voting rights of the shares.
d) Prices depend on the floating of shares.

Answer 12

c

Question 13

13) How would you price preferred shares?

a) As an annuity
b) As a growing annuity due
c) As a perpetuity
d) As a growing perpetuity

Answer 13

c

Question 14

14) Use the following statements to answer this question:
I. A retractable preferred share can be sold back to the issuer.
II. Preferred shares provide a benefit for taxes given that dividend income receives preferential tax treatment as compared to interest income.

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

Answer 14

a

Question 15

15) When dividends that have been in arrears are paid, the preferred shares have a __________ provision.

a) participating
b) cumulative
c) non-cumulative
d) retractable

Answer 15

b

Question 16

16) The retraction feature:

a) protects the issuer from interest-rate risk
b) allows the shareholder to sell it to the issuer at an early maturity date.
c) allows the issuer to buy it back from the shareholder at an early maturity date.
d) protects both the shareholder and the issuer regardless of the interest rates.

Answer 16

b

Question 17

17) Interest rates have gone up to 14 percent since you purchased your 10 percent preferred shares. You would be best off if the shares had a(n) __________ feature.

a) call
b) extraction
c) redemption
d) retraction

Answer 17

d

Question 18

18) Which of the following characteristics apply to straight preferred shares?
I. No maturity date
II. Pay a fixed dividend
III. Dividends are paid at regular intervals
IV. Have a positive yield spread over long Canada bonds
V. The right to sell them back to the issuer

a) I and II
b) I, II, and III
c) I, II, III, and IV
d) I, II, IV, and V

Answer 18

c

Question 19

19) What is the tax value of money?

a) The difference between your before-tax and after-tax earnings.
b) The tax rate multiplied by the total income reported to the government.
c) Accounting for the fact that dividends are taxed more favourably than is interest income.
d) Accounting for the fact that dividends are not taxed while interest income is taxable.

Answer 19

c

Question 20

20) Which of the following characteristics apply to retractable preferred shares?
I. No maturity date
II. Pay a fixed dividend at regular intervals
III. Have a negative yield spread (before tax) over mid-term Canada bonds
IV. The right to sell them back to the issuer

a) I and II
b) I, II, and III
c) I, II, III, and IV
d) II, III, and IV

Answer 20

d

Question 21

21) Which of the following characteristics apply to floating rate preferred shares?
I. Long maturity date
II. Pay a fixed dividend
III. Dividends are paid at regular intervals
IV. Have a positive yield spread (after tax) over bankers’ acceptances
V. The right to sell them back to the issuer

a) I and II
b) I, II, and III
c) III, IV, and V
d) I, III and IV

Answer 21

d

Question 22

22) In which of the following ways are some preferred shares similar to bonds?
I. Call provisions
II. Convertible features
III. Retraction provisions
IV. Rated by rating agencies

a) I, II, and III
b) I, II, and IV
c) II and III
d) I, II, III, and IV

Answer 22

d

Question 23

23) In which of the following ways do warrants differ from call options?
I. Warrants impact the firm while call options do not.
II. Call options have shorter maturities than warrants.
III. Any profit received from call options is taxable while that from warrants is not taxable.
IV. Volatility increases the value of call options but makes warrants less valuable.
V. The longer maturities of warrants make them less valuable.

a) I, II, and III
b) I, III, and V
c) II, IV, and V
d) I and II

Answer 23

d

Question 24

24) A company has 20 million shares outstanding that are trading at $30 per share. The company has 2 million warrants outstanding that have an exercise price of $28 per share. What is the payoff to the warrant holders exercising them, rounded to the nearest dollar?

a) $3,636,364
b) $ 2,800,000
c) – $3,636,364
d) $6,000,000

Answer 24

Answer: a, m = 2 million, n = 20 million, V = $30 x 20 million = $600 million, S = $30, X = $28
A. m / (n + m) * (V – (n * X)) = 2 / (22) * (600 – (20*28)) = $3,636,364

Question 25

25) Issuing bonds plus warrants is similar to issuing:

a) Retractable bonds
b) Convertible bonds
c) Floating rate bonds
d) Preferred shares

Answer 25

b

Question 26

26) Warrants are similar to call options on stocks. What’s the equivalent of the strike price?

a) The initial price of the warrant
b) The market price of the warrant
c) The price of exercise of the warrant
d) None of the above

Answer 26

c

Question 27

27) Use the following statements to answer this question:
I. A warrant’s value is due, in part, to its long-term maturity.
II. The intrinsic value of a warrant does not depend on the volatility of the stock.

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

Answer 27

c

Question 28

28) Which of the following support the rationale for issuing convertible bonds?

a) To reduce underwriting costs
b) To permit cheaper initial financing
c) To minimize dilution
d) All of the above are good reasons for issuing convertible bonds

Answer 28

d

Question 29

29) The ______________ specifies the number of shares received for each convertible bond.

a) conversion price
b) subscription price
c) conversion ratio
d) subscription ratio

Answer 29

c

Question 30

30) Which of the following is true regarding convertible bonds?

a) The convertible bond value is unrelated to the value of the stock.
b) The value of convertible debt is a function of the risk of default.
c) The conversion factor can be separated from the bond and sold separately to other investors.
d) When a bond is converted into stock, the company receives additional funds as part of the conversion.

