Midterm Exam 2

Question 1

how to calculate the coupon rate of a bond

Answer 1

need to know the percentage of the bond and times that by the face value

Question 2

disadvantages of debt

Answer 2

agency costs - covenants and restrictions
expected bankruptcy cost - risk of bankruptcy
loss of flexibility cost - obligation to pay

Question 3

What kind of bonds should generally give the highest yield

Answer 3

all else held equal a long-term bond has more risk, so it yields more than short term
junk bonds have a high risk to not be paid so it pays more than a high quality bond
tax free bonds have a lower yield

Question 4

what do protective covenants do?

Answer 4

bond holders want a covenant to help them place restrictions on the borrower and protect themselves

Question 5

bonds secured by assets

Answer 5

secured bonds have real estate behind it or other assets

Question 6

debenture bond

Answer 6

unsecured bond

Question 7

sinking fund

Answer 7

separate account for borrower to set aside money to buy back the bond
protects bondholder

Question 8

call and put provisions

Answer 8

call - the borrower can redeem the bond (borrower wins)

Put - the bond holder can make the borrower buy the bond back (bondholder wins)

Question 9

what factors make stocks harder to value than bonds

Answer 9

market fluctuations
we know what a bond will pay at maturity and we know the cash streams from the bond
we do not know for sure any of this
life of a stock has no maturity
can’t easily determine the rate of return

Question 10

default risk premium

Answer 10

bond ratings

the chance that the company will not pay

Question 11

taxability premium

Answer 11

municipal versus taxable

Question 12

liquidity premium

Answer 12

bonds that have more frequent trading will generally have lower required returns

Question 13

maturity premium

Answer 13

longer term bonds usually have higher required returns

Question 14

open market buyback

Answer 14

they buy just like any other consumer

Question 15

tender offer buyback

Answer 15

company says we want to buy back x number of shares at x amount, stockholders can choose to sell or not

Question 16

target purchase buyback

Answer 16

buys back from a specific stockholder and pays a premium

Question 17

if interest rates rise or decline, what happens to bond prices?

Answer 17

interest rates rise bond prices go down and vice versa

Question 18

clientele effect

Answer 18

the company will attract investors based on their dividend policy

Question 19

• The impact a stock repurchase program has on stock prices and investors

Answer 19

o Raises the stock price because earnings per share goes up because there are fewer stocks in the market. (earnings don’t change but number of shares is lower) – makes every share more valuable

Question 20

characteristics of preferred stock

Answer 20

 Stated dividend that must be paid before dividends can be paid to common stockholders
Dividends are not a liability of the firm, and preferred dividends can be deferred indefinitely
Most preferred dividends are cumulative – any missed preferred dividends have to be paid before common dividends can be paid
preferred stock does not carry voting rights