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Quizzer on Long Term Financing

1. In general, it is more expensive for a company to finance with equity capital than with debt
a. Long-term bonds have maturity date and must therefore be repaid in the future.
b. Investors are exposed to greater risk with equity capital.
c. Equity capital is in greater demand than debt capital
d. Dividends fluctuate to a greater extent than interest rates.

2. From the viewpoint of the investor, which of the following securities provides the least risk?
a. Mortgage bond
b. Subordinated debenture
c. Income bond
d. Debentures

3. The risk that securities cannot be sold at a reasonable price on short notice is called:
a. Default risk
b. Interest rate risk
c. Purchasing power risk
d. Liquidity risk

4. When a company desires to increase the market value per share of common stock, the company
will implement:
a. The sale of treasury stock
b. A reverse stock split
c. The sale of preferred stock
d. A stock split

5. Which one of the following is a disadvantage of the use of convertible bonds as a form of
a. Less restrictive covenants in bond indentures would usually be more acceptable to
investors in convertible bonds than to investors in nonconvertible bonds.
b. Convertible bonds defer equity financing until the stock price is higher.
c. Convertible bonds carry a lower interest rate at issuance than if the bond were not
d. The investor may choose not to convert the convertible bonds.

6. The major use of warrants in financing is to:

a. lower the cost of debt
b. avoid dilution of earnings per share
c. maintain managerial control
d. permit the buy back of bonds before maturity.

7. The par value of a common stock represents

a. The estimated market value of the stock when it was issued.
b. The liability ceiling of a shareholder when a company undergoes bankruptcy
c. The total value of the stock that must be entered in the issuing corporation’s records.
d. A theoretical value of stock.

8. In capital markets, the primary market is concerned with the provision of new funds for capital
investments through:
a. New issuance of bond and stock securities
b. Exchanges of existing bond and stock securities
c. The sale of forward or future commodities
d. New issues of bond and stock securities and exchanges of bond and stock securities.

9. The term underwriting spread refers to the:

a. Commission percentage an investment banker receives for underwriting a security issue.
b. Discount investment bankers receive on securities they purchase from the issuing
c. Difference between the price the investment banker pays for a new security issue
and the price at which the securities are resold.
d. Commission a broker receives for either buying or selling a security on behalf of an

10. Each share of non participating 8% cumulative preferred stock in a company that meets its
dividend obligations has all of the following characteristics except:
a. Voting rights in corporate elections
b. Dividend payments that are not tax deductible by the company.
c. No principal repayments
d. A superior claim to common stock equity in the case of liquidation

11. If a P1,000 bond sells for P1,125 which of the following statements are correct?
I. The market rate of interest is greater than the coupon rate on the bond.
II. The coupon rate on the bond is greater than the market rate of interest
III. The coupon rate and the market rate are equal.
IV. The bond sells at a premium
V. The bond sells at a discount

a. I and IV
b. I and V
c. II and IV
d. II and V

12. Debentures are:

a. Income bonds that require interest payments only when earnings permit.
b. Subordinated debt and rank behind convertible bonds
c. Bonds secured by the full faith and credit of the issuing firm.
d. A form of lease financing similar to equipment trust certificates.

13. Which one of the following characteristics distinguishes income bonds from other bonds?
a. The bondholder is guaranteed an income over the life of the security
b. By promising a return to the bondholder, an income bond is junior to preferred and
common stock.
c. Income bonds are junior to subordinated debt but senior to preferred and common stock
d. Income bonds pay interest only if the issuing company has earned the interest.

14. Serial bonds are attractive to investors because

a. All bonds in the issue mature on the same date
b. The yield to maturity is the same for all bonds in the issue.
c. Investors can choose the maturity that suits their financial needs
d. The coupon rate on these bonds is adjusted to the maturity date.

15. The best advantage of a zero coupon bond to the issuer is that the:
a. Bond requires a low issuance cost.
b. Bond requires no interest income calculation to the holder or issuer until maturity.
c. Interest can be amortized annually by the APR method and need not be shown as an
interest expense to the issuer.
d. Interest can be amortized annually on a straight line basis but is a non cash outlay.

16. Junk bonds are

a. Securities rated at less than investment grade
b. Worthless securities
c. Securities that are highly risky but offer only low yields
d. Considered illegal to issue.

17. Which one of the following statements is correct when comparing bond financing alternatives?
a. A bond with a call provision typically has a lower yield to maturity than a similar bond
without a call provision.
b. A convertible bond must be converted to common stock prior to its maturity.
c. A call provision is generally considered detrimental to the investor.
d. A call premium requires the investor to pay an amount greater than par at the time of

18. When a company desires to increase the market value per share of common stock, the company
will implement:
a. The sale of treasury stock
b. A reverse stock split
c. The sale of preferred stock
d. A stock split

19. Which of the following statements is incorrect?
a. Call provisions enable the issuer of a bond to redeem the bond under specified terms,
prior to the normal maturity date.
b. Sinking fund provisions usually require the issuer of a bond to retire a portion of the
bond issue each year.
c. An original issue discount bond pays no annual interest, is offered at a price
significantly less than the face value, and offers compensation to investors in the
form of capital gains.
d. A convertible bond allows the bondholder to exchange the bond for a specified number
of shares of common stock.

