2 L-T Financial Management - Financial Instruments

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Question 1 - CMA 691 1.5 - L-T Financial Management-Financial Instruments
Short-term interest rates are
A. Not significantly related to long-term rates.

B. Usually lower than long-term rates.
C. Usually higher than long-term rates.
D. Lower than long-term rates during periods of high inflation only.
Question 2 - ICMA 10.P2.111 - L-T Financial Management-Financial Instruments
Which one of the following provides the best measure of interest rate risk for a corporate bond?
A. Duration.
B. Yield to maturity.
C. Maturity.
D. Bond rating.
If Brewer Corporation's bonds are currently yielding 8% in the marketplace, why is the firm's cost of debt lower?
A. Additional debt can be issued more cheaply than the original debt.
B. Market interest rates have increased.
C. There should be no difference; cost of debt is the same as the bonds' market yield.
D. Interest is deductible for tax purposes.
A call provision
A. protects investors against margin calls.

B. allows bondholders to require the organization to retire the bond before original maturity.
C. provides an organization flexibility in financing if interest rates fall.
D. lowers the investors' required rate of return.
A stockholder owns 10 shares of Shudo Corporation common stock at a current market price of $10 per share. The
corporation will allow each shareholder to buy proportional new shares of stock at $9 per share. Currently, there are
5,000 shares outstanding and 500 new shares will be issued. What is the value of one right (rounded to the nearest
cent)?
A. $.09.
B. $.91.
C. $9.09.
D. $10.00.
(c) HOCK international, page 1

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D. $10.00.
An analyst is in the process of determining what the current share price should be for PaperToy Inc. In early January,
the analyst collected the following information on PaperToy Inc.
Dividend at end of current year = $1.00
Yearly dividend increase = 5%
Expected investor return = 10%
Based on the data provided, the current share price for PaperToy Inc. should be
A. $6.67.
B. $21.00.
C. $20.00.
D. $7.00.
The equity section of Allen Corporation's statement of financial position is presented as follows.
Preferred stock ($100 par value) $ 8,000,000
Common stock ($5 par value) 5,000,000
Paid-in capital in excess of par 12,000,000
Retained earnings 6,000,000
Net worth $31,000,000
The common shareholders of Allen Corporation have preemptive rights. If Allen Corporation issues 200,000 additional
shares of common stock at $6 per share, a current holder of 10,000 shares of Allen Corporation's common stock must
be given the option to buy
A. 2,400 additional shares.

B. 500 additional shares.
C. 1,667 additional shares.
D. 2,000 additional shares.
Gleason Industries is about to issue $3 million of bonds with a coupon rate of 8%. As inflation is causing interest rates
to rise above 8%:
A. The bonds will sell at a discount as the required rate of return devalues the bonds.
B. The bonds will sell at a premium to compensate investors for the low stated rate.
C. The value of the bonds will be greater than their face value.
D. The face value of the bonds will decline.
Frasier Products has been growing at a rate(c)

of HOCK international,
10% per pagethis
year and expects 2 growth to continue and produce earnings
per share of $4.00 next year. The firm has a dividend payout ratio of 35% and a beta value of 1.25. If the risk-free rate
is 7% and the return on the market is 15%, what is the expected current market value of Frasier's common stock?
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Frasier Products has been growing at a rate of 10% per year and expects this growth to continue and produce earnings
per share of $4.00 next year. The firm has a dividend payout ratio of 35% and a beta value of 1.25. If the risk-free rate
is 7% and the return on the market is 15%, what is the expected current market value of Frasier's common stock?
A. $16.00.
B. $20.00.
C. $28.00.
D. $14.00.
Question 10 - CIA 593 IV.56 - L-T Financial Management-Financial Instruments
Which of the following scenarios would encourage a company to use short-term loans to retire its 10-year bonds that
have 5 years until maturity?
A. The company is experiencing cash flow problems.

B. Interest rates have declined over the last 5 years.
C. The company expects interest rates to increase over the next 5 years.
D. Interest rates have increased over the last 5 years.
Wilton Corporation has 5,000 shares of 6% cumulative, $100 par value, preferred stock outstanding and 175,000
shares of common stock outstanding. No dividends have been paid by the company since May 31, year 2. For the year
ended May 31, year 4, Wilton had net income of $1,450,000 and wishes to pay common shareholders a dividend
equivalent to 25% of net income. The total amount of dividends to be paid by Wilton Corporation at May 31, year 4 is:
A. $392,500.
B. $422,500.
C. $407,500.
D. $362,500.
A company's stock trades rights-on for $50.00 and ex-rights for $48.00. The subscription price for rights holders is
$40.00, and four rights are required to purchased one share of stock.
The value of a right while the stock is still trading rights-on is
A. $0.40
B. $0.50
C. $2.00
D. $1.60
A downward-sloping yield curve depicting the term structure of interest rates implies that:
A. Prevailing short-term interest rates are lower than prevailing long-term interest rates.
B. Prevailing short-term interest rates are higher than prevailing long-term interest rates.
C. Interest rates have increased over recent years.
D. Interest rates have declined over recent years.
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A downward-sloping yield curve depicting the term structure of interest rates implies that:
A. Prevailing short-term interest rates are lower than prevailing long-term interest rates.
B. Prevailing short-term interest rates are higher than prevailing long-term interest rates.
C. Interest rates have increased over recent years.
D. Interest rates have declined over recent years.
Question 14 - HOCK CFMQ8 - L-T Financial Management-Financial Instruments
Preferred stock with a par value of $100 pays an annual dividend of 5%. If investors require a 3.75% rate of return,
what is the price of the preferred stock?
A. $100.00
B. $103.75
C. $133.33
D. $98.75
The best reason corporations issue Eurobonds rather than domestic bonds is that:
A. These bonds are normally a less expensive form of financing because of the absence of government regulation.
B. These bonds are denominated in the currency of the country in which they are issued.
C. Eurobonds carry no foreign exchange risk.
D. Foreign buyers more readily accept the issues of both large and small U.S. corporations than do domestic investors.
Which of the following is directly applied in determining the value of a stock when using the dividend growth model?
A. The firm's liquidity.

B. The firm's capital structure.
C. The investors' required rate of return on the firm's stock.
D. The firm's cash flows.
If a $1,000 bond sells for $1,125, 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 V.
B. I and IV.
C. II and IV.
D. II and V.
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V. The bond sells at a discount.
A. I and V.
B. I and IV.
C. II and IV.
D. II and V.
What variable is measured on the horizontal axis of the yield curve?
A. Par value of the bonds.

B. Duration of the bonds.
C. Yield of the bonds.
D. Years to maturity of the bonds.
Which one of the following statements is correct regarding the effect preferred stock has on a company?
A. Control of the firm is now shared by the common and preferred shareholders, with preferred shareholders having
greater control.
B. The firm's after-tax profits are shared equally by common and preferred shareholders.
C. Preferred shareholders' claims take precedence over the claims of common shareholders in the event of liquidation.
D. Nonpayment of preferred dividends places the firm in default, as does nonpayment of interest on debt.
Which one of the following best describes the record date as it pertains to common stock?
A. The date that is chosen to determine the ownership of shares.

B. Four business days prior to the payment of a dividend.
C. The date on which a prospectus is declared effective by the Securities and Exchange Commission.
D. The 52-week high for a stock published in the Wall Street Journal.
Which one of the following statements is correct when comparing bond financing alternatives?
A. A convertible bond must be converted to common stock prior to its maturity.

B. A call premium requires the investor to pay an amount greater than par at the time of purchase.
C. A call provision is generally considered detrimental to the investor.
D. A bond with a call provision typically has a lower yield to maturity than a similar bond without a call provision.

All of the following are characteristics of preferred stock except that
A. it may be callable at the option of the corporation.

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All of the following are characteristics of preferred stock except that
A. it may be callable at the option of the corporation.

B. it usually has no voting rights.
C. it may be converted into common stock.
D. its dividends are tax deductible to the issuer.
Morton Starley Investment Banking is working with the management of Kell Inc. in order to take the company public in
an initial public offering. Selected information for the year just ended for Kell is as follows.
Long-term debt (8% interest rate) $10,000,000
Common equity:
Common stock, par value $1 per share 3,000,000
Additional paid-in capital 24,000,000
Total assets 55,000,000
Net income 3,750,000
Dividend (annual) 1,500,000
If public companies in Kell’s industry are trading at a market to book ratio of 1.5, what is the estimated value per share
of Kell?
A. $13.50.
B. $27.50.
C. $16.50.
D. $21.50.
A share has a market price of $2.50. It is expected to be able to pay a steady dividend of 30 cents per share each year
starting in one year's time. There will not be any growth in dividends. The stock's beta is 0.8, and the risk-free rate is
3%. The investors' required rate of return on the shares is:
A. 10.2%
B. 12.0%
C. 15%
D. 30%
A call provision in a bond indenture
A. requires the issuer to call in its bonds if interest rates rise above a predetermined level to allow bondholders the
opportunity for higher rates.
B. allows the bondholder the option to buy shares of the company's common stock at a specified price within a
specified period.
C. allows the issuer to call in the bonds before maturity, usually along with payment of an additional sum called a call
premium. (c) HOCK international, page 6
D. permits bondholders to call for additional bond issuances at predetermined intervals.
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specified period.
C. allows the issuer to call in the bonds before maturity, usually along with payment of an additional sum called a call
premium.
D. permits bondholders to call for additional bond issuances at predetermined intervals.
Assume that nominal interest rates just increased substantially but that the expected future dividends for a company
over the long run were not affected. As a result of the increase in nominal interest rates, the company's stock price
should
A. Decrease.
B. Increase.
C. Change, but in no obvious direction.
D. Stay constant.
Bull & Bear Investment Banking is working with the management of Clark Inc. in order to take the company public in an
initial public offering. Selected financial information for Clark is as follows.
Long-term debt (8% interest rate) $10,000,000
Common equity:
Common stock, par value $1 per share 3,000,000
Additional paid-in capital 24,000,000
Total assets 55,000,000
Net income 3,750,000
Dividend (annual) 1,500,000
If public companies in Clark’s industry are trading at twelve times earnings, what is the estimated value per share of
Clark?
A. $12.00.
B. $9.00.
C. $15.00.
D. $24.00.
A major use of warrants in financing is to
A. maintain managerial control.

B. lower the cost of debt.
C. avoid dilution of earnings per share.
D. permit the buy-back of bonds before maturity.
Question 29 - CMA 695 P1 Q13 - L-T Financial Management-Financial Instruments

The equity section of Smith Corporation's statement of financial position is presented below.
Preferred stock, $100 par $12,000,000
Common stock, $5 par 10,000,000
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The equity section of Smith Corporation's statement of financial position is presented below.
Preferred stock, $100 par $12,000,000
Common stock, $5 par 10,000,000
Net worth $49,000,000
The common shareholders of Smith Corporation have preemptive rights. If Smith Corporation issues 400,000
additional shares of common stock at $6 per share, a current holder of 20,000 shares of Smith Corporation's common
stock must be given the option to buy
A. 3,774 additional shares.

B. 1,000 additional shares.
C. 4,000 additional shares.
D. 3,333 additional shares.
A financial manager usually prefers to issue preferred stock rather than debt because
A. The preferred dividend is often cumulative, whereas interest payments are not.
B. The cost of fixed debt is less expensive since it is tax deductible even if a sinking fund is required to retire the debt.
C. In a legal sense, preferred stock is equity; therefore, dividend payments are not legal obligations.
D. Payments to preferred stockholders are not considered fixed payments.
Question 31 - CFM CH19 II.12 - L-T Financial Management-Financial Instruments
The market price of Mulva Corporation's common stock is $60 per share, and each share gives its owner one
subscription right. Four rights are required to purchase an additional share of common stock at the subscription price of
$54 per share.
If Mulva's common stock is currently selling "rights-on," the theoretical value of a right is closest to
A. $1.50
B. $1.20
C. $0.96
D. $6.00
If a firm is to be purchased entirely for cash, which of the following items would the purchaser consider?
I. The incremental future after-tax cash flow from operations

II. Cash paid to the seller's shareholders
III. The present value of the seller's liabilities
A. I, II, and III.

B. I.
C. I and III.
D. I and II. (c) HOCK international, page 8
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B. I.
C. I and III.
D. I and II.
A share has a market price of $2.50. It is expected to be able to pay a steady dividend of 30 cents per share each year
starting in one year's time. There will not be any growth in dividends. Other things being equal, if the expected dividend
goes up to 33 cents:
A. The share price would go down to $2.25.

B. The share price would go up to $2.53.
C. The share price would stay at $2.50.
D. The share price would go up to $2.75.
Question 34 - HOCK LTF 112 - L-T Financial Management-Financial Instruments
The current price of Mutts, Inc. stock is $30 per share, and during the current year, the stock paid a 5% dividend. The
stock’s beta is 1.2. The expected return to the market is 9%; and the risk-free rate is 3%. Mutts, Inc.'s cost of retained
earnings is 10.2%. What should the company’s next year’s dividend be?
A. $2.70 per share

B. $1.545 per share
C. $1.574 per share
D. $1.80 per share
Which one of the following statements concerning debt instruments is correct?
A. A 25-year bond with a coupon rate of 9% and one year to maturity has more interest rate risk than a 10-year bond
with a 9% coupon issued by the same firm with one year to maturity.
B. For long-term bonds, price sensitivity to a given change in interest rates is greater the longer the maturity of the
bond.
C. A bond with one year to maturity would have more interest rate risk than a bond with 15 years to maturity.
D. The coupon rate and yield of an outstanding long-term bond will change over time as economic factors change.
Which one of the following rights is ordinarily sacrificed by the holders of preferred stock in exchange for other
preferences received over common shareholders?
A. The right to accrue dividend payments in arrears when payments are not made for a period of time.
B. The right to vote for members of the board of directors and in other matters requiring a vote.
C. The right to share in the residual assets of the company upon liquidation.
D. The right to share in the periodic earnings of the company through the receipt of dividends.
Below is a partial Statement of Financial Position for Monosone, Inc.:

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Below is a partial Statement of Financial Position for Monosone, Inc.:

Monosone, Inc.
Statement of Financial Position
December 31, Year 1
Total assets $10,000,000
Current liabilities $ 2,000,000
Long-term debt 3,000,000
Common stock (1,000,000 shares authorized,
500,000
100,000 shares outstanding at $5 par value)
Total liabilities and shareholder's equity $10,000,000
Expected dividend payments:
December 31, year 2 $2.00
Expected selling price on:
An investor is considering buying Monosone, Inc.'s common stock on January 1, year 2 and anticipates, with
reasonable assurance, selling it December 31, year 4 at $25.00 per share. What is the approximate intrinsic value on
January 1, year 2 of each share (rounded to the nearest dollar) when the required rate of return is 10%?
A. $31.
B. $30.
C. $24.
D. $19.
If the yield curve on a term structure of interest rates graph is a flat line with no slope, which one of the following
statements is correct?
A. Long-term rates are the same as short-term rates.

