Cma-P3-Su08

Front 1

Which of the following obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and
the bond rating is downgraded?

1- Poison put clause
2- Cross-default clause
3- Affirmative covenant
4- Negative pledge clause

Back 1

Correct Answer A.

A poison put clause is a covenant that obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and the bond rating is downgraded. This type of bond covenant is used as a defensive strategy to prevent hostile takeovers.

Front 2

All of the following may reduce the coupon rate on a bond issued at par:

a- sinking fund.
b- restrictive covenant.
c- call provision.
d- change in rating from Aa to Aaa.

Back 2

Answer C

Of all the solutions offered, only one would have the possible effect of reducing the coupon rate of a bond. All the others would have the effect of increasing the coupon rate of a bond. The change in the coupon rate of a bond would depend on whether the added clause is a benefit to the issuing corporation or a benefit to the investor. A clause benefiting the issuing corporation would have the effect of increasing the bond rate. A clause benefiting the investor would have the effect of decreasing the bond rate, essentially trading one benefit for another from the perspective of the investor. In this problem, only a call provision is a benefit to the issuing corporation. It gives the corporation the right to call in the bond for redemption. If interest rates decline, the corporation can call in the bonds and replace them with lower-interest bonds.

Front 3

What type of covenant enables a lender to get out of a loan if the borrower fails to meet its obligations on any debt issue?

a- Poison put clause
b- Cross-default clause
c- Affirmative covenant
d- Negative pledge clause

Back 3

Answer B

A cross-default clause is a covenant that enables a lender to get out of a loan if the corporation fails to meet its obligations on any debt issue.

Front 4

What can be said about the market price of a bond if the effective rate of interest is greater than the stated rate of interest?

a- The market price is greater than the par value of a bond.

b- The market price is equal to the par value of a bond.

c- The market price is less than the par value of a bond.

d- There is insufficient information.

Back 4

Ans. C

When the effective rate of interest is greater than the stated rate of interest, the market price the par value of a bond.

Front 5

Depending on the state of incorporation, which of the following is not a type of common stock that can be issued by a corporation?

a- Par value
b- Stated value
c- No par value/no stated value
d- Guaranteed value

Back 5

d- Guaranteed value

Guaranteed value is a type of common stock. Depending on the state of incorporation, three types (par value, stated value, and no par
value/no stated value) are types of common stock that can be issued by a corporation.

Front 6

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- does not receive any additional benefit from a rights offering.

B- receives an additional benefit from a rights offering.

C- merely receives a return of capital.

D- should redeem the right and purchase the stock before the ex-rights date.

Back 6

A - share owner receives benefits from a rights offering if:

Right Price (RP) = Rights on Share Market Price - Subscription Price ÷ Before Ex-Rights Day 1 + Number of Rights per Purchased Share

$2.00 = ($50 - $40)/(1 + N)
$2.00 (1 + N) = $10
$2.00N + $2.00 = $10
$2.00N = $8
N = $8/$2 = 4

After the ex-rights date, the value of the Right is sold separately and the value of the right is:

Right Price (RP) = Rights on Share Market Price - Subscription Price ÷ After Ex-Rights Day = Number of Rights per Purchased Share

RP = ($50 - $40)/4
= $10/4 = $2.50

If the stock is theoretically worth $47.50 after it goes ex-rights, then the shareholder does not receive any additional value from the rights
offering as the market value of the share ($50) is equal to the price of the share ex-right ($47.50) + the value of the rights after the ex-rights day ($2.50).

Front 7

An example of a poison pill, a form of takeover defense, is:

A- the selling off of profitable units in an attempt to dissuade the hostile corporate raider.

B- the issuance of rights that allow shareholders to purchase stock in the proposed merged company at a substantial discount.

C- the act of substantially increasing a company's debt.

D- an agreement to buy back from the hostile raider a large block of stock at a premium.

Back 7

A poison pill is a strategic act that may be performed by a company targeted for takeover. It is done in hopes of making the takeover less
attractive to the acquiring company. One way to create this defense is to create a situation that will raise the cost of the takeover. The issuance of rights allowing shareholders to purchase stock in the proposed merged company at a substantial discount will raise the potential cost of a takeover. Consequently, this is an example of a poison pill.

Front 8

Baylor Company paid out one-half of its 20X1 earnings in dividends. Baylor's earnings increased by 20%, and its dividend increased by 15% in 20X2. Baylor's dividend payout ratio for 20X1 was:


A- 75.0%.
B- 52.3%.
C- 47.9%.
D- 95.8%.

