more possible theory questions final exam

Question 1

preferred shares/stock definition

Answer 1

a share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends.

• Represents equity of a corporation, but is different from common stock because it has preference over common in the payments of dividends and in the assets of the corporation in the event of bankruptcy
• Preferred shares have a stated liquidating value, usually $100 per share
• Preferred dividends are either cumulative or noncumulative

Question 2

convertible bonds

Answer 2

a fixed-income corporate debt security that yields interest payments, but can be converted into a predetermined number of common stock or equity shares

convertible bonds give the right to exchange the bond for a specific number of shares of the issuer’s common stock

Question 3

syndicated loans

Answer 3

• Large money-center banks frequently have more demand for loans than they have supply
• Small regional banks are often in the opposite situation
• As a result, a larger money center bank may arrange a loan with a firm or country and then sell portions of the loan to a syndicate of other banks
• A syndicated loan may be publicly traded

A syndicated loan is a loan made respectively by two or more lenders contracting directly with a borrower under the same credit agreement with the lenders dividing the responsibility to lend the full amount of the loan. Each lender has a direct legal relationship with the borrower and receives its own promissory note from the borrower.

Question 4

zero coupon bond

Answer 4

a debt security that does NOT pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value

• Make no periodic interest payments (coupon rate = 0%)
• The entire yield to maturity comes from the difference between the purchase price and the par value
• Cannot sell for more than par value
• Sometimes called zeroes, deep discount bonds, or original issue discount bonds (OIDs)
• Treasury Bills and principal - only Treasury strips are good examples of zeroes

Question 5

participating loans

Answer 5

Participation loans are loans made by multiple lenders to a single borrower.

Several banks, for example, might chip in to fund one extremely large loan, with one of the banks taking the role of the “lead bank”. This lending institution then recruits other banks to participate and share the risks and profits.

A loan participation involves a sharing or selling of ownership interests in a loan between two or more financial institutions.

With participations, the contractual relationship runs from the borrower to the lead bank and from the lead bank to the participants, whereas with syndications, the financing is provided by each member of the syndicate to the borrower pursuant to a common negotiated agreement with each member of syndicate having a direct contractual relationship with the borrower.

Question 6

eurobonds

Answer 6

bonds denominated in a particular currency and issued simultaneously in the bond markets of several countries

It’s a time of international bond that is issued in a place outside of the issuer’s home country and issued in a currency that is different that the place that it is issued.

Question 7

asset beta

Answer 7

Unlevered beta (a.k.a. Asset Beta) is the beta of a company without the impact of debt. It is also known as the volatility of returns for a company, without taking into account its financial leverage. It compares the risk of an unlevered company to the risk of the market.

Question 8

unlevered beta

Answer 8

Beta is a measure of market risk. Unlevered beta (or asset beta) measures the market risk of the company without the impact of debt.

‘Unlevering’ a beta removes the financial effects of leverage thus isolating the risk due solely to company assets. In other words, how much did the company’s equity contribute to its risk profile.

Question 9

Actions the company can take in default (what happens in financial distress)

Answer 9

FINANCIAL DISTRESS

I. NO FINANCIAL RESTRUCTURING
II. FINANCIAL RESTRUCTURING

1. PRIVATE WORKOUT
2. LEGAL BANKRUPTCY (CHAPTER 11)

• REORGANIZE AND EMERGE
• MERGE WITH ANOTHER FIRM
• LIQUIDATION

Question 10

Forms of takeover

Answer 10

TAKEOVERS:

1. ACQUISITION
   A. MERGER
   B. ACQUISITION OF STOCK
   C. ACQUISITION OF ASSETS
2. PROXY CONTEST
3. GOING PRIVATE (LBO)

Question 11

what are the 3 standard approaches to valuation under leverage?

Answer 11

All three approaches attempt the same task: valuation in the presence of debt financing
1. APV: adjusted present value
2. FTE: flow to equity
3. WACC: weighted average cost of capital

a key difference between the APV, WACC & FTE approaches to valuation is -> how debt effects are considered

WACC: adding the weighted average after tax cost of debt to the weighted average cost of equity

Guidelines:
* Use WACC or FTE if the firm’s target debt-to-value ratio applies to the project over the life of the project
* Use the APV if the project’s level of debt is known over the life of the project
* In the real world, the WACC is, by far, the most widely used

Question 12

One-for-four reverse stock split

Answer 12

the company would provide one new share for every four old shares

Stock splits – essentially the same as a stock dividend except it is expressed as a ratio
* For example, a 2 for 1 stock split is the same as a 100% stock dividend.
* Stock price is reduced when the stock splits
* Common explanation for split is to return price to a “more desirable trading range”

Question 13

stock split

Answer 13

A stock split happens when a company increases the number of its shares to boost the stock’s liquidity. Although the number of shares outstanding increases by a specific multiple, the total dollar value of all shares outstanding remains the same because a split does not fundamentally change the company’s value.