B. Long-term rates are higher than short-term rates.
C. The intermediate-term interest rate is lower than the T-bill interest rate.
D. Bank borrowing rates will rise.
Which of the following brings in additional capital to the firm?
A. Exercise of warrants.
B. Conversion of convertible bonds to common stock.
C. Two-for-one stock split.
D. Purchase of option through an option exchange.

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The market value of a share of stock is $50, and the market value of one right prior to the ex-rights date is $2.00 after
the offering is announced but while the stock is still selling rights-on. The offer to the shareholder is that it will take
three rights to buy an additional share of stock at a subscription price of $40 per share. If the theoretical value of the
stock when it goes ex-rights is $47.50, then the shareholder
A. Merely receives a return of capital.

B. Does not receive any additional benefit from a rights offering.
C. Receives an additional benefit from a rights offering.
D. Should redeem the right and purchase the stock before the ex-rights date.
Protective clauses set forth in an indenture are known as
A. provisions.
B. covenants.
C. requirements.
D. addenda.
Many states have laws that provide preemptive rights for shareholders. A preemptive right is when a company must
A. Give existing shareholders stock warrants equal to their proportionate ownership share in the company when issuing
a new public offering.
B. Give dividends to the common shareholders first before giving dividends to the preferred shareholders.
C. Sell shares to existing shareholders equal to their proportionate ownership share in the company when issuing a
new public offering.
D. Give existing shareholders the opportunity to maintain their proportionate ownership share in the company when
issuing a new public offering.
James Hemming, the chief financial officer of a midwestern machine parts manufacturer, is considering splitting the
company’s stock, which is currently selling at $80.00 per share. The stock currently pays a $1.00 per share dividend. If
the split is two-for-one, Mr. Hemming may expect the post split price to be
A. exactly $40.00, regardless of dividend policy.

B. less than $40.00, regardless of dividend policy.
C. greater than $40.00, if the dividend is changed to $0.45 per new share.
D. greater than $40.00, if the dividend is changed to $0.55 per new share.

The par value of a common stock represents
A. the total value of the stock that must be entered in the issuing corporation's records.
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The par value of a common stock represents
A. the total value of the stock that must be entered in the issuing corporation's records.
B. the liability ceiling of a shareholder when a company undergoes bankruptcy proceedings.
C. a theoretical value of $100 per share of stock with any differences entered in the issuing corporation's records as
discount or premium on common stock.
D. the estimated market value of the stock when it was issued.
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. A superior claim to common stock equity in the case of liquidation.

B. Voting rights in corporate elections.
C. No principal repayments.
D. Dividend payments that are not tax deductible by the company.
Serial bonds are attractive to investors because
A. the yield to maturity is the same for all bonds in the issue.
B. all bonds in the issue mature on the same date.
C. the coupon rate on these bonds is adjusted to the maturity date.
D. investors can choose the maturity that suits their financial needs.
The formula for determining the value of one stock right when the price of the stock is rights-on is
(Pon − S)
Ron =
(N + 1)
Where:
Ron = market value of one right when the stock is selling rights-on.
Pon = market value of one share of stock with rights-on.
N = number of rights necessary to purchase one share of stock.
S = subscription price per share.
If the market price of a stock is $50 per share, the subscription price is $40 per share, and three rights are necessary
to buy an additional share of stock, the theoretical market value of one right used to buy the stock prior to the ex-rights
date is
A. $2.00.
B. $40.00.
C. $10.00. (c) HOCK international, page 12
D. $2.50.
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A. $2.00.
B. $40.00.
C. $10.00.
D. $2.50.
In practice, dividends
A. fluctuate more widely than earnings.

B. are usually set as a fixed percentage of earnings.
C. usually exhibit greater stability than earnings.
D. tend to be a lower percentage of earnings for mature firms.
Question 49 - CMA 695 1.8.5 Adapted - L-T Financial Management-Financial Instruments
Below is a Statement of Financial Position for Martin Corporation:

Martin Corporation
Statement of Financial Position
(Dollars in millions)
Assets:
Current Assets $ 75
Plant and Equipment 250
Total Assets $325
Liabilities and shareholders' equity:
Liabilities:
Current Liabilities $ 46
Long-term debt (12%) 64
Common equity:
Common stock, $1 par $ 10
Additional paid in capital 100
Retained earnings 105
Total liabilities and shareholders' equity $325
Additional Data:
The long term debt was originally issued at par ($1,000 per bond) and is currently trading at $1,250 per bond.
Martin Corporation can now issue debt at 150 basis points over U.S. treasury bonds.
The current risk-free rate (U.S. Treasury bonds) is 7%.
The expected market return is currently 15%.
The beta for Martin is 1.25.
Martin's effective corporate income tax rate is 40%.
Martin paid a dividend of $1.00 per share last year.
Martin's dividend is expected to grow at the rate of 5% per year.
What price should Martin's common stock sell for currently?
A. $10.50
B. $6.67
C. $8.75
D. $8.33 (c) HOCK international, page 13
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B. $6.67
C. $8.75
D. $8.33
Dorsy Manufacturing plans to issue mortgage bonds subject to an indenture. Which of the following restrictions or
requirements are likely to be contained in the indenture?
I. Receiving the trustee's permission prior to selling the property.
II. Maintain the property in good operating condition.
III. Insuring plant and equipment at certain minimum levels.
IV. Including a negative pledge clause.
A. I and IV only.
B. II and III only.
C. I, III, and IV only.
D. I, II, III and IV.
A requirement specified in an indenture agreement which states that a company cannot acquire or sell major assets
without prior creditor approval is known as a
A. protective covenant.
B. put option.
C. call provision.
D. warrant.
Which one of the following describes a disadvantage to a firm that issues preferred stock?
A. Preferred stock dividends are legal obligations of the corporation.

B. Preferred stock typically has no maturity date.
C. Most preferred stock is owned by corporate investors.
D. Preferred stock is usually sold on a higher yield basis than bonds.
All of the following may reduce the coupon rate on a bond issued at par except a
A. Sinking fund.
B. Change in rating from Aa to Aaa.
C. Call provision.
D. Conversion option.

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subscription right. Four rights are required to purchase an additional share of common stock at the subscription price of
$54 per share.
What is the theoretical value of one share of Mulva common stock when it goes "ex-rights"?
A. $59.04
B. $58.50
C. $54.00
D. $58.80
Which one of the following is a debt instrument that generally has a maturity of ten years or more?
A. A note.
B. A chattel mortgage.
C. A bond.
D. A financial lease.
A sinking fund for a bond issue is a(n)
A. periodic payment by a debtor to accumulate funds for the retirement of the bonds when they mature.
B. periodic payment by a debtor to pay for the initial issuing costs of the bond issue.
C. periodic payment by a debtor to pay the annual interest costs prescribed by the bond issue.
D. alternative to traditional long-term debt financing.
The common stock of a beverage company has a current market price of $34. The beverage company is estimated to
earn $2 per share in the next year. The average price/earnings ratio of companies in the beverage industry is 15. Using
the price/earnings ratio as the comparable valuation method, the beverage company’s stock is
A. $2 undervalued.
B. $4 overvalued.
C. $2 overvalued.
D. $4 undervalued.
Vega Inc. needs to raise $50,000,000 for expansion. The two available options are to sell 7%, 10-year bonds at face
value or to sell 5% preferred stock at par for which annual dividends would be paid. Vega’s effective income tax rate is
(c) HOCK
30%. Which one of the following best describes international,
the difference page
in Vega’s 15 flow for the second year after issue?
cash
A. Cash flow with the stock issue is $525,000 higher.

B. Cash flow with the stock issue is $700,000 higher.
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Vega Inc. needs to raise $50,000,000 for expansion. The two available options are to sell 7%, 10-year bonds at face
value or to sell 5% preferred stock at par for which annual dividends would be paid. Vega’s effective income tax rate is
30%. Which one of the following best describes the difference in Vega’s cash flow for the second year after issue?
A. Cash flow with the stock issue is $525,000 higher.

B. Cash flow with the stock issue is $700,000 higher.
C. Cash flow with the bond issue is $50,000 higher.
D. Cash flow with the bond issue is $225,000 higher.
A company's stock was trading rights-on for $50.00, and when it went ex-rights the market price was $48.00. The
subscription price for rights holders is $40.00, and four rights are required to purchase one share of stock.
The value of a right when the stock was trading ex-rights was
A. $0.50
B. $2.00
C. $2.50
D. $0.40
The maximum acquisition value of an inefficiently run corporation is the discounted net present value of the
A. Current market value of the firm.

B. Current earnings before interest and taxes (EBIT).
C. Current net profits.
D. Expected future cash flow.
The price of Investors, Inc. stock is $31.25, and its beta is 1.2. The stock’s next annual dividend will be $1.25, and
dividends are expected to grow at the rate of 5% per year. The risk-free rate is 3%. What is the expected return to the
market?
A. 8.17%
B. 8.00%
C. 9.00%
D. 10.20%
The call provision in some bond indentures allows
A. the bondholder to exchange the bond, at no additional cost, for common shares.
B. the bondholder to redeem the bond early by paying a call premium.
C. the issuer to pay a premium in order to prevent bondholders from redeeming bonds.
(c)the
D. the issuer to exercise an option to redeem HOCK international, page 16
bonds.
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B. the bondholder to redeem the bond early by paying a call premium.

C. the issuer to pay a premium in order to prevent bondholders from redeeming bonds.
D. the issuer to exercise an option to redeem the bonds.
The best advantage of a zero-coupon bond to the issuer is that the
A. Bond requires no interest income calculation to the holder or issuer until maturity.
B. Interest can be amortized annually by the APR method and need not be shown as an interest expense to the issuer.
C. Bond requires a low issuance cost.
D. Interest can be amortized annually on a straight-line basis but is a non-cash outlay.
Preferred stock may be retired through the use of any one of the following except a
A. conversion.
B. sinking fund.
C. call provision.
D. refunding.
Which one of the following characteristics distinguishes income bonds from other bonds?
A. Income bonds pay interest only if the issuing company has earned the interest.
B. By promising a return to the bondholder, an income bond is junior to preferred and common stock.
C. The bondholder is guaranteed an income over the life of the security.
D. Income bonds are junior to subordinated debt but senior to preferred and common stock.
Question 66 - CFM Sample Q. 10 - L-T Financial Management-Financial Instruments
Rogers Inc. operates a chain of restaurants located in the Southeast. The company has steadily grown to its present
size of 48 restaurants. The board of directors recently approved a large-scale remodeling of the restaurant, and the
company is now considering two financing alternatives.
The first alternative would consist of

Bonds that would have a 9% effective annual rate and would net $19.2 million after flotation costs
Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4% flotation cost
Common stock that would yield $24 million after a 5% flotation cost
The second alternative would consist of a public offering of bonds that would have an 11% effective annual rate and
would net $48 million after flotation costs.
Rogers' current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred stock,
and 50% common stock. The current market value of the common stock is $30 per share, and the common stock
dividend during the past 12 months was $3(c) perHOCK
share.international, page 17 the growth rate of dividends to equal the
Investors are expecting
historical rate of 6%. Rogers is subject to an effective income tax rate of 40%.
The interest rate on the bonds is greater for the second alternative consisting of pure debt than it is for the first
alternative consisting of both debt and equity because
Part 2 : 01/14/19 11:24:21
Rogers' current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred stock,
and 50% common stock. The current market value of the common stock is $30 per share, and the common stock
dividend during the past 12 months was $3 per share. Investors are expecting the growth rate of dividends to equal the
historical rate of 6%. Rogers is subject to an effective income tax rate of 40%.
The interest rate on the bonds is greater for the second alternative consisting of pure debt than it is for the first
alternative consisting of both debt and equity because
A. The pure debt alternative would flood the market and be more difficult to sell.
B. The diversity of the combination alternative creates greater risk for the investor.
C. The pure debt alternative carries the risk of increasing the probability of default.
D. The combination alternative carries the risk of increasing dividend payments.
A publicly-traded corporation in an industry with an average price/earnings ratio of 20 has the following summary
financial results.
Sales $1,000,000
Expenses 500,000
Operating income $ 500,000
Taxes 300,000
Net income $ 200,000
Assets $2,500,000
Liabilities $1,000,000
Shareholders' equity$1,500,000
A competitor wishes to make a bid to acquire the stock of the company. What is the current market value?
A. $1,500,000.
B. $10,000,000.
C. $20,000,000.
D. $4,000,000.
Question 68 - HOCK CMA P2 SDV4 - L-T Financial Management-Financial Instruments
New Company's sales and profits are growing rapidly, and so is its dividend. Its dividend is growing at an annual rate of
25%. This growth in the dividend is expected to continue for two years. After that, the rate of growth is expected to slow
down to 10% per year. The investors' required rate of return on the stock is 16%. The next annual dividend is expected
to be $1.00. The beta of New Company's stock is 1.5. The U.S. Treasury bill rate is 4%.
What is an appropriate market price for New Company's stock?
A. $13.80
B. $23.00
C. $18.88
D. $4.00
Debentures are
A. a form of lease financing similar to equipment trust certificates.
B. subordinated debt and rank behind convertible bonds.
C. bonds secured by the full faith and credit of the issuing firm.
Part 2 : 01/14/19 11:24:21
Debentures are
A. a form of lease financing similar to equipment trust certificates.

B. subordinated debt and rank behind convertible bonds.
C. bonds secured by the full faith and credit of the issuing firm.
D. income bonds that require interest payments only when earnings permit.
A share has a market price of $50.00. It is expected to be able to pay a steady dividend of $2.50 per share each year
starting in one year's time. There will not be any growth in the dividend. If the investors' required rate of return changes
to 8%, the effect would be
A. the dividend would increase to $4.00.

