Chapter 19 notes

Question 1

shareholder’s rights

Answer 1

Residual holders are the equity holders

Question 2

Preferred shares

Answer 2

– a form of equity financing

• Event of liquidation, preferred shareholders rank ahead of common shareholders
• Are priced as a perpetuity
• Provide a benefit for taxes given that dividend income receives preferential tax treatment as compared to interest income
• When dividneds are in arrears are paid, the preferred shares have a cumulative provision

Question 3

Preferred shares are similar to bonds in that

Answer 3

• Call provisions
• Convertible features
• Retraction provisions
• Rated by rating agencies

Question 4

Straight preferred shares

Answer 4

• Have no maturity date
• Pay a fixed dividend
• Dividends are paid at regular intervals
• Have a positive yield spread over long Canada bonds

Question 5

Retractable preferred shares

Answer 5

• Can be sold back to the issuer
• The retraction feature allows the shareholder to sell it to the issuer at an early maturity date
• If interest rates go up, it would be beneficial to have a retractable preferred share
• Pay a fixed dividend at regular intervals
• Have a negative yield spread (before tax) over mid-term Canada bonds
• The right to sell them back to the issuer

Question 6

Floating Rate preferred shares

Answer 6

• Long marturity date
• Divdiends are paid at regular intervals
• Have a positive yield spread (after tax) over banker;s acceptances

Question 7

Share class

Answer 7

• Prices depend on voting rights of the shares

o Therefore, when there is a takeover,this is the reason they pay a different price for different types of shares

Question 8

PRemeptive right

Answer 8

• A common stock has the characteristics of a call option because it has unlimited upside potential

Question 9

What is the tax value of money

Answer 9

• Accounting for the fact that dividends are taxed more favourably than is interest income

Question 10

warrants

Answer 10

• Differe from call options in that
  o Warrants impact the firm while call options do not
  o Call options have shorter maturities than warrants
• Issuing bonds plus warrants is similar to issuing
  o Convertible bonds
• They are similar to call options on stocks, the equivalent of the strike price is the price of exercise of the warrant
• A wrrant’s value is due , in part to its long-term maturity

Question 11

Convertible bonds are issued to

Answer 11

• They are issued to
  o Reduce underwting costs
  o Permit cheaper initial financing
  o Minimize dilution

Question 12

convertible bonds conversion ratio

Answer 12

specifies the number of shares recived for each convertible bond

Question 13

the value of convertible debt is

Answer 13

a function fo the risk of default

Question 14

the prie a convertible bond would sell for if it could be converted into common stock is called

Answer 14

the straight bond value

Question 15

if the share price rises above conversion price

Answer 15

invesotrs will convert te bonds

Question 16

what is the conversion premium

Answer 16

• The percentage difference between the value at which the bonds are trading and their conversion value

Question 17

how do you allocate the amount of hard retractable preferred shares in the f.s

Answer 17

liabilities

Question 18

how do you allocate the amout of soft retractable preferred shares in te f.s

Answer 18

ownership equity

Question 19

what is a hard retraction requirement for preferred shares

Answer 19

the preferred shares must be paid off with cash

Question 20

what are income bonds

Answer 20

• They appear similar to debt but are closer to equity
• They are generally issued after a reorganization
• The interest is tied to some level of the cash flow of the firm

Question 21

what is an index bond

Answer 21

An Index Bond 
-	Is not not a callable bond 
-	It is a 
o	Commodity bond 
o	Real return bond 
o	Income bond

Question 22

Rank securities form highest to lowest

Answer 22

1. bank loans
2. long-term unsecured debt
3. convertib le preferred shares
4. common equity