Financial Management 3

Question 1

What are the characteristics of a Junk Bond?

Answer 1

High interest rate

High default risk

Question 2

What are debenture bonds?

Answer 2

Bonds unsecured by collateral

Question 3

What are subordinated debentures?

Answer 3

Debenture Bonds that will be repaid if any assets are left after liquidation of a company

Question 4

What are Redeemable Bonds?

Answer 4

Provision in Bond contract allows demand of Bond payment under certain circumstances

Question 5

What is a Callable Bond?

Answer 5

Borrower can pay off debt early

Question 6

What is a Convertible Bond?

Answer 6

Lender can demand payment via company stock instead of money

Question 7

What is a Sinking Fund?

Answer 7

Borrower deposits regular sums into an account that will eventually pay off the debt

Question 8

What is the disadvantage of Common Stock in comparison to bonds?

Answer 8

Common Stock is more expensive to issue than debt.

Why? Investors demand a greater ROI than debtors (bondholders)

Question 9

What is the advantage of Preferred Stock?

Answer 9

Hold dividend priority over common stock

Question 10

What is Weighted Average Cost of Capital?

Answer 10

A company uses this to determine the true cost of their capital

Example:
Debt costs 5%; 40% of Cap.
Equity costs 12%; 60% of Cap.
(5% x 40%) + (12% x 60%)
WACC : 9.2%

Question 11

What is CAPM?

Answer 11

A stock’s expected performance is based on its beta (risk) compared to that of the stock market.

More risk : more expected return.

Question 12

How is Cost of Debt calculated?

Answer 12

(Interest Expense - Tax Benefit) / Carrying Value of Debt