B. the share price will go up to $62.50.
C. the share price will go down to $31.25.
D. there will be no change in either the dividend or the share price.
A.
Short-term rates are related to long-term rates, although that relationship can change from time to time. Term Structure
of Interest Rates graphs describe the various relationships that can exist at any given time between short-term rates
and long-term rates. The yield curve can be upsloping, downsloping, flat, or humped.
Yield curve theories attempt to explain the slopes of the yield curves.
1. The Pure Expectations Theory states that the shape of the yield curve is determined exclusively by expectations
in the market of future interest rates.
2. Liquidity Preference Theory says that if investors increase their risk by holding long-term bonds, they will require
higher compensation in the form of a higher interest rate for assuming that increased risk.
3. The Segmented Markets Theory focuses on cash needs of different groups of investors and borrowers and
maintains that each group chooses securities that meet its forecasted cash needs.
4. The Preferred Habitat Theory is a compromise. It agrees with the Segmented Markets Theory in saying that
investors and borrowers normally concentrate on a particular maturity market. However, it also recognizes, in
agreement with the Pure Expectations Theory, that expectations about future interest rate movements can
cause investors and borrowers to leave their preferred maturity markets for other maturity markets.
B. Usually short-term interest rates are lower than long-term interest rates. This is due partially to the fact that
there is less risk in a short term situation because there is less time for something to happen that would
prevent the repayment of whatever amount was financed.
C. There is less risk in a short term situation because there is less time for something to happen that would prevent the
repayment of whatever amount was financed. Interest rates incorporate the amount of repayment risk that the investor
perceives. The higher the risk, the higher the rate. Therefore, short-term rates would not usually be higher than
long-term rates.
D. During a period of high inflation, short-term interest rates are probably going to be higher than long-term interest
rates.
(c) Management-Financial
Question 2 - ICMA 10.P2.111 - L-T Financial HOCK international, page 19
Instruments
A.
Part 2 : 01/14/19 11:24:21
A.
Short-term rates are related to long-term rates, although that relationship can change from time to time. Term Structure
of Interest Rates graphs describe the various relationships that can exist at any given time between short-term rates
and long-term rates. The yield curve can be upsloping, downsloping, flat, or humped.
Yield curve theories attempt to explain the slopes of the yield curves.
1. The Pure Expectations Theory states that the shape of the yield curve is determined exclusively by expectations
in the market of future interest rates.
2. Liquidity Preference Theory says that if investors increase their risk by holding long-term bonds, they will require
higher compensation in the form of a higher interest rate for assuming that increased risk.
3. The Segmented Markets Theory focuses on cash needs of different groups of investors and borrowers and
maintains that each group chooses securities that meet its forecasted cash needs.
4. The Preferred Habitat Theory is a compromise. It agrees with the Segmented Markets Theory in saying that
investors and borrowers normally concentrate on a particular maturity market. However, it also recognizes, in
agreement with the Pure Expectations Theory, that expectations about future interest rate movements can
cause investors and borrowers to leave their preferred maturity markets for other maturity markets.
B. Usually short-term interest rates are lower than long-term interest rates. This is due partially to the fact that
there is less risk in a short term situation because there is less time for something to happen that would
prevent the repayment of whatever amount was financed.
C. There is less risk in a short term situation because there is less time for something to happen that would prevent the
repayment of whatever amount was financed. Interest rates incorporate the amount of repayment risk that the investor
perceives. The higher the risk, the higher the rate. Therefore, short-term rates would not usually be higher than
long-term rates.
D. During a period of high inflation, short-term interest rates are probably going to be higher than long-term interest
rates.
A.
Interest rate risk is the risk that the value of the investment will change over time as a result of changes in the
market rate of interest. The duration of a fixed income security measures how vulnerable the market value of
the security is to future changes in market interest rates. When market interest rates increase, market values
of fixed income securities decrease. And when market interest rates decrease, market values of fixed income
securities increase.
But not all fixed income securities vary in value by the same extent. How much an individual fixed income
security will vary in value with changes in interest rates depends upon its duration. As the duration increases,
the volatility of the price of the debt instrument increases. The longer the time to wait until a future payment is
received, the greater will be the effect of a change in the rate of interest on the present value of the payment.
So the market value of short-term securities such as money market financial instruments will be only slightly
affected, if at all, by changes in the market interest rate. But the market value of a long-term corporate bond
with several years to maturity will be significantly affected by market interest rate changes.
B. The yield to maturity of a bond is its effective annual yield, including the amortization of any premium or discount, if
the bond is held until it matures. It does not provide any measure of interest rate risk for a corporate bond.
C. The maturity date of a fixed income security is the date it matures and the date the issuer of the security must repay
(c) HOCK
the full amount of the principal plus any accrued international,
and unpaid page
interest to the 20
investors. The length of time to the
security's maturity date is a factor in measuring the amount of interest rate risk for a corporate bond, but it is not the
only factor. The lengths of time to the scheduled payments of interest prior to its maturity are also important.
D. Interest rate risk is the risk that the value of the investment will change over time as a result of changes in the
Part 2 : 01/14/19 11:24:21
C. The maturity date of a fixed income security is the date it matures and the date the issuer of the security must repay
the full amount of the principal plus any accrued and unpaid interest to the investors. The length of time to the
security's maturity date is a factor in measuring the amount of interest rate risk for a corporate bond, but it is not the
only factor. The lengths of time to the scheduled payments of interest prior to its maturity are also important.
D. Interest rate risk is the risk that the value of the investment will change over time as a result of changes in the
market rate of interest. A bond's rating assigned by the rating agencies does not provide a measure of its interest rate
risk. A bond's rating provides a means to judge the security's credit, or default, risk.
A. Additional debt may or may not be issued more cheaply than earlier debt, depending upon the interest rates in the
market place.
B. A firm's cost of debt is equal to the market yield rate reduced for the tax deductibility of interest. The tax deductibility
of interest always causes the market yield rate to be higher than the firm's cost of debt capital.
C. A firm's cost of debt is equal to the market yield rate reduced for the tax deductibility of interest. The tax deductibility
of interest always causes the market yield rate to be higher than the firm's cost of debt capital.
D.
A firm's cost of debt is equal to the market yield rate reduced for the tax deductibility of interest. The tax
deductibility of interest always causes the market yield rate to be higher than the firm's cost of debt capital.
The cost of debt capital is the net effect of the market yield rate and the offsetting tax deduction. The actual
cost of debt equals the market yield rate times (1 − the marginal tax rate). Thus, if a firm with an 8% market
yield rate is in a 40% tax bracket, the net cost of the debt capital is 4.8% [8% x (1 − 0.4)].
A. A margin call is related to the purchase of shares on margin, not the call provision of a bond.
B. A call provision gives the issuer, not the bondholder, the option of retiring the bond before its maturity date.
C. A call provision gives the issuer the right to retire (pay off) the bonds before the original maturity date. This
is good for the company because if interest rates fall and there are cheaper sources of financing available,
they can call the older, more expensive bonds and obtain cheaper sources of financing.
D. If anything, a call provision will cause the investor to require a higher rate of return to compensate for the risk that
the bond will be called before its maturity date.
A.
In order to solve this question, we need to determine the value of the right when it is selling rights-on. This is
done using the following formula:
Po − Pn
Vr =
r+1
Where:
Part 2 : 01/14/19 11:24:21
Vr =
r+1
Where:
Po = The value of a share with the rights still attached

Pn = The subscription (sales) price of a share
r = The number of rights needed to buy a new share
Vr = The value of the right
Since 5,000 shares are outstanding and 500 new shares will be issued, 10 shares will be required to buy a new
share (5,000 ÷ 500).
Putting the values into the formula, we calculate that the value of one right is
10 − 9
Vr = = 0.0909
10 + 1
B. This is the value of the 10 rights that will be required to purchase a new share of stock.
C. This answer results from incorrectly interpreting the calculated answer. See the correct answer for a complete
explanation.
D. This is simply the current market price of the share of stock.
A. This is $1.00 divided by 0.15. This is an incorrect use of the dividend growth model. The denominator used should
be the investors' required rate of return (r, or 0.10) minus the expected growth rate of the dividend (g, or 0.05). This
answer uses r + g instead of r − g in the denominator.
B. This answer results from increasing the dividend at the end of the current year by 5% for use in the dividend growth
model. Note that the analysis is taking place in early January, and the $1.00 dividend is to be paid at the end of the
current year. Therefore, $1.00 is the next annual dividend to be paid. It should not be increased by 5% for the
purposes of this calculation.
C.
The dividend growth model should be used to calculate the fair value of the stock. The dividend growth model
is:
d1
P0 =
r−g
Where: P0 = the fair value today of a share of stock;
d1 = the next annual dividend to be paid;
r = the investors' required rate of return; and
g = the expected growth rate of the dividend.
The next annual dividend to be paid (d1) is the $1.00 dividend at the end of the current year. Note that the
analysis is taking place in early January, and the $1.00 dividend is to be paid at the end of the current year.
Therefore, $1.00 is the next annual dividend to be paid. It should not be increased by 5% for the purposes of
this calculation.
The investors' required rate of return (r) is 10% or 0.10.

The expected growth rate of the dividend (g) is 5% or 0.05.
Therefore,
$1.00
Part 2 : 01/14/19 11:24:21
The investors' required rate of return (r) is 10% or 0.10.
The expected growth rate of the dividend (g) is 5% or 0.05.
Therefore,
$1.00
P0 =
0.10 − 0.05
P0 = $20
D.
This is $1.05 divided by 0.15. This is an incorrect use of the dividend growth model for two reasons:
(1) The analysis is taking place in early January, and the $1.00 dividend is to be paid at the end of the current year.
Therefore, $1.00 is the next annual dividend to be paid, and that should be the numerator in the model. It should
not be increased by 5% for the purposes of this calculation.
(2) The denominator used should be the investors' required rate of return (r, or 0.10) minus the expected growth rate
of the dividend (g, or 0.05). This answer uses r + g instead of r − g in the denominator.
A.
This is not the correct answer. Please see the correct answer for an explanation.
We have been unable to determine how to calculate this incorrect answer choice. If you have calculated it, please let
us know how you did it so we can create a full explanation of why this answer choice is incorrect. Please send us an
email at support@hockinternational.com. Include the full Question ID number and the actual incorrect answer choice --
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B.
This answer results from dividing the 10,000 shares owned by the shareholder by the 200,000 new shares to be issued
and multiplying the result by the 10,000 shares owned by the shareholder. The shareholder should be given the option
to buy the same proportion of the new shares to be issued as he holds of the total number of common shares presently
outstanding. Therefore, the divisor in the calculation needs to be the number of common shares presently outstanding,
not the number of new shares to be issued. Furthermore, the result needs to be multiplied by the number of new
shares to be issued, not by the number of shares currently owned by the shareholder.
C. This answer results from dividing retained earnings by the par value per share to calculate the number of common
shares outstanding before the new issue of stock. The number of common shares outstanding is the amount on the
common stock line divided by the par value per share.
D. Preemptive rights allow the existing shareholders to purchase the same percentage of a new issuance that
they owned of the outstanding shares prior to the issuance. Before the new issue of stock, there were
1,000,000 common shares outstanding ($5,000,000 divided by $5 par value per share). This shareholder held
1% of the outstanding shares (10,000 shares divided by 1,000,000 shares) before the issuance, so they have
the right to purchase 1%, or 2,000 shares, of the new issue.
A. Because the bonds will have an interest rate that is lower than the market rate, the bond will need to sell at
a discount so that the effective interest rate is equal to the higher market interest rate.
B. Because the bonds will have an interest rate that is lower than the market rate, the bond will need to sell at a
discount so that the effective interest rate is equal to the higher market interest rate. When they sell at a premium, the
selling price is higher than the face amount.
Part 2 : 01/14/19 11:24:21
a discount so that the effective interest rate is equal to the higher market interest rate.
B. Because the bonds will have an interest rate that is lower than the market rate, the bond will need to sell at a
discount so that the effective interest rate is equal to the higher market interest rate. When they sell at a premium, the
selling price is higher than the face amount.
C. Because the bonds will have an interest rate that is lower than the market rate, the bond will need to sell at a
discount so that the effective interest rate is equal to the higher market interest rate. The sales price is the value of the
bond and the sales price will be less than the face amount of the bond.
D. The face value of the bonds will not change, no matter what the market rate of interest is or no matter what inflation
is. The face value is set and determined and does not change.
A. This answer could result from using 10% minus the beta coefficient in the denominator of the Dividend Growth
Model. However, the denominator of the Dividend Growth Model is r − g, where r = the investors' required rate of return
and g = the growth rate.
B.
This requires the use of both the Capital Asset Pricing Model and the Dividend Growth Model. First, we use
the CAPM to find the investors' required rate of return:
r = rF + β(rM − rF)
Where:
rF = the risk-free rate
rM = the market rate of return
β = the stock's beta coefficient
Plugging the numbers into the formula, we have:
r = 0.07 + 1.25(0.15 − 0.07) = 0.17
Next, we take the investors' required rate of return and use it as the r in the Dividend Growth Model, stated to
solve for P0, to find the expected current market value of a share of stock:
d1
P0 =
r−g
Where:
P0 = the fair value today of a share of stock
d1 = the next annual dividend to be paid
r = the investors' required rate of return
g = the expected growth rate of the dividend
Earnings per share next year are expected to be $4, and the dividend payout ratio is 0.35. Therefore, the next
dividend will be $4 × 0.35, or $1.40.
Plugging these numbers into the Dividend Growth Model, we get
P0 = $1.40 / (0.17 − 0.10) = $20
C. This answer results from using the return on the market minus the growth rate in the denominator of the Dividend
Growth Model. However, the denominator of (c)the
HOCK international,
Dividend pageis24
Growth Model r − g, where r = the investors' required rate
of return and g = the growth rate.
D. This answer results from using just the growth rate in the denominator of the Dividend Growth Model. However, the
Part 2 : 01/14/19 11:24:21
C. This answer results from using the return on the market minus the growth rate in the denominator of the Dividend
Growth Model. However, the denominator of the Dividend Growth Model is r − g, where r = the investors' required rate
of return and g = the growth rate.
D. This answer results from using just the growth rate in the denominator of the Dividend Growth Model. However, the
denominator of the Dividend Growth Model is r − g, where r = the investors' required rate of return and g = the growth
rate.
A. If the company switches to short-term loans, they will essentially have to retire the bonds early as the loans become
due. If they are having cash flow problems, this will make those problems worse by increasing the short-term cash
outflows that will be required.
B. If interest rates have declined since the bonds were issued, the company can take out new financing at a
lower rate of interest and use the money from the new financing to retire the original, more expensive debt.
This will lower their cost of interest for the next five years.
C. If short-term rates will rise in the future, the company will not benefit by switching to short-term loans, for which the
rate will go up in future periods.
D. If interest rates have increases in the past five years the company is better off keeping the bonds that they have
issued because the interest rate on the bonds is lower than what the interest rate on the new loans would be.
A. This answer includes only 1 year of the cumulative preferred dividend. Because the cumulative preferred dividend
was not declared in the previous year, the calculation needs to include 2 years of cumulative preferred dividends.
B. Total dividends include the dividends on both common shares and preferred shares. The common stock
dividends were $1,450,000 × 25% = $362,500. As the cumulative preferred dividends must be paid before the
common dividends are paid, they are also included into computation. Since the cumulative preferred
dividends were not paid or declared in the previous period, two years worth of cumulative preferred dividends
must be paid in the current period before any common dividends can be paid. The amount due for the
cumulative preferred dividend is: 5,000 shares × $100 par value × 6% × 2 years = $60,000. So, the total
dividends to be paid are $362,500 + $60,000 = $422,500.
C.
This answer results from subtracting the preferred dividend to be paid ($60,000) from net income before calculating the
amount of the common dividend to be paid. The problem says that the company wishes to pay common shareholders
a dividend equivalent to 25% of net income, not 25% of net income reduced by the dividend to be paid to preferred
shareholders.
Note that net income minus the cumulative preferred dividend paid is not income available to common shareholders.
When there is cumulative preferred stock, income available to common shareholders is calculated by subtracting from
net income the cumulative preferred dividends earned, whether or not those dividends were paid. Furthermore, even if
net income minus the cumulative preferred dividends paid were the correct way to calculate income available to
common shareholders, income available to common shareholders is used only for calculating earnings per share, not
for calculating the amount to pay to common shareholders as a dividend.
D. This is the amount of the common stock dividend and excludes the preferred stock dividend. See the correct
answer for a complete explanation.