Answer 30

b

Question 31

31) Hudson Bay Fishing Corporation has issued bonds that can be converted into common shares when the share price is $50. The current market price of the stock is $35. The bond has a face value of $1,000 and currently sells for $975. What is the conversion ratio for this bond?

a) 20
b) 28.6
c) 24.4
d) 27.9

Answer 31

Answer: a, $1000 / 50 = 20

Question 32

32) The conversion premium is defined as which of the following?

a) The number of shares that a convertible security can be exchanged for.
b) The price at which a convertible security can be converted into common shares.
c) The value of a convertible security if it is immediately converted into common shares.
d) The percentage difference between the value at which the bonds are trading and their conversion value

Answer 32

d

Question 33

33) The price at which a convertible bond would sell for if it could not be converted into common stock is called:

a) Floor value
b) Straight bond value
c) Convertible bond value
d) Conversion value

Answer 33

b

Question 34

34) Which of the following statements regarding convertible bonds is true?

a) The floor value is the lowest price for which a convertible bond will be sold.
b) The convertible bond’s floor value is determined by the maximum of the straight bond value and the conversion value.
c) If the share price rises above the conversion price, investors will convert the bonds.
d) All of the above statements are true.

Answer 34

c

Question 35

35) A 12% coupon bond has 20 years to maturity when market rates on similar non-convertible bonds are 9.25%. It is convertible into 20 common shares and has a $1,000 par value. The shares are currently trading at $40. What is the straight bond value, assuming it pays annual coupons?

a) $1,247
b) $1,000
c) $1,207
d) $1,287

Answer 35

Answer: a, PMT = -120, N = 20, FV = -1000, I/Y = 9.25%, compute PV = $1,247

Question 36

36) A 12% coupon bond has 20 years to maturity when market rates on similar non-convertible bonds are 9.25%. It is convertible into 20 common shares and has a $1,000 par value. The shares are currently trading at $40. What is the floor value of the bond, assuming it pays annual coupons?

a) $1,247
b) $1,000
c) $800
d) $2,000

Answer 36

Answer: a, Floor value = max [PMT = -120, N = 20, FV = -1000, I/Y = 9.25%, compute PV = $1,247, 20*40 = 800] = $1,247

Question 37

37) A 10% semiannual coupon bond has 10 years to maturity when market rates on similar non-convertible bonds are 8.5%. It is convertible into 40 common shares and has a $1,000 par value. The shares are currently trading at $30. What is the floor value of the bond, assuming it pays semi-annual coupons?

a) $2,000
b) $1,100
c) $1,200
d) $1,000

Answer 37

Answer: c, Floor value=max(straight bond value, CV) where CV=CRmarket price
PMT = -50, N = 20, FV = -1000, I/Y = 4.25%, compute PV = $1,099.71
CV=4030=1,200
Floor value=1,200

Question 38

38) Which of the following factors are considered when determining whether a security is debt or equity?
I. Permanence factor
II. Subordination factor
III. Objective factor
IV. Legal factor
V. Subjective factor 

a) I and II
b) I, II, and III
c) I, II, and IV
d) I, II, IV, and V

Answer 38

d

Question 39

39) If you are to allocate the amount of hard retractable preferred shares in the financial statements, where would they go?

a) Assets
b) Liabilities
c) Ownership equity
d) None of the above

Answer 39

b

Question 40

40) If you are to allocate the amount of soft retractable preferred shares in the financial statements, where would they go?

a) Assets
b) Liabilities
c) Ownership equity
d) None of the above

Answer 40

c

Question 41

41) Which of the following is the hard retraction requirement?

a) The preferred shares must be paid off with common shares or other preferred shares.
b) The preferred shares must be paid off with cash.
c) The preferred shares must be paid off within 30 days of retraction.
d) The preferred shares can only be retracted in cases of financial distress.

Answer 41

b

Question 42

42) Which of the following statements regarding income bonds is/are true?

a) They appear similar to debt but are closer to equity.
b) They are generally issued after a reorganization.
c) The interest is tied to some level of the cash flow of the firm.
d) All of the above statements are true

Answer 42

d

Question 43

43) Which of the following is not an example of an indexed bond?

a) Commodity bond
b) Real return bond
c) Income bond
d) Callable bond

Answer 43

d

Question 44

44) Which of the following securities provides a firm with results similar to those of a real return bond?

a) Adjustable rate convertible subordinated securities
b) Liquid yield option notes
c) Income bond
d) Original issue discount bond

Answer 44

d

Question 45

45) Rank the risk of the following securities from lowest to highest.
I. Long-term unsecured debt
II. Convertible preferred shares
III. Common equity
IV. Bank loans

a) I, II, III, IV
b) IV, III, II, I
c) I, II, IV, III
d) IV, I, II, III

Answer 45

d