20. Which of the following are criteria used in establishing bond ratings?
a. Certain debt management ratios, including the debt ratio, the times-interest earned ratio,
and the fixed charge coverage ratio.
b. Whether the bond has a sinking fund provision.
c. The stability of the issuing firm's sales and earnings.
d. All of the above are correct.

21. Suppose a stock is not currently paying dividends, and its management has announced that it will
not pay a dividend for several years, but that it does expect to start paying dividends sometime in
the future. Under these conditions, which of the following statements is most correct?
a. The value of the stock can be found using DCF procedures by finding the present
value of expected future dividends accounting for their timing and amount.
b. Such a stock should have a value of zero until it actually begins paying dividends.
c. Since it is expected to someday pay dividends, the value of the stock today can be found
with this equation: P0 = D1/(r - g).
d. Under these conditions, we can estimate a value for the stock, but we cannot use any
form of the constant growth DCF model to do so.

22. Which of the following statements concerning common stock is most correct?
a. Companies are required by law to issue only one class of common stock, although the
rights and privileges associated with shares within that class may vary.
b. A company whose stock is all owned by a few people (typically its managers) is said
to be "privately owned" or "closely held."
c. The preemptive right fails to protect shareholders against dilution of value when a
company decides to issue additional common stock.
d. Institutional investors hold more than seventy-five percent of the common stock
outstanding, but their trading and large block trades mean that they have a minimal
influence on stock prices.

23. Which of the following statements is NOT correct about the rights granted to common
a. Common stockholders have the right to elect a firm's directors.
b. Stockholders may transfer their right to vote to a second party by means of a proxy.
c. In large, publicly traded firms, managers typically have some stock but their personal
holdings are generally insufficient to win voting control.
d. Dividends due to common stockholders are cumulative.

24. Which of the following statements most correctly identifies the payoff of a call option?
a. The maximum of either the stock price minus the exercise price or zero.
b. The maximum of either the exercise price minus the stock price or zero.
c. The difference between the price a stock is sold for and the price paid for the stock.
d. The difference between the price received from the short sell of a stock and the price the
stock is bought back for.

25. Which of the following statements about preferred stock is most correct?
a. Preferred stock dividends are cumulative.
b. Preferred stock normally will have voting rights.
c. The before-tax yield on preferred stock is generally greater than that of corporate bonds,
while the after-tax yield on preferred stock is usually less.
d. Preferred stock dividends are generally not entitled to dividends in arrears.

26. Which of the following is a disadvantage of preferred stock, from the issuer's perspective?
a. The obligation to pay preferred dividends is not contractual.
b. Preferred issues typically reduce the cash flow drain from the repayment of the principal
that occurs with debt issues.
c. Issuing preferred stock allows firms to avoid the dilution of common equity that occurs
when common stock is sold.

d. The after-tax cost of preferred stock is usually higher than the after-tax cost of debt.

27. Which of the following statements is most correct?

a. Firms which use "off balance sheet" financing, such as leasing, will show higher
debt ratios once the effects of their leases are reflected in their financial statements.
b. A key difference between an operating lease and a capital lease is that with a capital
lease, the total lease payments on the asset are roughly equal to the full price of the asset
plus a return on the investment in the asset.
c. If a firm capitalizes a lease, this means that the firm issues equity capital in proportion to
its current capital structure, in an amount sufficient to support the lease payment
d. The fixed charges associated with a lease can be as high as, but never be greater than, the
fixed payments associated with a loan.

28. Which of the following statements is incorrect?

a. An operating lease is one in which the lessor maintains and finances the property.
b. A sale and leaseback occurs when a firm arranges to sell land, buildings, or equipment
and lease the property back for a specified period of time.
c. An important characteristic of operating leases is that they are fully amortized,
which means that the payments required by the lease contract do not fully recover
the cost of the equipment.
d. For a capital lease to occur, a bargain purchase option must be available to the lessee at
the end of the term.

29. Capital leases differ from operating leases in which of the following ways except?
a. They provide maintenance services.
b. They are not cancelable.
c. They are fully amortized.
d. They transfer title at the end of the term.

30. Suppose, there are two identical firms looking to acquire new equipment. Firm B has chosen to
borrow money to buy the equipment, while Firm L has chosen to lease the equipment. Apart from
this decision, the firms share every characteristic. Prior to the decision, the two firms had identical
income statements and balance sheets. After the decision to lease and buy are made, which of the
following statements is most correct?
a. Firm B must have a higher debt ratio.
b. Firm B must have the higher times interest earned ratio.
c. Firm B must have the lower ROE.
d. All of the above are correct.