Part 2 : 01/14/19 11:24:21
answer for a complete explanation.
A. This is the rights on value of the right if the subscription price is $48. See the correct answer for a complete
explanation.
B. This is the ex-rights value of the right if the subscription price is $48. See the correct answer for a complete
explanation.
C. In order to solve this question, we need to determine the value of the right when it is selling rights-on. This
is done using the following formula: Vr=Po - Pn / (r + 1) Solving for this equation, we get ($50 - $40) / (4 + 1) =
$2.00.
D. This is the rights on value of the right if the subscription price is $40 and the value of the share with the right is $48.
See the correct answer for a complete explanation.
A. If the yield curve slopes downward, that indicates that the expected long-term interest rates are lower, not higher,
than the current interest rates.
B. If the yield curve slopes downward, that indicates that the expected long-term interest rates are lower than
the current interest rates.
C. Past interest rates are not included in the yield curve. See the correct answer for a complete explanation.
D. Past interest rates are not included in the yield curve. See the correct answer for a complete explanation.
A. This is the par value of the stock.
B. This is the par value of the stock plus the investors' required rate of return.
C. If the preferred stock pays a 5% annual dividend on the par value of $100, the annual dividend will be $100 ×
0.05, or $5. If investors require a 3.75% rate of return, we use the perpetual annuity model and divide the
annual dividend of $5 by the required rate of return to calculate the market value of the stock. $5 ÷ 0.0375 =
$133.33.
D. If the investors' required rate of return is lower than the rate of return based on the par value, the price of the
preferred stock will be above its par value, not below.
A. Eurobonds are bonds that are issued in a currency other than the currency of the country in which they are
sold. Since Eurobonds are outside the direct control of the U.S. monetary authorities, they often have lower
costs than domestic bonds because the cost of regulatory compliance is lower.
B. Eurobonds are not denominated in the currency of the country in which they are issued.
C. Eurobonds, and any other item denominated in a foreign currency, carry foreign exchange risk.
Part 2 : 01/14/19 11:24:21
sold. Since Eurobonds are outside the direct control of the U.S. monetary authorities, they often have lower
costs than domestic bonds because the cost of regulatory compliance is lower.
B. Eurobonds are not denominated in the currency of the country in which they are issued.
C. Eurobonds, and any other item denominated in a foreign currency, carry foreign exchange risk.
D. While this statement may be true in respect to large, well known companies, individuals are hesitant to buy bonds of
companies that they do not know. Therefore, it may be hard for a small company to issue bonds in a country other than
the one in which it operates.
A.
The firm's liquidity is not used in determining the value of a stock when using the dividend growth model. The formula
for the dividend growth model is:
C = (D1 / P0) + G
When restated to determine the value of a stock, the formula is:
P0 = D1 / (C − G)
B.
The firm's capital structure is not used in determining the value of a stock when using the dividend growth model. The
formula for the dividend growth model is:
C = (D1 / P0) + G
P0 = D1 / (C − G)
C.
The dividend growth model is used to calculate the cost of retained earnings (investors' required rate of
return). The simplified formula is
C = (D1 / P0) + G
where C is the investors' required rate of return, D1 is the next dividend, P0 is the stock's price, and G is the
growth rate in dividends.
The model can be restated and used to determine the stock price when the next year's dividend, the investors'
rate of return (cost of retained earnings) and the growth rate in dividends are known. The restated formula is
P0 = D1 / (C − G)
D.
The firm's cash flow is not used in determining the value of a stock when using the dividend growth model. The formula
for the dividend growth model is:
C = (D1 / P0) + G
When restated to determine the value of a (c) HOCK

stock, international,
the formula is: page 27
P0 = D1 / (C − G)
Part 2 : 01/14/19 11:24:21
C = (D1 / P0) + G
P0 = D1 / (C − G)
A. This bond sells at a premium, not a discount. When a bond sells at a premium (a price higher than the face value)
the market rate of interest is lower than the stated rate of interest.
B. When a bond sells at a premium (a price higher than the face value) the market rate of interest is lower than the
stated rate of interest.
C. The bond sold at a premium because its price was higher than its face value. Since the bond sold at a
premium, we know that the market rate of interest was lower than the stated rate (coupon rate) on the bond.
D. When the market price is higher than the face value, the bond sells at a premium, not a discount.
A. The par value of an individual bond is its stated amount or its face value. The par value of bonds is not represented
graphically on a yield curve graph.
B. The duration of an individual fixed income security is a weighted average of the times until the receipt of both
interest and principal, weighted according to the proportion of the total present value of the bond represented by the
present value of each cash flow to be received. Duration is not represented graphically on a yield curve graph.
C. The yield curve shows the market rates for various maturities of bonds on a given date. The market rates, or the
yields, are on the vertical axis, not the horizontal axis.
D. The yield curve shows the market rates for various maturities of bonds on a given date. The years to
maturity of the bonds are on the horizontal axis and the market rates are on the vertical axis.
A. Preferred shareholders generally are unable to vote so preferred shareholders have less control over the company
than common shareholders, who get to vote.
B. The after-tax profits do not need to be shared equally between the preferred and common shareholders.
C. In the event of a liquidation, the claims of preferred shareholders do have priority over the claims of
common shareholders.
D. The nonpayment of interest puts the company in default, but the nonpayment of interest does not put the company
into default.

