Valuation and Characteristics of Stocks and Bonds

Question 1

A corporate ______________ is a long-term debt obligation issued by corporations that normally pays interest and promises to return the principal upon maturity.

Answer 1

bond.

This is the definition of a corporate bond. The repayment terms are usually clearly defined and the maturity period can vary up to 30 years.

Question 2

Legal protection is afforded to bondholders via the bond ______ and the trustee.

Answer 2

indenture.

The indenture declares the legal conditions under which the bond was issued and the trustee is a paid third party who ensures that the issuer does not default.

Question 3

The bond indenture normally has a ______-fund requirement, which is a mechanism for the issuer to retire those bonds.

Answer 3

sinking.

The corporation makes annual or semi-annual payments to the trustee, who then uses these funds to repurchase the bonds using a call feature.

Question 4

The three common features of a bond issue are the call feature, _______ feature and stock-purchase warrants.

Answer 4

conversion.

The conversion feature in convertible bonds allows bondholders to convert their bond into a pre-determined number of shares of stock. The stock-purchase warrant allows the bondholder to purchase a certain number of shares at a stated price during a particular period.

Question 5

The call feature may also contain a call price and if it is greater than the bond’s par value and this amount is known as the call _____.

Answer 5

premium.

The call price is the stated price that the bond can be repurchased at before maturity and the call premium is the extra amount the bond was bought back that exceeds the par value.

Question 6

Independent agencies such as Moody’s and Standard & Poor’s assess the _______ level of publicly traded bonds.

Answer 6

risk.

This is one of the main tasks of these agencies.

Question 7

________, subordinated debentures and income bonds are traditional unsecured bonds.

Answer 7

Debentures.

This is a type of unsecured traditional bond that has been around for many years.

Question 8

Mortgage bonds, collateral trust bonds and equipment trust certificates are __________ traditional bonds.

Answer 8

secured.

These bonds are secured by equipment, real estate or collateral trust.

Question 9

Contemporary corporate bonds include zero-coupon bonds, _____ bonds, floating-rate bonds, extendable notes and putable bonds.

Answer 9

junk.

These are more modern versions of corporate bonds.

Question 10

Holders of common and preferred stock are holders of equity capital, yet the ______ of the company are given preference when making a claim to the income and assets of a company.

Answer 10

creditors.

The creditors get paid first and they bear the least risk – the debt may be secured or unsecured but they will get paid before the owners of the company, who bear the greatest risk and are paid last. In bankruptcy, the order of payment is determined by law.

Question 11

Equity capital is a permanent form of financing as there is no ______ date.

Answer 11

maturity.

Equity capital does not mature and hence no repayment is required.

Question 12

Long-term debts of a company normally have maturity dates between 5 to __ years.

Answer 12

20.

This is the usual term of long-term debts.

Question 13

____ debt provisions are the terms and conditions under which a long-term debt is agreed.

Answer 13

standard.

This is the term coined for these provisions as they are the “standard” for this type of agreement.

Question 14

Examples of standard debt provisions include maintaining good accounting records to GAAP standards, regularly providing the lender with _____ financial statements, paying taxes in a timely fashion and maintaining the business as a “going concern”.

Answer 14

audited.

Accounting records and audited financial statements are critical to the lender, thereby ensuring that the borrower is running the company according to the relevant standards, with statements verified by an independent third party.

Question 15

The standard debt provisions normally present ____ difficulties for a credit-worthy borrower.

Answer 15

no.

These provisions would not be onerous to a financially legitimate borrower, as these would normally be part of their standard business procedures anyway.

Question 16

When a long-term debt agreement contains _____ covenants, it means that certain operational and financial limitations are placed upon the borrower.

Answer 16

restrictive.

This is the definition of restrictive covenants and is a means of protecting the lender by keeping an eye on and controlling the borrower’s activities.

Question 17

A common restrictive covenant is subordination, which means that subsequent borrowing from another lender will be ranked ____ the claims made by the original lender.

Answer 17

below.

This is to ensure that the original lender has their claim satisfied first before any subsequent creditors.

Question 18

The cost of long-term debt is usually ____ than that of short-term debt.

Answer 18

greater.

It is greater because interest rates tend to be higher and there is greater risk for the lender.

Question 19

A long-term loan is one made by a financial institution to a business, with an initial maturity date exceeding __ year and may be secured or unsecured.

Answer 19

1.

One year is the minimum term, though it is more common to have terms of between five to twelve years.

Question 20

Long-term loans generally require regular loan payments that pay off the interest and principal at the end of the term, though some also require a _____ payment upon maturity.

Question 21

The main privilege preferred stockholders possess over common stockholders is the promise of a ______ periodic dividend.

Answer 21

fixed.

This return is fixed and expressed as a percentage or dollar amount.

Question 22

The real owners of a company are the _________ stockholders because they invest money hoping for a return in the form of dividends and hopefully, capital gain.

Answer 22

common.

This is the definition of common stockholders – they have no guarantee of a return on their investment, hence they are known as the “real” owners.

Question 23

The common stock can be privately owned, ______ owned or publicly owned.

Answer 23

closely.

This means that all the common stock is owned by a small group of investors, for example, a family.

Question 24

Common stock can be sold with or without a ______ value.

Answer 24

par.

This value is an arbitrarily assigned value placed on the stock in the company’s charter.

Question 25

More than one class of common stock may be issued, with the fundamental difference being ____ rights.

Answer 25

voting.

These different classes of stock are issued to defend against a hostile merger or to increase the quantity of common stock but not assigning any voting rights to that new class. (nonvoting common stock).

Question 26

___________ shares are those that carry more votes per share than other regular common stock.

Answer 26

supervoting.

This is the definition of supervoting shares and is granted by a company to give the holders stronger voting rights.

Question 27

A ____ statement is signed by a stockholder to pass his right to vote to another party.

Answer 27

proxy.

This is the definition of a proxy statement. Solicitations of proxies are monitored by the Securities and Exchange Commission (SEC) to guard against impropriety.

Question 28

The ______ voting system is one where each stockholder has one vote for each share owned.

Answer 28

majority.

This is the definition of the majority voting system and the stockholder can vote all of his shares for each director.

Question 29

In the ______________ voting system, each common stock shareholder has as many votes as there are directors and votes may all be cast for one or distributed among several director(s).

Answer 29

cumulative.

This is the definition of the cumulative voting system, which is a semi-proportional voting system which empowers minority shareholders.

Question 30

The Board of _______ has the power to decide whether or not to make a payment of dividends to common stockholders.

Answer 30

directors.

As the leaders of the company, they make these important financial decisions.

Question 31

_______ rights allow stockholders to buy extra stocks in direct proportion to the number of stocks they already own.

Answer 31

stock.

This is the definition of stock rights are usually used by smaller companies with closely owned or publicly owned but not actively traded shares.

Question 32

When new common stock shares are issued, preemptive rights permit stockholders to retain a __________ share in the business relative to the new issue.

Answer 32

Proportionate.

This is the definition of preemptive rights and allows these stockholders to maintain their voting control and to prevent dilution of ownership.

Question 33

The pros of common stock are that it places a small amount of financial limitations on the company, there is no maturity date and it is flexible in increasing the company’s _________capability.

Answer 33

borrowing.

The issue and sale of common stock increase the company’s equity base and hence will be able to obtain more long-term debt financing at better cost.