31. Which of the following is not a condition that must be present for a lease to be classified as a
capital lease?
a. The present value of lease payments is equal to or greater than 90 percent of the initial
value of the asset.
b. The firm employs double-declining balance depreciation towards the property.
c. The lease runs for a period equal to or greater than 75 percent of the asset's life.
d. The lessee can purchase the property or renew the lease at less than the fair market price
when the lease expires.

32. A long-term contract under which a borrower agrees to make payments of interest and principal on
specific dates is called a:
a. common stock.
b. preferred stock.
c. equity contract.
d. bond.

33. A bond that pays no annual interest but is sold at a discount below the par value is called:
a. an original maturity bond.
b. a floating rate bond.
c. a fixed maturity date bond.
d. a zero coupon bond.

34. The rate of return earned on a bond if it is held until maturity is its:
a. yield-to-call.
b. coupon payment. .
c. yield-to-maturity.
d. sinking fund yield.

35. ___________ have control of the firm since they have the right to elect a firm’s directors.
a. Bondholders
b. Preferred stockholders
c. Creditors
d. Common stockholders

36. The price of a stock is:

a. the future value of all expected future dividends, discounted at the dividend growth rate.
b. the present value of all expected future dividends, discounted at the dividend growth
c. the future value of all expected future dividends, discounted at the investor’s required
d. the present value of all expected future dividends, discounted at the investor’s
required return.

37. Since preferred stock dividends are fixed, valuing preferred stock is roughly equivalent to valuing:
a. a zero growth common stock.
b. a positive growth common stock
c. a short-term bond
d. an option.

38. A protective feature on preferred stock that requires preferred dividends previously not paid to be
paid before any common dividends can be paid is the ____________ provision.
a. arrearages
b. cumulative
c. conversion
d. par

39. An arrangement whereby a firm sells land, buildings, or equipment and simultaneously leases the
property back for a specified period under specific terms is called a:
a. preferred stock.
b. capital lease.
c. sale and leaseback.
d. lessor agreement.

40. Financing in which the assets and liabilities involved do not appear on the firm’s balance sheet is
a. balance sheet financing.
b. off-balance sheet financing.
c. income financing.
d. unknown financing.

41. A security that is exchangeable at the option of the holder for the common stock of the issuing
firm is a:
a. put option.
b. futures contract
c. bond indenture.
d. convertible security

42. A convertible debenture’s value will generally __________ its conversion value and also
________ its straight-bond value.
a. be less than; be less than
b. be less than; be greater than
c. be greater than; be less than
d. be greater than; be greater than

43. On January 1, of the current year, Bongo Company issued convertible bonds with P1,000 par
value and a conversion ratio of 50. Which of the following should be the probable market price per
share of the company’s common stock on January 1?
a. Under P20
b. P20
c. Between P20 and P50
d. Above P50

44. Preferred stock valuation usually treats the preferred stock as a:

a. capital asset.
b. perpetuity.

c. common stock.
d. long-term bond.

45. Which statement is true?

a. Investors can sue the corporation if it does not pay the agreed-upon preferred dividend.
b. Preferred stock of a given company is less risky to the investor than corporate bonds of
the same corporation.
c. Most issues of preferred stock have a cumulative feature.
d. Preferred stock usually has a maturity that is less than the average maturity of bonds
issued by the same company.

46. Which statement is true?

a. Preferred stock is similar to corporate bonds because dividends on preferred stock, like
interest on bonds, are a tax-deductible expense to the corporation.
b. Preferred stock is similar to corporate bonds because the corporation usually pays
the holders of the securities a fixed amount.
c. Preferred stockholders are considered to be the true owners of corporations.
d. Preferred stockholders have priority over bondholders when it comes to the payment of

47. Preferred stock is similar to a bond because:

a. it has a maturity at which time the corporation repays par value.
b. it has a fixed amount to the investor.
c. it represents an ownership interest.
d. all of the above.

48. What feature allows preferred stockholders the right to receive dividends over and above the
stated dividend?
a. Cumulative
b. Convertible
c. Participating
d. Preemptive

49. The disadvantages of debt include all but which of the following?
a. Inflation will make the debt payments higher.
b. Indenture agreements can put restrictions on the borrower.
c. Too much debt might hurt the firm’s stock price.
d. Principal and interest payments must be met.

50. Which of the following is true about an operating lease?

a. It would have a lease term equal to 75% or more of the estimated value of the asset being
b. It is usually short-term and often can be cancelled at the option of the lessee.
c. It must be included as a liability on the balance sheet.
d. It is always more expensive than a factored loan.