A. The record date is the eligibility date for common shareholders to receive a declared dividend. A
shareholder who owns this stock on the record date will receive the dividend on those shares.
Part 2 : 01/14/19 11:24:21
A. The record date is the eligibility date for common shareholders to receive a declared dividend. A
shareholder who owns this stock on the record date will receive the dividend on those shares.
B. There is no firm rule as to the number of days between the record date and the payment date.
C. The record date refers to the issuance of dividends and who is entitled to them. It does not relate to the prospectus.
D. The record date refers to the issuance of dividends and those shareholders who will receive a dividend, not the
stock price itself.
A. Convertible bonds may be converted to shares before their maturity, but it is not required that they be converted.
B. The call premium is connected to the calling of the bonds by the issuer, not the sale of the bonds. The call premium
is the amount of the premium that the issuer must pay to call the bonds.
C. A call provision is usually considered detrimental to the investor because the company can call the bonds if
a cheaper source of financing becomes available. If a cheaper source is available for the company, it is
unlikely that the bondholder will be able to find an investment opportunity that pays the same rate as the
bonds did.
D. Because the call provision is considered to be detrimental to the bondholders, they will require a slightly higher rate
of return on callable bonds, not a lower rate of return.
A. Preferred stock may have a call provision which allows the corporation to repurchase the shares at a specific price
or at a specified time. The terms of a given issue of preferred stock are stated in a document called the "Certificate of
Designation."
B. Preferred stockholders typically do not have voting rights.
C. Preferred stock may have a provision that allows the holders to convert the preferred stock to common stock at their
option. Shareholders may choose to do this in order to have voting privileges or to take advantage of future increase in
the common stock price. The terms of a given issue of preferred stock are stated in a document called the "Certificate
of Designation."
D. Dividends are paid after taxes and are not deductible to the corporation.
A. This is the total of capital stock and additional paid-in capital divided by the number of shares outstanding and then
multiplied by 1.5. Book value is total equity, and retained earnings is a part of equity.
B. This is total assets divided by the number of shares outstanding and then multiplied by 1.5. Book value is total
equity, not total assets.
C.
The first thing to do is to calculate the total equity of Kell, then divide that by the number of shares
outstanding to determine the book value per share. Multiplying the book value per share by 1.5 gives the
estimated value per share of Kell.
Part 2 : 01/14/19 11:24:21
C.
The first thing to do is to calculate the total equity of Kell, then divide that by the number of shares
outstanding to determine the book value per share. Multiplying the book value per share by 1.5 gives the
estimated value per share of Kell.
Total equity is $33,000,000 ($3,000,000 in common stock plus $24,000,000 in Additional Paid-In Capital plus
$6,000,000 in Retained Earnings).
Par value is $1 per share, and common stock is $3,000,000. Therefore, there are 3,000,000 shares outstanding
($3,000,000 ÷ $1).
Book value per share is $33,000,000 ÷ 3,000,000, which is $11 per share. $11 per share multiplied by 1.5
is $16.50, which is the estimated value per share of Kell.
D. This is total equity plus long-term debt divided by the number of shares outstanding and then multiplied by 1.5. Book
value is total equity only. It does not include long-term debt, which is a liability.
A. This answer results from using the Capital Asset Pricing Model and using the rate of return on the investment as the
return on the market. The Capital Asset Pricing Model is not needed to calculate the rate of return on this investment.
B. The stock's beta and the risk-free rate are irrelevant information. The only information needed to calculate
the rate of return on this stock are the annual dividend and the market value of the stock. Because the amount
of the dividend is not expected to change, this is a perpetual annuity. The return is calculated as the annual
dividend divided by the market value of the investment, or $0.30 ÷ $2.50, which is 12%.
C. This is the annual dividend divided by the stock price, plus the risk-free rate. The risk-free rate is not needed to
calculate the investors' required rate of return. See correct answer for an explanation.
D. This is the amount of the expected annual dividend in cents. It is not the investors' required rate of return for the
stock.
A. A call provision enables the issuer of the bond to retire the bonds before their maturity date. It has nothing to do with
the interest rate.
B. A call provision does not allow the bondholder the option to buy shares of the company's common stock at a
specified price within a specified period.
C. A call provisions allows the issuer of the bonds to call the bonds and retire them before their maturity date.
The price at which the bonds are repurchased is usually predetermined and includes a premium. This
premium offsets the loss to the bondholder when the bonds are called before their maturity.
D. A call provision does not allow the bondholder to call for additional bond issuances at predetermined intervals.
A. (c) HOCK international, page 30
The question does not say whether the dividend is expected to increase or not, but that information does not
affect the correct answer. Either the Dividend Growth Model or the Zero Growth Dividend Model can be used
Part 2 : 01/14/19 11:24:21
A.
The question does not say whether the dividend is expected to increase or not, but that information does not
affect the correct answer. Either the Dividend Growth Model or the Zero Growth Dividend Model can be used
to determine the answer to this question.
If the dividend is assumed to be growing and the Dividend Growth Model is used, the formula is:
P0 = Next Annual Dividend / (Investors' Required Rate of Return − Annual Future Growth Rate of the Dividend)
If the dividend is not assumed to be growing and the Zero Growth Dividend Model is used, the formula is:
P0 = Annual Dividend / Investors' Required Rate of Return
An increase in the nominal interest rate will cause the Investors' Required Rate of Return as used in both
formulas to increase. As a result, the denominator of either formula will increase while the numerator stays
the same, and the result will be a decreased market price for the stock.
B. A higher interest rate increases the required return of investors, which results in a lower stock price.
C. A higher interest rate increases the required return of investors, which results in a lower stock price.
D. A higher interest rate increases the required return of investors, which results in a lower stock price.
A. This is the par value of $1 per share multiplied by the earnings multiple of 12. "Earnings" refers to earnings per
share. Earnings per share should be calculated, then multiplied by the earnings multiple of 12 to calculate the
estimated value per share. Earnings per share is income available to common stockholders divided by the number of
common shares outstanding.
B.
The question tells us that public companies in Clark's industry are trading at twelve times earnings. So first we need to
calculate Clark's earnings per share, then multiply that by the earnings multiple of 12 to calculate the estimated value
per share of Clark. To calculate EPS, we need to divide net income by the number of shares outstanding.
This answer results from calculating EPS by subtracting dividends from net income and then dividing by the number of
shares outstanding. The only dividends that should be subtracted from net income in calculating EPS are preferred
dividends, and this company does not have any preferred stock. Common dividends belong to the common
stockholders and they are included in earnings per share.
C.
The question tells us that public companies in Clark's industry are trading at twelve times earnings. So first
we need to calculate Clark's earnings per share, then multiply that by the earnings multiple of 12 to calculate
the estimated value per share of Clark. To calculate EPS, we need to divide net income by the number of
shares outstanding.
The amount of the dividend is irrelevant, because it is a dividend on common stock. (Since this company does
not have any preferred stock, the dividend must be on common stock.) Only dividends on preferred stock are
subtracted from net income in calculating income available to common shareholders. The dividends paid to
common stockholders are part of the income available to common stockholders, so they are not subtracted
from net income.
($3,000,000 ÷ $1).
Net income of $3,750,000 divided by 3,000,000 shares outstanding equals EPS of $1.25 per share. Multiplying
Part 2 : 01/14/19 11:24:21
from net income.
($3,000,000 ÷ $1).
Net income of $3,750,000 divided by 3,000,000 shares outstanding equals EPS of $1.25 per share. Multiplying
$1.25 per share by 12 gives us an estimated value per share of $15.00.
D. This is retained earnings divided by the number of shares outstanding and then multiplied by 12. "Earnings" means
earnings per share. Earnings per share should be calculated, then multiplied by the earnings multiple of 12 to calculate
the estimated value per share. Earnings per share is income available to common stockholders divided by the number
of common shares outstanding. "Retained earnings" is the balance sheet account that accumulates net income in a
permanent account. Retained earnings is not used in calculating earnings per share.
A. The issuing of warrants has no immediate impact on managerial control of the company, but if the warrants are
exercised, this will decrease managerial control over the company.
B. By including warrants with the bonds that are issued the company is able to reduce the cost of the debt.
This is because the purchaser of the bond is receiving two items of value - the bond and the warrants.
Therefore, the interest rate can be a little bit lower and the buyer will still purchase the bonds because of the
warrant that is attached to it.
C. The issuance of warrants does not affect Basic EPS, but it will cause Diluted EPS to be reduced.
D. The issuance of warrants does not impact whether or not the bonds may be bought-back before their maturity. This
is determined by whether the bonds are callable or not.
A. Because the shareholder currently owns 1% of the company's shares ($10,000,000 in the common stock account
divided by $5 par value gives 2,000,000 shares), the shareholder is entitled to buy 1% of the newly issued shares.
B. Because the shareholder currently owns 1% of the company's shares ($10,000,000 in the common stock account
C. Because the shareholder currently owns 1% of the company's shares ($10,000,000 in the common stock
account divided by $5 par value gives 2,000,000 shares), the shareholder is entitled to buy 1% of the newly
issued shares. Since the company is issuing 400,000 new shares, 1% of this is 4,000 shares.
D. Because the shareholder currently owns 1% of the company's shares ($10,000,000 in the common stock account
A. This is a correct statement in that preferred dividends are often cumulative and interest is not. However, interest is
not cumulative because it must be paid every period, no matter what. So, preferred shares are preferable because
even if the preferred stock's dividend is cumulative, it does not need to be paid each period.
B. This is a reason to issue debt instead of preferred shares. The question asks for a reason to issue preferred shares
instead of debt. (c) HOCK international, page 32
C. Though preferred stock shares some of the characteristics of bonds, the payment of dividends is not a
legal requirement for preferred shares. Therefore, if the company does not pay a preferred dividend in one
Part 2 : 01/14/19 11:24:21
B. This is a reason to issue debt instead of preferred shares. The question asks for a reason to issue preferred shares
instead of debt.
C. Though preferred stock shares some of the characteristics of bonds, the payment of dividends is not a
legal requirement for preferred shares. Therefore, if the company does not pay a preferred dividend in one
period, it is not in default on the shares. However, if interest on debt is not paid one period, the company is
technically in default on the bonds and can be forced into bankruptcy and liquidation. Non-payment of a
dividend cannot force a company into bankruptcy and liquidation, an advantage for preferred shares in
contrast to debt.
D. Even though a preferred dividend is not a legal requirement, it is considered to be a fixed payment. Preferred
dividends are set as a percentage of the preferred stock's par value when the preferred stock is issued. That
percentage does not change and the par value upon which it is based does not change, so the preferred dividend is a
fixed payment. The only choice the company's directors have is whether or not to declare the dividend each period.
Furthermore, if the preferred stock is cumulative, even if the dividend is not paid in a given period, that period's
dividend will need to be paid in the future before any future common dividends can be paid.
A.
P0 − Pn
Vr =
r+1
Where:
Vr = Value of right
P0 = Value of one share with rights attached
Pn = Subscription (sale) price of one newly issued share
r = Number of rights required to buy one share
This answer is
P0 − Pn
Vr =
r
The denominator of the formula needs to be r + 1 instead of r.
B.
P0 − Pn
Vr =
r+1
Where:
Vr = Value of right
(c) HOCK
Pn = Subscription (sale) price of one newly issuedinternational,
share page 33
Putting the information from the question into the formula, we get [(60 - 54) / (4 + 1)]. Solving the formula, we
Part 2 : 01/14/19 11:24:21
Vr = Value of right
Pn = Subscription (sale) price of one newly issued share
Putting the information from the question into the formula, we get [(60 - 54) / (4 + 1)]. Solving the formula, we
get $1.20 as the value of the right when the share is selling rights-on.
C.
This is not the correct answer. See the correct answer for a complete explanation.
D. This is the difference between the subscription price and the price of the share when it is selling with the rights
(rights-on).
A. All of these items would be considered in the determination of how much to pay for a business because all
of these are in one way or another connected to the future cash flows of the business.
B. The present value of the seller's liabilities and the cash paid to the sellers' shareholders would also be considered in
the determination of the purchase price of the company.
C. The cash paid to the seller's shareholders would also be considered in the determination of the purchase price of
the company.
D. The present value of the seller's liabilities would also be considered in the determination of the purchase price of the
company.
A. If the expected dividend increases, the share price should increase.
B. This answer is the current share price plus the increase in the dividend. See the correct answer for an explanation.
C. If the expected dividend increases, the share price should increase.
D.
If the expected dividend increases, the share price should increase. Because the amount of the dividend is not
expected to change after it increases, this is a perpetual annuity.
We first need to calculate the current investors' rate of return on this perpetual annuity. The return is
calculated as the annual dividend divided by the market value of the investment, or $0.30 ÷ $2.50, which is
12%.
Now that we know the investors' required rate of return, we can calculate what the share price would go up to
if the annual dividend goes up to $0.33, (c)
a new perpetual
HOCK annuity.page
international, The 34
equation to solve is $0.33 ÷ X = 0.12.
Solving for X, we get a share price of $2.75.
Part 2 : 01/14/19 11:24:21
Now that we know the investors' required rate of return, we can calculate what the share price would go up to
if the annual dividend goes up to $0.33, a new perpetual annuity. The equation to solve is $0.33 ÷ X = 0.12.
Solving for X, we get a share price of $2.75.
A.
This is the stock price multiplied by the expected return to the market. This is not the correct way to calculate next
year's dividend.
To calculate next year's dividend, it is necessary to use the Dividend Growth Model and solve for G, then use that to
calculate the next year's dividend.
B.
This is the stock price multiplied by the dividend yield rate of 0.05 and multiplied again by 1 + the risk-free rate of 0.03.
This is not the correct way to calculate next year's dividend.
C.
The cost of retained earnings is equal to the investors’ required rate of return. The problem says that the cost
of retained earnings is 10.2%, so the investors' required rate of return is 10.2%. (You can confirm this by using
the Capital Asset Pricing Model and the stock's beta, the risk-free rate and the return to the market, if you
wish. However, it is not necessary to do so, because the investors' required rate of return is given. The
information on the stock's beta, the risk-free rate and the return to the market are included as distractors in
this problem.)
The current year’s dividend is 5% of the stock price, so the current year’s dividend is $1.50. We have
everything we need for the Dividend Growth Model except for the growth rate in dividends. To find what next
year’s dividend should be, we can use the Dividend Growth Model, solve for the rate of growth, and then
multiply the current year’s dividend ($1.50) by 1 + the growth rate.
The Dividend Growth Model is (D1 / P0) + G = C, where C is the cost of retained earnings and the investors’
required rate of return. D1 is next year’s dividend, so it is the current year’s dividend multiplied by 1 + the
dividend growth rate. The growth rate in dividends is what we need to find.
Letting G be the growth rate in the dividend, the formula will be:
(((1.50 × (1 + G)) / 30) + G = 0.102
((1.50 + 1.50G) / 30) = 0.102 – G
1.50 + 1.50G = 30 × (0.102 − G)
1.50 + 1.50G = 3.06 – 30G
1.50 + 31.5G = 3.06
31.5G = 1.56
G = 0.0495, which is the dividend growth rate
Therefore, next year’s dividend should be

(c)$1.50
HOCK × international,
(1 + 0.0495), orpage
$1.574
35 per share.
D.
This is the stock price multiplied by the dividend yield rate of 0.05 and multiplied again by the stock's beta of 1.2. This is
Part 2 : 01/14/19 11:24:21
Therefore, next year’s dividend should be $1.50 × (1 + 0.0495), or $1.574 per share.
D.
This is the stock price multiplied by the dividend yield rate of 0.05 and multiplied again by the stock's beta of 1.2. This is
not the correct way to calculate next year's dividend.
A. Both bonds have the same amount of interest rate risk, because both bonds have the same coupon rate and both
have one year to maturity.
B.
Duration measures how vulnerable the market value of a fixed-income security is to future changes in market
interest rates. When market interest rates increase, market values of fixed income securities decrease. And
when market interest rates decrease, market values of fixed income securities increase. But not all fixed
income securities vary in value by the same extent. How much an individual fixed income security will vary in
value with changes in interest rates depends upon its duration.
As a bond’s maturity date approaches, its duration shortens, and its market value becomes less sensitive to
market interest rate changes. So a long-term bond's price sensitivity to a given change in interest rates will be
greater the longer the maturity of the bond, and the bond will have more interest rate risk. A bond with a
shorter maturity will be less sensitive to market rate changes and thus will have less interest rate risk.
C. A long-term bond's price sensitivity to a given change in interest rates will be greater the longer the maturity of the
bond, and the bond will have more interest rate risk. A bond with a shorter maturity will be less sensitive to market rate
changes and thus will have less interest rate risk. A bond with 15 years to maturity would have more interest rate risk
than a bond with one year to maturity.
D. The coupon rate and the yield-to-maturity of a bond do not change over time for the buyer of that bond. The coupon
rate never changes regardless of who holds the bond. The bond's yield-to-maturity does not change as long as the
buyer holds the bond to maturity. If the investor sells the bond before its maturity date, though, that investor's yield on
the bond will be affected by the market price of the bond received on the date of the sale.
A. If preferred stock is cumulative, preferred stockholders have the right to accrue dividend payments in arrears when
payments are not made for a period of time. Although not all preferred stockholders have this right (the preferred stock
must be cumulative preferred stock), this is not a right that is sacrificed by the holders of preferred stock in exchange
for other preferences received over common shareholders.
B. This is a right that is sacrificed by the holders of preferred stock in exchange for other preferences received
over common shareholders. Holders of preferred stock do not have any right to vote for members of the board
of directors or to vote in other matters requiring a vote.
C. This is not a right that is sacrificed by the holders of preferred stock in exchange for other preferences received over
common shareholders. Holders of preferred stock have the right to share in the residual assets of the company upon
liquidation. Their right takes priority over the right of the common shareholders.
D. This is not a right that is sacrificed by the(c) HOCKofinternational,

holders page
preferred stock 36
in exchange for other preferences received over
common shareholders. Holders of preferred stock have the right to share in the periodic earnings of the company
through the receipt of dividends.
Part 2 : 01/14/19 11:24:21
liquidation. Their right takes priority over the right of the common shareholders.
D. This is not a right that is sacrificed by the holders of preferred stock in exchange for other preferences received over
common shareholders. Holders of preferred stock have the right to share in the periodic earnings of the company
through the receipt of dividends.
A. This is the amount of future cash flows from the share, not discounted. To get the current value of the share, these
future cash flows need to be discounted at the required rate of return.
B.
This is not the correct answer. Please see the correct answer for an explanation.
C.
The intrinsic value of the share may be determined by taking the present value of the future cash flows
(dividends and future sales price). This present value is calculated using the required rate of return, which
here is 10%. The dividends are expected to be $2.00, $2.10 and $2.25 for each of the next three years and then
the share will be sold at the end of the third year for $25. The present value calculation using Present Value of
$1 factors for 10% for one year, two years, and three years, is:
($2.00 × 0.909) + ($2.10 × 0.826) + ($2.25 × 0.751) + ($25.00 × 0.751) =
$1.818 + $1.735 + $1.690 + $18.775 = $24.02
D. This is approximately the discounted value of the expected selling price of the share only. We also need to include
the discounted value of the future dividend payments as well.
A.
The term structure of interest rates describes the relationship between interest rates on bonds and the
maturities of the bonds as of a moment in time. The term structure of interest rates is a graph showing the
rates for each different term of bond for bonds having the same risk characteristics. The various terms (1
month, 3 months, 6 months, 1 year, 2 year, and so forth) are on the X-axis, and the interest rates are on the
Y-axis.
Usually, shorter-term bonds have lower yields, because an investor has less risk with a shorter-yield bond,
and so the yield curve will be upsloping with the rates becoming higher as the bonds' maturities become
longer. If the yield curve on a term structure of interest rates graph is a flat line with no slope, it means that
long-term interest rates are the same as short-term interest rates.
B.
The term structure of interest rates describes the relationship between interest rates on bonds and the maturities of the
(c) HOCK
bonds as of a moment in time. The term structure international,
of interest rates is page 37 showing the rates for each different term
a graph
of bond for bonds having the same risk characteristics. The various terms (1 month, 3 months, 6 months, 1 year, 2
year, and so forth) are on the X-axis, and the interest rates are on the Y-axis.
Part 2 : 01/14/19 11:24:21
bonds as of a moment in time. The term structure of interest rates is a graph showing the rates for each different term
A flat yield curve would not depict long-term rates that are higher than short-term rates.
C.
A flat yield curve would not mean that the intermediate-term interest rate is lower than the T-bill interest rate. Since
each term structure of interest rates graph depicts a type of bonds that have the same risk characteristics but different
maturities, such a graph could not indicate anything about the relationship between two different types of bonds.
D.
A flat yield curve does not mean that bank borrowing rates will rise. A flat yield curve is an indication that the market
expects that interest rates will not change much in the future.
A. When warrants are exercised the company receives new capital. The amount may be less than if a share
was sold in the open market, but the exercise of the warrant still brings capital to the company.
B. The conversion of convertible bonds does not bring new capital to the company.
C. In a stock split, there is no new capital received by the company making the split.
D. The purchase of an option on an option exchange does not involve the company so no new capital is brought to the
company.
A. A shareholder does not receive any return of capital as a result of a right offering. Please see the correct answer for
a complete explanation.
B.
The question tells us that the market value of one right prior to the ex-rights date is $2.00. However, the
theoretical value of the right (what its market value should be) is $2.50. We can calculate the theoretical value
of the right when the stock is selling rights-on using this formula:
Vr = (Po − Pn) ÷ ( r + 1)
Where: (c) HOCK international, page 38