Question 14

regular cash dividend

Answer 14

cash payment made by a firm to its owners in the normal course of business

Question 15

declaration date

Answer 15

date on which the board of directors passes a resolution authorizing payment of a dividend to the shareholders

Question 16

Definition and types of risks

Answer 16

Definition: The chance that an investment’s actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment

Types:
- Market risk
Change in the value of an asset due to changes in Exchange rates, interest rates, inflation rates, bond prices, equity prices or commodity prices
- Credit risk
The other party fails to meet the agree conditions (payments and dates).
Example :Counterparty risk and country risk
- Liquidity risk
Difficulty to close a position in the market
Difficult access to financing

Question 17

date of payment of dividends

Answer 17

date on which the firm mails out the checks of its declared dividends

Question 18

sinking-fund debt

Answer 18

A sinking fund is a fund containing money set aside or saved to pay off a debt or bond. A company that issues debt will need to pay that debt off in the future, and the sinking fund helps to soften the hardship of a large outlay of revenue.

Question 19

debentures

Answer 19

A debenture is a type of bond or other debt instrument that is unsecured by collateral. Since debentures have no collateral backing, they must rely on the creditworthiness and reputation of the issuer for support. Both corporations and governments frequently issue debentures to raise capital or funds.

Question 20

callable debt

Answer 20

Callable or redeemable bonds are bonds that can be redeemed or paid off by the issuer prior to the bonds’ maturity date. When an issuer calls its bonds, it pays investors the call price (usually the face value of the bonds) together with accrued interest to date and, at that point, stops making interest payments.

Question 21

indenture debt

Answer 21

Definition: An indenture is a legally binding loan document in which two parties agree on a set of conditions and loan terms requiring the borrower to pay the lender a series of principle and interest payments over time.

Question 22

subordinated debt (or junior debt)

Answer 22

Subordinated debt is an unsecured borrowing. If the issuing bank were liquidated, its subordinated debt would be paid only after its other debt obligations (including deposit obligations) are paid in full but before any payment to its stockholders.

Question 23

treasury stock

Answer 23

Treasury stock, also known as treasury shares or reacquired stock, refers to previously outstanding stock that is bought back from stockholders by the issuing company. The result is that the total number of outstanding shares on the open market decreases.

Question 24

retained equity

Answer 24

Retained earnings are the amount of profit a company has left over after paying all its direct costs, indirect costs, income taxes and its dividends to shareholders. This represents the portion of the company’s equity that can be used, for instance, to invest in new equipment, R&D, and marketing.

Question 25

capital surplus (share premium account)

Answer 25

Capital surplus, or share premium, most commonly refers to the surplus resulting after common stock is sold for more than its par value. Capital surplus includes equity or net worth otherwise not classifiable as capital stock or retained earnings.

Question 26

underpricing can be explained by

Answer 26

• oversubscription of an issue

- strong demand by investors

Question 27

Cost of debt

Answer 27

interest rate required on issuance of new debt (yield to maturity on outstanding debt)

Question 28

green shoe option is used for

Answer 28

• cover oversubscription

- cover excess demand

Question 29

a rights offering is

Answer 29

the issuing of an option directly to the shareholders to acquire stock

Question 30

syndicate

Answer 30

a group of investment bankers who pool their efforts to underwrite a security

Question 31

What Happens in Financial Distress?

Answer 31

Firms deal with distress by:

• Selling major assets.
• Merging with another firm.
• Reducing capital spending and research and development.
• Issuing new securities.
• Negotiating with banks and other creditors.
• Exchanging debt for equity.
• Filing for bankruptcy.

Question 32

asset restructuring

Answer 32

• Selling major assets
• Merging with another firm
• Reducing capital spending and R&D spending

Question 33

financial restructuring

Answer 33

• Issuing new securities
• Negotiating with banks and other creditors
• Exchanging debt for equity
• Filing for bankruptcy

Question 34

proxy voting

Answer 34

• A proxy is the legal grant of authority by a shareholder to someone else to vote his or her shares
• For convenience, the actual voting in large public corporations is usually done by proxy

Question 35

A note usually refers to

Answer 35

an unsecured debt with a maturity shorter than that of a debenture

Question 36

floating rate bonds

Answer 36

Floating rate bonds deliver variable interest, determined by a coupon rate which changes according to the market interest rate, offering potential gains to investors.

Question 37

foreign bonds

Answer 37

bonds issued in another nation’s capital market by a foreign borrower

Question 38

Derivative securities:

Answer 38

Definition: security whose value comes from or is derived from the value of other assets

Types:
- swaps
- options
- futures
- forward

Question 39

Market Portfolio -

Answer 39

Portfolio of all assets in the economy. In practice, a broad stock market index, such as the S&P Composite, is used to represent the market

Question 40

Beta -

Answer 40

Sensitivity of a stock’s return to the return on the market portfolio

Question 41

flotation costs

Answer 41

Flotation costs represent the expenses incurred upon the issue, or float, of new bonds or stocks

Question 42

debt beta

Answer 42

typically assumed to be 0

Question 43

record date

Answer 43

Date on which company determines existing shareholders