Po = the value of a share with the rights still attached
Pn = the subscription price of a share
r = the number of rights needed to buy one new share
Part 2 : 01/14/19 11:24:21
Where:
Po = the value of a share with the rights still attached

Pn = the subscription price of a share
r = the number of rights needed to buy one new share
Vr = the value of the right
Solving for Vr in this equation, we get
Vr = ($50 − $40) / (3 + 1) = $2.50.
But the market value of the right is only $2.00, according to the question. It is not as high as it should be. The
question tells us that the theoretical value of the share when it goes ex-rights (the theoretical value of the
share without the right) is $47.50. Because the value of a share when it is ex-rights will be $47.50, if the
shareholder were to sell their rights at the market price of $2.00, they would have only $49.50 worth of value
instead of the $50 they should have. So in this situation, because the market value of the right is lower than it
should be, the rights have no value to the shareholder. The shareholder does not receive any additional
benefit from the rights offering. In fact, the market value of the shareholder's holdings in the company is
decreased.
C. The market value of the right is $2.00 while the stock is still selling rights-on, according to the question. However,
the theoretical value of the right is different from its market value. Because of that, the shareholder does not receive an
additional benefit from the rights offering. Please see the correct answer for a complete explanation and calculation of
the theoretical value of the right.
D. This answer is incorrect because the rights cannot be redeemed before the ex-rights date. The rights cannot be
redeemed until they are issued, and the ex-rights date comes before the issue date.
A. The "provisions" of a bond indenture are the terms of the bond. The include the issuer’s obligations to the bond
holders. They may or may not be protective clauses.
B. Covenants are restrictions on the issuer included in a bond indenture that preserve the company's financial
solvency and thus its ability to repay the debt. They provide protection to the holder of the bond, so they are
known as "protective covenants." Covenants may include a requirement that the issuer maintain a certain
minimum level of working capital, limitation on capital expenditures, limitation on other indebtedness, or other
requirements.
C. Protective clauses in bond indentures are not called "requirements." This is not a defined term for a bond indenture.
D. Protective clauses in bond indentures are not called "addenda."
A. Preemptive rights guarantee that existing shareholders will have the opportunity to purchase the same percentage
of a new issuance of stock as they owned of the company before the new issuance. This does not have to be done
through the issuance of warrants, however.
B. This is not what a preemptive right is.
C. Preemptive rights guarantee that existing shareholders will have the opportunity to purchase the same percentage
of a new issuance of stock as they owned of the company before the new issuance. The stockholder may not have the
cash necessary to purchase these newly issued shares, but they must be given the opportunity to do so, if they have
preemptive rights. If the existing shareholders do not exercise this right, the shares may be sold to anyone.
D. Preemptive rights guarantee that existing shareholders will have the opportunity to purchase the same
Part 2 : 01/14/19 11:24:21
C. Preemptive rights guarantee that existing shareholders will have the opportunity to purchase the same percentage
of a new issuance of stock as they owned of the company before the new issuance. The stockholder may not have the
cash necessary to purchase these newly issued shares, but they must be given the opportunity to do so, if they have
preemptive rights. If the existing shareholders do not exercise this right, the shares may be sold to anyone.
D. Preemptive rights guarantee that existing shareholders will have the opportunity to purchase the same
percentage of a new issuance of stock as they owned of the company before the new issuance. The
stockholder may not have the cash necessary to purchase these newly issued shares, but they must be given
the opportunity to do so, if they have preemptive rights.
A. This answer does not take into consideration the value of the dividends. Normally, the price of a share of stock after
a two-for-one split will be exactly 50% of the price before the split, because there are twice as many shares
outstanding. If the dividend does not drop by exactly 50% when the stock is split two-for-one, then the price of a share
would be adjusted to take the change in the dividend into consideration.
B. After a two-for-one split, the price of a share of stock will normally be exactly 50% of the price before the split,
because there are twice as many shares outstanding, if the dividend is unchanged. An unchanged dividend would be
one that is exactly 50% of what it was before the split. In a 2-for-1 stock split, if the price drops by more than 50%, a
change in the dividend policy might explain the drop. The value of the dividends needs to be considered as well.
C. Normally, the price of a share of stock after a two-for-one split will be exactly 50% of the price before the split,
because there are twice as many shares outstanding. The dividend would be expected to be exactly 50% of what it
was before the split. If the dividend is changed to $0.45 per share after the two-for-one split, then the dividend has
dropped. In a two-for-one split, if the dividend drops by more than 50%, then the price of a share after the split should
be less than 50% of its price before the split, in order to take the change in the dividend into consideration.
D.
The dividend yield before the split is $1 ÷ $80, or 1.25%. If the stock is split 2-for-1, each shareholder will have
twice as many shares after the split. Normally, the price of a share of stock after a 2-for-1 split will be exactly
50% of the price before the split, because there are now twice as many shares outstanding, so the dividend
per share should be 50% of its previous level in order to keep the payout to each shareholder the same. So if
no change is made in the dividend, the dividend will be $0.50 per share, and the market price per share will
become $40. That maintains the same dividend yield rate for the shareholders: $0.50 ÷ $40 = 1.25%.
In a two-for-one split, if the dividend drops by less than 50%, then the price of a share after the split should be
greater than 50% of its price before the split, because the stockholder is getting a higher dividend yield and
would be willing to pay more for the stock.
If, instead of paying $0.50 per share in dividends, the dividend is changed to $0.55 per share, the market price
of the stock will adjust so that the same dividend yield rate is maintained. To calculate what the market price
of the stock will adjust to, we let X equal the new share price:
$0.55 ÷ X = 0.0125.
Solving for X, we get X = $44
So, all other things being equal, the market price of the stock should be expected to increase to $44 if the
dividend is changed to $0.55.
A. The sales price is the amount that must be entered in the issuing company's records for the sale of stock.
B. The par value of common stock represents the legal capital of the company. This is the maximum amount
that a shareholder can be liable for if the company goes bankrupt. This is also the amount of capital that may
not be distributed as a dividend by the company. Many companies have a low par value for their shares.
Part 2 : 01/14/19 11:24:21
A. The sales price is the amount that must be entered in the issuing company's records for the sale of stock.
B. The par value of common stock represents the legal capital of the company. This is the maximum amount
that a shareholder can be liable for if the company goes bankrupt. This is also the amount of capital that may
not be distributed as a dividend by the company. Many companies have a low par value for their shares.
C. This is not what the par value of a share of common stock represents. The par value of a share of common stock
represents the legal capital of the company.
D. The par value of common stock is not related to the estimated market value of the stock when it was issued.
A. In the case of a liquidation preferred shares have a superior claim to the assets of the company compared to
common shareholders. Since the question asks for which is not a characteristic, this answer is incorrect because this is
a characteristic of preferred shares.
B. Preferred shares do not have the right to vote in corporate elections. Since the question asks for which of
the items is not a characteristic of this type of share, this is the correct answer.
C. Preferred shares (and common shares) do not have a principal repayment. Since the question asks for which is not
a characteristic, this answer is incorrect because this is a characteristic of preferred shares.
D. The dividends that are paid to preferred shareholders are not tax deductible. Since the question asks for which is
not a characteristic, this answer is incorrect because this is a characteristic of preferred shares.
A. The bonds within a serial issuance of bonds may have different yields to maturity because of the fact that the bonds
each have a different period of time until maturity.
B. Serial bonds do not all mature at the same date.
C. The coupon rate does not depend on whether a bond is a serial bond or a term bond.
D. Serial bonds are an issuance of bonds that have different maturity dates. Therefore, some of the bonds
have a 10 year maturity, some 11 years, some 12 years and so on. Because of this, investors are able to buy a
bond that has the time until maturity that best suits their needs.
A. This is not the correct theoretical market value of one right prior to the ex-rights date, using the formula given.
Please see the correct answer for a complete explanation.
B. This is the subscription price of the stock. This is not the correct theoretical market value of one right prior to the
ex-rights date, using the formula given. Please see the correct answer for a complete explanation.
C. This is the difference between the market price of the stock and the subscription price. This is not the correct
theoretical market value of one right prior to the ex-rights date, using the formula given. Please see the correct answer
for a complete explanation.
D.
In order to answer this question, we simply need to put the information in the question into the formula that is
given. Doing this, we get
Part 2 : 01/14/19 11:24:21
theoretical market value of one right prior to the ex-rights date, using the formula given. Please see the correct answer
for a complete explanation.
D.
In order to answer this question, we simply need to put the information in the question into the formula that is
given. Doing this, we get
($50 − $40)
Ron =
(3 + 1)
Solving this formula, we get $2.50 is the value of a right. We can check this as follows: first let us assume that
we have one shareholder who purchased 3 shares for $50, received 3 rights and then purchased the fourth
share for $40. This person will have spent a total of $190 for four shares, an average of $47.50 per share. A
second person purchased three rights for $2.50 each and then one share for $40. This person has one share
for which they paid $47.50. So, the value of the rights must be $2.50 since this works out evenly under both
scenarios.
A. Most companies maintain a stable dividend over time which means that dividends fluctuate less than earnings.
B. Dividends are usually not a set percentage of earnings. If dividends were a set percentage of earnings, dividends
would fluctuate greatly as profits fluctuated and companies do not like their dividends to fluctuate greatly.
C. Because of the fact that investors look to dividends as a sign of growth and health of the company,
companies generally do not fluctuate their dividends greatly from one year to the next as this indicates
uncertainty for the company. Therefore, even when income fluctuates greatly from year to year, the company
will probably not change its dividend by much from one year to the next.
D. More mature firms generally pay a higher percentage of their earnings as a dividend than less mature firms. This is
because the older, more mature firm has less need for capital investment than a younger firm.
Question 49 - CMA 695 1.8.5 Adapted - L-T Financial Management-Financial Instruments
A. This is the Next Annual Dividend divided by the Expected Market Return minus the Annual Growth Rate of
Dividends. However, the value of common stock is the Next Annual Dividend divided by the Investors' Required Rate of
Return minus the Annual Growth Rate of Dividends.
B. This is the previous year's dividend divided by the expected market return. However, the value of common stock is
found by means of the Constant Growth Model, which is Next Annual Dividend divided by the Investors' Required Rate
of Return minus the Annual Growth Rate of Dividends.
C.
To determine the value of the common stock, it is necessary to use both the Capital Asset Pricing Model, to
find the current cost of Martin's common equity (investors' required rate of return), and then the Dividend
Growth Model, to find the price of the common stock.
The Capital Asset Pricing Model formula is: R = RF + [β(RM − RF)]. Plugging the values into the formula, we
have 0.07 + [1.25(0.15 − 0.07)] which equals 0.17 or 17%, which is the investors' required rate of return.
We now have all the information needed(c)

to HOCK
use theinternational,
Dividend Growth
page Model
42 to value this stock. The formula for
the Dividend Growth Model is restated to solve for the stock price, as follows:
P0 = Next Annual Dividend / (Investors' Required Rate of Return − Annual Growth Rate of Dividends)
Part 2 : 01/14/19 11:24:21
We now have all the information needed to use the Dividend Growth Model to value this stock. The formula for
the Dividend Growth Model is restated to solve for the stock price, as follows:
P0 = Next Annual Dividend / (Investors' Required Rate of Return − Annual Growth Rate of Dividends)
P0 = ($1.00 × 1.05) / (0.17 − 0.05)
= $1.05 ÷ 0.12
= $8.75
D. This answer does not take into account the growth rate in the dividend.
A.
Receiving the trustee's permission is important if the issuer of the mortgage bond wants to sell the property, because
the property is the collateral for the bond.
Inclusion of a negative pledge clause would also be likely, because a negative pledge clause is a covenant in an
indenture that states that the corporation will not pledge any of its assets for other debt, if doing so would give the
investors in these bonds less security.
However, these are not the only restrictions or requirements that are likely to be contained in the indenture.
B.
The requirement to maintain the property in good condition is important because the property is the collateral for the
bond. If the issuer were to default and the property sold to satisfy the investors in the bond, the investors want to be
certain the property will be worth enough to cover their investment. If it is not maintained properly, its market value will
decrease and it might not be able to be sold for enough to satisfy the investors in case of a default.
Insuring the plant and equipment at certain minimum levels would also be required, because if a fire or other disaster
were to occur and destroy the assets securing the mortgage bond, the investors would have no collateral to back up
their investment.
C.
Receiving the trustee's permission is important if the issuer of the mortgage bond wants to sell the property, because
the property is the collateral for the bond.
Insuring the plant and equipment at certain minimum levels would also be required, because if a fire or other disaster
were to occur and destroy the assets securing the mortgage bond, the investors would have no collateral to back up
their investment.
Inclusion of a negative pledge clause would also be likely, because a negative pledge clause is a covenant in an
indenture that states that the corporation will not pledge any of its assets for other debt, if doing so would give the
investors in these bonds less security.
D.
All four of the restrictions or requirements

(c) are
HOCKlikely to be contained
international, pagein
43the indenture.
Receiving the trustee's permission is important if the issuer of the mortgage bond wants to sell the property,
because the property is the collateral for the bond.
Part 2 : 01/14/19 11:24:21
D.
All four of the restrictions or requirements are likely to be contained in the indenture.
Receiving the trustee's permission is important if the issuer of the mortgage bond wants to sell the property,
because the property is the collateral for the bond.
The requirement to maintain the property in good condition is important because the property is the collateral
for the bond. If the issuer were to default and the property sold to satisfy the investors in the bond, the
investors want to be certain the property will be worth enough to cover their investment. If it is not maintained
properly, its market value will decrease and it might not be able to be sold for enough to satisfy the investors
in case of a default.
Insuring the plant and equipment at certain minimum levels would also be required, because if a fire or other
disaster were to occur and destroy the assets securing the mortgage bond, the investors would have no
collateral to back up their investment.
Inclusion of a negative pledge clause would also be likely, because a negative pledge clause is a covenant in
an indenture that states that the corporation will not pledge any of its assets for other debt, if doing so would
give the investors in these bonds less security.
A. Covenants are restrictions on the issuer included in an indenture that preserve the company's financial
solvency and thus its ability to repay the debt. They provide protection to the lenders (the bond holders), so
they are known as "protective covenants." One example of a protective covenant is a requirement that the
company cannot acquire or sell major assets without prior approval of the creditor. The purchase of major
assets could endanger the borrower’s current position and working capital. The sale of major assets could
endanger profit generation or revenue creation in addition to removing assets that the lender could look to for
repayment of the loan.
B. A put option in a bond indenture gives the holder of the bond the right to sell, or "put" the bond back to the issuer
prior to the bond's maturity date. A bond with this provision is called a "putable bond." For example, the indenture may
state that the holder may put the bond after a certain date, at a certain price. If the bond pays an interest rate that is
lower than the market rate, the holders will probably put the bond, get their money back, and reinvest the funds in
something with a higher, market level of return. A put option in a bond indenture does not prevent the company from
acquiring or selling major assets without prior creditor approval.
C. A call provision enables the company to pay off (redeem) the bond before its maturity date, usually at a premium to
its face value. It does not prevent the company from acquiring or selling major assets without prior creditor approval.
D. A warrant may be attached to a bond. When a warrant is attached to a bond, it gives the owner the option to buy
stock in the company. It does not prevent the company from acquiring or selling major assets without prior creditor
approval.
A. The payment of a preferred stock dividends is discretionary. Missing a dividend payment will not be a default on the
part of the issuer. The board of directors can omit paying a preferred stock dividend if it chooses. Therefore, preferred
stock dividends are not legal obligations of the corporation.
B. Preferred stock usually does not have a maturity date, but that is not a disadvantage to the firm that issues it.
C. Preferred stock can be owned by corporate investors, institutional investors, or private investors.
D. Because equity carries no guarantee of a return, investors typically demand a higher yield to compensate
for the higher risk.
Part 2 : 01/14/19 11:24:21
C. Preferred stock can be owned by corporate investors, institutional investors, or private investors.
D. Because equity carries no guarantee of a return, investors typically demand a higher yield to compensate
for the higher risk.
A. Investors prefer bonds to have sinking funds since it provides some guarantee that the bonds will be able to be paid
when they mature. Because investors like sinking funds, bonds with sinking funds will be able to be issued at a lower
rate of interest.
B. This change in rating is an increase in the rating, meaning that there is less risk associated with the bonds. This will
enable the issuer to decrease the interest rate of the bonds.
C. A call provision is considered to be detrimental by the bondholder because this gives the issuer the right to
retire the bonds at any time prior to maturity. This option will be exercised if interest rates fall and the issuer is
able to find other, cheaper sources of financing. In this environment, the investor may not be able to find an
investment with the same rate of return. To cover for this increased level of risk, the investor will require that
callable bonds pay a higher rate of interest.
D. A conversion option is considered to be a benefit by the investor because it enables the investor to convert the
bonds to shares if that would be beneficial. Therefore, bonds that have a conversion feature will be able to issued at a
lower interest rate.
A.
This is not the correct answer. Please see the correct answer for a complete explanation.
B.
This was calculated using $1.50 as the value of a right while it is attached to the share. This $1.50 value of a right while
it is attached to the share was calculated incorrectly as the difference between the market price of the stock and the
subscription price divided by the number of rights required to purchase one share. This is not the correct way to
calculate the value of a right while it is attached to the share. The difference between the market price of the stock and
the subscription price should be divided by the number of rights required to purchase one share + 1.
C. This is the subscription price. See the correct answer for a complete explanation.
D.
In order to determine the value of one share after it is selling ex-rights, we need to subtract the value of the
right from the price of the share when it was selling rights-on.
P0 − Pn (c) HOCK international, page 45

Vr =
r+1
Part 2 : 01/14/19 11:24:21
P0 − Pn
Vr =
r+1
Where: Po = The market value of one share with the rights still attached
Pn = The subscription (sales) price of a share
r = The number of rights needed to buy one new share
Vr = The value of one right when the stock is selling rights-on
Putting the information from the question into the formula, we get [($60 − $54) / (4 + 1)]. Solving the formula,
we get $1.20 as the value of the right when the share is selling rights-on. Subtracting this $1.20 from the
rights-on price, we get the value of the share when it is selling ex-rights. So, the value of the share ex-rights is
$58.80 ($60 − $1.20).
A. A note may be a short-term loan (under one year) or it may be a term note, for a period of greater than one year.
However, it would seldom have a term as long as 10 years.
B. Chattel mortgages are loans that are secured by movable, identifiable personal property such as a car. Since the
security for a chattel mortgage is not a long-term fixed asset, the term of the loan that it secures must be short-term.
For example, a car's value decreases quickly, so it could not be used to secure a ten-year loan.
C. Bonds are medium to long-term negotiable debt securities that have been issued by governments,
government agencies, states or other government bodies, international organizations such as the World Bank,
and companies. A bond would generally have a maturity of ten years or more.
D. A financial lease is normally used to finance the purchase of equipment. Depending on the equipment, the lease
may be anywhere from 1 years to a longer term, but it would seldom be as long as 10 years.
A. When a bond has a sinking fund requirement, the issuer of the bonds is required to make periodic
contributions to the fund. This fund will be used to repay the face amount of the bonds when the bonds
mature. If there is a sinking fund requirement, the buyers of the bonds are more comfortable that the bonds
will actually be repaid when they mature. This enables the issuing company to pay a slightly lower interest
rate on the bonds because they are more secure.
B. A sinking fund does require a periodic payment, but the payment is to accumulate money to repay the face amount
when the bond matures. It is not connected to the payment of bond issue costs.
C. A sinking fund does require a periodic payment, but the payment is to accumulate money to repay the face amount
when the bond matures. It is not connected to the payment of bond interest costs.
D. A sinking fund is not a form of financing, but rather a means to accumulate the money necessary to pay debt as it
matures. See the correct answer for a complete explanation.
(c) HOCK
Question 57 - ICMA 1603.P2.063 - L-T Financial international, pageInstruments
Management-Financial 46
A.
Part 2 : 01/14/19 11:24:21
A.
This answer results from comparing the price/earnings ratio of the beverage company stock with the average
price/earnings ratio of companies in the beverage industry. That is not the amount by which the beverage company's
stock is overvalued or undervalued but rather it is the variance of the company's P/E ratio in comparison with the
average P/E ratio of the industry.
The price/earnings ratio is the market price of a share of common stock divided by the company's earnings per share.
Using the price/earnings ratio as the comparable valuation method, the fair value of a share of the company's stock is
its estimated earnings per share in the next year multiplied by the average price/earnings ratio for the industry.
That fair value should be compared with the stock's current market price to determine whether the stock is currently
overvalued or undervalued in the market and by how much. If the company's stock price is higher than the fair value of
the stock, the company's stock is overvalued. If the company's stock price is lower than the fair value of the stock, the
company's stock is undervalued.
B.
The price/earnings ratio is the market price of a share of common stock divided by the company's earnings
per share. Using the price/earnings ratio as the comparable valuation method, the fair value of a share of the
company's stock is its estimated earnings per share in the next year multiplied by the average price/earnings
ratio for the industry.
That fair value should be compared with the stock's current market price to determine whether the stock is
currently overvalued or undervalued in the market and by how much. If the company's stock price is higher
than the fair value of the stock, the company's stock is overvalued. If the company's stock price is lower than
the fair value of the stock, the company's stock is undervalued.
The average price/earnings ratio of companies in the same industry as the beverage company is 15. Since this
company is estimated to earn $2 per share in the next year, the fair value of a share of this company's stock,
based on the average P/E ratio for the beverage industry, is 15 × $2, or $30. Since the common stock of the
company has a current market price of $34, the beverage company's stock is $4 overvalued.
C.
This answer results from comparing the price/earnings ratio of the beverage company stock with the average
price/earnings ratio of companies in the beverage industry. That is not the amount by which the beverage company's
stock is overvalued or undervalued but rather it is the variance of the company's P/E ratio in comparison with the
average P/E ratio of the industry.
The price/earnings ratio is the market price of a share of common stock divided by the company's earnings per share.
Using the price/earnings ratio as the comparable valuation method, the fair value of a share of the company's stock is
its estimated earnings per share in the next year multiplied by the average price/earnings ratio for the industry.
D.
The beverage company's stock is overvalued, not undervalued. The price/earnings ratio is the market price of a share
of common stock divided by the company's earnings per share. Using the price/earnings ratio as the comparable
valuation method, the fair value of a share of the company's stock is its estimated earnings per share in the next year
multiplied by the average price/earnings ratio for the industry.
(c)by
overvalued or undervalued in the market and HOCK international,
how much. page 47 stock price is higher than the fair value of
If the company's
Part 2 : 01/14/19 11:24:21
A. This answer results from using a 35% effective tax rate to adjust the bond interest and using a 30% tax rate to
adjust the preferred stock dividend. The effective tax rate for the bond interest is 30%, and the preferred dividend
should not be adjusted at all because dividends are not tax deductible.
B. This answer results from calculating the cost of the preferred stock as if the preferred dividend were tax-deductible.
Dividends paid are not tax-deductible, so the dividend rate should not be adjusted for taxes.
C.
The after-tax interest rate on the bonds will be 70% of 7% (0.70 × [1 − 0.30]), or 4.9%. The after-tax cash outflow
for interest in the second year after issue will be $50,000,000 × 0.049, or $2,450,000.
The cash outflow for dividends on the preferred stock in the second year after issue will be $50,000,000 × 0.05,
or $2,500,000.
Thus the net cash flow for the second year after issue with the bond issue will be $50,000 higher. In other
words, the net cash benefit of selling the bonds instead of the preferred stock will be $50,000. Because the
cost of capital for the bonds will be 4.9% versus 5% for the preferred stock, the cost of the bonds will be
$50,000 lower than the cost of the preferred stock, so the cash flow with the bond issue will be $50,000 higher.
D. This answer results from using a 35% effective tax rate. The effective tax rate is 30%.
A.
This is the market price of the stock rights-on minus the market price of the stock ex-rights, divided by the number of
rights needed to buy one share.
The value of a stock right when the stock is ex-rights is the market value of the stock ex-rights minus the subscription
price, divided by the number of rights needed to buy one new share.
B.
The value of a right when the stock is trading ex-rights is the market value of the stock ex-rights minus the
subscription price, divided by the number of rights needed to buy one new share, as follows.
($48 − $40) ÷ 4 = $2
An alternate method of calculating the value of the right when the stock is trading ex-rights is to compare the
market price of the share when it was selling rights-on with the market price of the share after it went
ex-rights. When the stock was trading rights-on, its market price was $50, and when the stock went ex-rights,
the market price decreased to $48. The difference is $2. Since the only difference between the rights-on
market price and the ex-rights market price is the value of the right, the right must have a value of $2.
C.
This is the market price of the stock rights-on minus the subscription price, divided by the number of rights needed to
buy one new share.
Part 2 : 01/14/19 11:24:21
C.
This is the market price of the stock rights-on minus the subscription price, divided by the number of rights needed to
buy one new share.
D.
This is the rights-on value of the right if the subscription price is $48.
A. The current market value of a firm that is run inefficiently will be lower than if it were run efficiently. Therefore, a
potential purchaser would be willing to pay more than the current market value if they believe that they can correct the
inefficiencies.
B. The current earnings before interest and taxes of a firm that is run inefficiently will be lower than if it were run
efficiently. Therefore, a potential purchaser would be willing to pay more than the current market value if they believe
that they can correct the inefficiencies.
C. The current net profits of a firm that is run inefficiently will be lower than if it were run efficiently. Therefore, a
potential purchaser would be willing to pay more than the current market value if they believe that they can correct the
inefficiencies.
D. When determining the acquisition value of anything, the maximum amount to pay is the present value of
the expected future cash flows from whatever is being acquired. When determining these future cash flows,
the potential purchaser will factor in any increases in sales that will result from the firm being run more
efficiently in the future.
A. This answer results from using the wrong amount for the next annual dividend in the Dividend Growth Model. The
problem states that $1.25 is the next annual dividend. Therefore, that amount does not need to be increased by 1 plus
the annual growth rate to get next year's dividend, because it is already next year's dividend. If the problem had stated
that the dividend amount given was the current year's dividend, it would be appropriate to multiply it by 1 plus the
annual growth rate to get next year's dividend to use in the Dividend Growth Model.
B.
The first step in solving this is to use the Dividend Growth Model and solve for R to find the investors'
required rate of return for the security. The second step is to use the Capital Asset Pricing Model to solve for
the expected return to the market.
The Dividend Growth Model is:
P0 = D1 / (R − G)
R is the cost of retained earnings for the security, which is also the investors' required rate of return.
P0, or the price of the stock, is given as $31.25.
G, the growth rate, is given as 5% or 0.05.

Part 2 : 01/14/19 11:24:21
R is the cost of retained earnings for the security, which is also the investors' required rate of return.
P0, or the price of the stock, is given as $31.25.
G, the growth rate, is given as 5% or 0.05.
D1 is the next dividend to be paid. The problem tells us that the next annual dividend will be $1.25. It is not
necessary to multiply $1.25 by 1 + the growth rate to get the next dividend because $1.25 is already the next
dividend. Therefore, using the Dividend Growth Model to solve for R, the investors' required rate of return:
31.25 = $1.25 / (R − 0.05)
Multiply both sides of the equation by (R − 0.05) to get the (R − 0.05) out of the denominator:
31.25 (R − 0.05) = 1.25
31.25R − 1.5625 = 1.25
Add 1.5625 to both sides of the equation to isolate the term containing the unknown on one side of the equals
sign:
31.25R = 2.8125
Divide both sides of the equation by 31.25 to solve for R:

R = 0.09
The formula for the Capital Asset Pricing Model is:
R = RF + β(RM − RF)
Where R is the cost of retained earnings, which is also the investors' required rate of return.
Using the investors' required rate of return calculated in the first step by means of the Dividend Growth Model
and letting X stand for RM, we can solve the CAPM for RM, or the return to market, as follows:
0.09 = 0.03 + 1.2(X − 0.03)
0.09 = 0.03 + 1.2X − 0.036
0.096 = 1.2X
X = 0.08 or 8%
C. This is the investors' required rate of return. However, the problem asks for the expected return to the market.
D. This answer results from using the investors' required rate of return in place of the return to the market in the Capital
Asset Pricing Model. The return to the market is what we are solving for, so that would be represented by an "X" in the
CAPM formula.
A. A convertible provision, not a call provision, allows bonds to be converted into common shares.
B. The bondholder does not redeem the bond. To "redeem" means to recover ownership of by paying a specified sum.
Only the issuer of a bond can redeem the bond, because redeeming a bond takes place when the issuer buys the bond
issue back from the holders.
C. Bondholders do not redeem bonds. To "redeem" means to recover ownership of by paying a specified sum. Only
the issuer of a bond can redeem the bond, because redeeming a bond takes place when the issuer buys the bond
issue back from the holders. (c) HOCK international, page 50
D. A corporate bond indenture may include a call provision. A call provision allows the bond issuer to buy
back the bond at a stated price before its maturity date. The call price is usually above the par (face) value of
the bond. A call provision gives the company flexibility, because if interest rates decline, the company can call
Part 2 : 01/14/19 11:24:21
C. Bondholders do not redeem bonds. To "redeem" means to recover ownership of by paying a specified sum. Only
the issuer of a bond can redeem the bond, because redeeming a bond takes place when the issuer buys the bond
issue back from the holders.
D. A corporate bond indenture may include a call provision. A call provision allows the bond issuer to buy
back the bond at a stated price before its maturity date. The call price is usually above the par (face) value of
the bond. A call provision gives the company flexibility, because if interest rates decline, the company can call
the higher-interest bonds and refinance that issue at a lower interest rate. Or, if the company feels that the
covenants in the bond indenture are too restrictive and the bond is callable, the company may choose to
refinance the bond if it is able to issue another bond to pay off the callable bond that does not have such
restrictive covenants.
A. Each period the amount of the discount at the sale of the bond needs to be amortized so even though there is no
cash payment, there is an interest calculation each period.
B. The interest expense that is amortized each period must be shown as interest expense by the issuer.
C. The issuance costs for a zero-coupon bond are no less or more than for any other bond.
D. In a zero-coupon bond the bond is sold at a discount from its face amount. During the life of the bond, no
interest is paid, but at the maturity date the face amount of the Bond is repaid to the buyer. So, there is no
annual interest cash payment for a zero-coupon bond.
A. Some preferred stock carries a provision that allows it to be converted into common stock. If the preferred stock is
converted, it is retired.
B. Preferred stock may provide for a "mandatory" sinking fund with a specific amount to be set aside each year for
retirement of the preferred stock at a specific sinking fund price. The existence of a Mandatory sinking fund does not
mean that the preferred stock should be reported on the balance sheet as long-term debt, although according to the
SEC, preferred stock with a mandatory sinking fund should be listed ahead of preferred stock without a mandatory
sinking fund.
C. Some preferred stock carries a call provision that allows the company to repurchase the shares for a specified price
or at a specific time. Preferred stock that is repurchased is retired.
D. Refunding is the redemption of a bond by raising more funds through another bond that is issued to pay off
the first bond. When a company conducts a refunding operation, it recalls its existing bonds from the market
and sells the new bond. Refunding may be done because the bonds are nearing maturity or because interest
rates have fallen. Refunding is not an option for the retirement of preferred stock.
A. Income bonds are different from other types of bonds because they pay interest only when the company
achieves a given level of net income. This means that for the holder of interest bonds, there is a chance that
they will not receive interest every year.
B. Income bonds do not promise a return to the bondholder and no bonds are junior to preferred and common
shareholders. All bondholders are senior to(c) HOCK
both international,
preferred and commonpage 51
shareholders in the order of priority upon
liquidation.
C. Income bonds pay interest only if there are sufficient profits. Therefore, the bondholder is not guaranteed an income
Part 2 : 01/14/19 11:24:21
B. Income bonds do not promise a return to the bondholder and no bonds are junior to preferred and common
shareholders. All bondholders are senior to both preferred and common shareholders in the order of priority upon
liquidation.
C. Income bonds pay interest only if there are sufficient profits. Therefore, the bondholder is not guaranteed an income
over the life of the bond.
D. Income bondholders and all bondholders for that matter are senior to both preferred and common shareholders in
the order of priority upon liquidation.
Question 66 - CFM Sample Q. 10 - L-T Financial Management-Financial Instruments
A. Because $50,000,000 is minuscule in the debt markets.
B. Because the diversity decreases, not increases, risk.
C. As a larger proportion of an entity's capital is provided by debt, the debt becomes riskier and more
expensive. Hence, it requires a higher interest rate.
D. Because the combination alternative maintains the same debt-equity mixture, which would not warrant a rate
increase in the cost of debt or equity.
A. This is the book value of the equity in the company. The market value of a company is different from its book value.
B. This is the company's operating income multiplied by the industry price/earnings ratio. "Earnings" as used in the
price/earnings ratio refers to income available to common stockholders, or net income in this case.
C. This is the company's sales multiplied by the industry price/earnings ratio. This is not the correct way to calculate the
market value of a business.
D.
The price/earnings ratio is the price of one share of a company's stock divided by the earnings per share of
the company. However, the same ratio can be calculated for the company as a whole and used to value the
company. The market value of all the shares of stock outstanding divided by the company's net income
available to common stockholders is equivalent to the P/E ratio except it is for all the shares of stock
outstanding, not just one share.
In this question, we know the net income available to common stockholders ($200,000), and we know the
target P/E ratio (20, the average P/E ratio of the industry in which the company operates). The market value of
all the shares of stock outstanding (the price of one share multiplied by the number of shares outstanding) is
therefore $200,000 × 20, or $4,000,000.
Question 68 - HOCK CMA P2 SDV4 - L-T Financial Management-Financial Instruments
A.
$13.80 is the projected Year 3 dividend divided by the Year 3 growth rate.
B. This is the Year 3 dividend divided by the difference between the investors' required rate of return and the growth
rate, as in the Dividend Growth Model. This is only one part of the calculation needed to determine the appropriate
market price for the stock.
Part 2 : 01/14/19 11:24:21
$13.80 is the projected Year 3 dividend divided by the Year 3 growth rate.
B. This is the Year 3 dividend divided by the difference between the investors' required rate of return and the growth
rate, as in the Dividend Growth Model. This is only one part of the calculation needed to determine the appropriate
market price for the stock.
C.
Finding the market price of this stock requires the use of the 2-stage dividend discount model, since the
annual rate of growth in the dividend is expected to be 25% for two years and then decrease to 10%.
The first step is to find the present values of the dividends to be received during the first two years and sum
the results. The Year 2 dividend is 125% of the Year 1 dividend.
Present Value
End of Year Dividend PV Factor @ 16% of Dividend
1 $1.00 0.862 $ 0.862
2 1.25 0.742 0.929
PV of future dividends - Years 1 and 2: $1.791
We next project the dividend for Year 3 by multiplying the Year 2 dividend ($1.25) by 1 + the growth rate for
Year 3 (1.10). The Year 3 dividend is therefore projected to be $1.25 × 1.10, or $1.38.
Now, we use the Constant Growth Model (Dividend Growth Model), and we pretend that Year 3 is Year 1, and
so the end of Year 2 becomes Year 0. We use this model to calculate what the value of the stock will be at the
end of Year 2, assuming a required rate of return of 16% and an annual growth in dividends of 10% going
forward from the end of Year 2, beginning with Year 3:
P2 = d3 / (r − g)
P2 = $1.38 / (0.16 − 0.10)
P2 = $23.00
This present value of $23.00 occurs at the end of Year 2, not at Year 0. Therefore, it needs to be discounted
back 2 years to Year 0. We will discount it back as though it is a single sum that will be received in 2 years.
The present value of $1 factor for 2 years at 16% is 0.743, so the present value of $23.00 two years from now is
$23.00 × 0.743, or $17.09. This is the present value as of Year 0 of the dividends to be received beginning at
the end of Year 3 and continuing indefinitely.
The final step is to add together the present value of the future dividends for Years 1 and 2 ($1.79) and the
present value of the dividends to be received from Year 3 to infinity ($17.09) to calculate the value today, at
Year 0, for a share of this stock:
$1.79 + $17.09 = $18.88
$18.88 is an appropriate market price for this stock, given the projected dividends and the 16% required rate of
return by investors in the stock.
D. $4.00 is the current annual dividend divided by the current rate of growth.
A. Debentures are bonds that are not supported by any collateral. They are not a form of collateral similar to trust
certificates that do have collateral.
B. Debenture bonds are bonds that do not have collateral behind them. Debenture bonds have the same rank as other
bonds. (c) HOCK international, page 53
C. Debentures are a type of bond that have no collateral behind them. They are supported only by the
company that has issued these bonds, and their full faith and credit.
Part 2 : 01/14/19 11:24:21
B. Debenture bonds are bonds that do not have collateral behind them. Debenture bonds have the same rank as other
bonds.
C. Debentures are a type of bond that have no collateral behind them. They are supported only by the
company that has issued these bonds, and their full faith and credit.
D. Debenture bonds are bonds that do not have collateral behind them. The payment of interest only when earnings
permit is a characteristic of an income bond.
A. A stock's dividend does not automatically change just because its investors' required rate of return changes.
B. The current investors' required rate of return for this stock is 5%, calculated as $2.50 ÷ $50.00. If the investors'
required rate of return increases to 8%, the price of a share of stock will go down, not up.
C.
The present investors' required rate of return at a share price of $50.00 and an annual dividend of $2.50 is 5%.
Using the perpetual annuity model, it is calculated as $2.50 ÷ $50.00, which is 0.05.
If the investors' required rate of return increases to 8%, the equation to solve to calculate the new share price
is $2.50 ÷ X = 0.08. Solving for X, we get X = $31.25, and that will be the new share price.
D. The share price will adjust so that purchasers of the stock will receive a return of 8% on their investment.

2 L-T Financial Management - Financial Instruments

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Part 2 : 01/14/19 11:24:21

Question 1 - CMA 691 1.5 - L-T Financial Management-Financial Instruments

Short-term interest rates are

A. Not significantly related to long-term rates.

Question 2 - ICMA 10.P2.111 - L-T Financial Management-Financial Instruments

Question 3 - CMA 692 1.12 - L-T Financial Management-Financial Instruments

Question 4 - CMA 1291 1.7 - L-T Financial Management-Financial Instruments

A. protects investors against margin calls.

Question 5 - CMA 1288 1.8 - L-T Financial Management-Financial Instruments

(c) HOCK international, page 1

Question 6 - ICMA 13.P2.068 - L-T Financial Management-Financial Instruments

Question 7 - CMA 689 1.6 - L-T Financial Management-Financial Instruments

A. 2,400 additional shares.

Question 8 - CMA 689 1.1 - L-T Financial Management-Financial Instruments

Question 9 - ICMA 08.P3.029 - L-T Financial Management-Financial Instruments

Frasier Products has been growing at a rate(c)

Question 9 - ICMA 08.P3.029 - L-T Financial Management-Financial Instruments

Question 10 - CIA 593 IV.56 - L-T Financial Management-Financial Instruments

A. The company is experiencing cash flow problems.

Question 11 - CMA 689 1.4 - L-T Financial Management-Financial Instruments

Question 12 - CMA 696 1.1 - L-T Financial Management-Financial Instruments

The value of a right while the stock is still trading rights-on is

Question 13 - CIA 1192 IV.47 - L-T Financial Management-Financial Instruments

Question 14 - HOCK CFMQ8 - L-T Financial Management-Financial Instruments

Question 15 - CMA 1288 1.7 - L-T Financial Management-Financial Instruments

Question 16 - CIA 1190 IV.53 - L-T Financial Management-Financial Instruments

A. The firm's liquidity.

Question 17 - CMA 695 1.6 - L-T Financial Management-Financial Instruments

IV. The bond sells at a premium.

V. The bond sells at a discount.

V. The bond sells at a discount.

Question 18 - ICMA 13.P2.023 - L-T Financial Management-Financial Instruments

What variable is measured on the horizontal axis of the yield curve?

A. Par value of the bonds.

Question 19 - CMA 689 1.8 - L-T Financial Management-Financial Instruments

Question 20 - ICMA 10.P2.124 - L-T Financial Management-Financial Instruments

A. The date that is chosen to determine the ownership of shares.

Question 21 - CMA 695 1.2 - L-T Financial Management-Financial Instruments

A. A convertible bond must be converted to common stock prior to its maturity.

Question 22 - ICMA 10.P2.126 - L-T Financial Management-Financial Instruments

A. it may be callable at the option of the corporation.

Question 22 - ICMA 10.P2.126 - L-T Financial Management-Financial Instruments

All of the following are characteristics of preferred stock except that

A. it may be callable at the option of the corporation.

Question 23 - ICMA 10.P2.073 - L-T Financial Management-Financial Instruments

Question 24 - HOCK CFMQ4 - L-T Financial Management-Financial Instruments

Question 25 - CIA 589 IV.56 - L-T Financial Management-Financial Instruments

A call provision in a bond indenture

Question 26 - CIA 593 IV.49 - L-T Financial Management-Financial Instruments

Question 27 - ICMA 10.P2.072 - L-T Financial Management-Financial Instruments

Question 28 - CMA 1291 1.6 - L-T Financial Management-Financial Instruments

A major use of warrants in financing is to

A. maintain managerial control.

Question 29 - CMA 695 P1 Q13 - L-T Financial Management-Financial Instruments

Question 29 - CMA 695 P1 Q13 - L-T Financial Management-Financial Instruments

A. 3,774 additional shares.

Question 30 - CMA 1288 1.9 - L-T Financial Management-Financial Instruments

Question 31 - CFM CH19 II.12 - L-T Financial Management-Financial Instruments

Question 32 - CMA 695 1.5 - L-T Financial Management-Financial Instruments

I. The incremental future after-tax cash flow from operations

A. I, II, and III.

Question 33 - HOCK CFMQ5 - L-T Financial Management-Financial Instruments

A. The share price would go down to $2.25.

Question 34 - HOCK LTF 112 - L-T Financial Management-Financial Instruments