Back 8

C is correct.

Dividend payout ratio = Dividend per share / Earnings per share


20X1 Dividend/Payout ratio =
.50 / 1.00

20X2 Dividend/Payout ratio = (.50)(1.15) / (1.00)(1.20)
= .575 / 1.20
= .479
= 47.9%

Front 9

Which one of the following factors is correct with respect to a rights offering to current shareholders?

A- Shares issued through a rights offering have lower cash flotation costs than those associated with a public offering.

B- A rights offering increases the likelihood of a favorable reception to the issue of new stock.

C- The margin requirements for stock purchased by the use of rights are lower than for stock purchased without the use of rights.

D- The issue of rights has no impact on the market value of the common stock.

Back 9

D is correct

Shares purchased through a rights offering give shareholders the right to maintain their proportional share of ownership in a company by
purchasing shares in any newly authorized issues of stock. This right is a benefit to the market value of the stock because shareholders have more control over possible dilution of their shares. The other answer choices are all correct with regard to rights offerings.

Front 10

Which one of the following events will likely result in a higher price-earnings ratio for a company's common shares?

A- The investors' required rate of return on the common shares falls.

B- The rate of growth in dividends is expected to decline.

C- The economy is expected to enter a recession.

D- The dividend yield increases when the dividend per share remains unchanged.

Back 10

A is correct.

The price-earnings (P/E) ratio equals the market price per share of a company's common stock divided by the earnings per share. If investors' required rate of return on the common shares falls, the stock price as well as the P/E ratio will increase, according to the Capital-Asset Pricing Model (CAPM) and the dividend discount model. If the rate of growth of dividends is expected to decline, the market price of the stock is expected to decline. In addition, if the economy enters a recession, the risk of the declining market price of the stock is increasing, which will lead to a lower P/E ratio. Finally, if the dividend yield increases while the annual dividend remains constant, the stock market price as well as the P/E ratio are expected to decline.

Front 11

A financial manager generally prefers to issue preferred stock rather than debt because:

A- payments to preferred stockholders are not considered fixed payments.

B- the cost of fixed debt is less expensive as it is tax deductible even if a sinking fund is required to retire the debt.

C- the preferred dividend is often cumulative whereas interest payments are not.

D- in a legal sense, preferred stock is equity; therefore, dividend payments are not legal obligations.

Back 11

D is correct:

Preferred stock has two advantages over debt. The main advantage is that interest payments must be paid on debt while dividend payments, although generally made, are not legal obligations and may be delayed or canceled if necessary. Also, once debt is incurred, the principal must generally be repaid, whereas companies are not obligated to repurchase stock issued.

Front 12

Preferred stock has features that are characteristics of both equity and debt instruments. When analyzing the financial structure of a company with preferred stock, the party that would look at the preferred stock of the company more as a debt instrument than as an equity instrument is:


A- a bank holding a short-term note of the company.

B- a holder of the company's bonds.

C- a potential common shareholder of the company.

D- an employee of the company.

Back 12

C is correct:

A common shareholder would view preferred stock as a debt instrument because a common shareholder's ownership in a company is the
residual equity that remains after the liabilities of bondholders and preferred stockholders are subtracted. The common shareholder's ownership is subordinate to the claims of debt holders and preferred stockholders.

Front 13

Disclosed regarding financial instruments with off-balance-sheet risk of accounting loss?

Back 13

The following items must be disclosed regarding financial instruments with off-balance-sheet risk of accounting loss:

1- Accounting loss incurred if any party to the instrument failed completely to perform and the collateral proved to be of no value

2-Face or contract amount.

3- Instrument's nature and terms, including credit risk, market risk, cash requirements, and related accounting policies

4- Entity's policy for requiring collateral it accepts, and a description of collateral on instruments presently held

Front 14

A company enters into an agreement to make a payment today in exchange for the possibility of receiving future payments if a reference
interest rate (e.g., LIBOR) exceeds a specific level on various settlement dates specified in the contract. The company holds:


A- an interest rate collar.
B- an interest rate floor.
C- a swaption.
D- an interest rate cap.

Back 14

D is correct.

An interest rate cap is a contract that calls for receiving payments if a reference interest rate exceeds the specified limits on various settlement dates specified in the contract.

An interest rate floor is a contract that calls for payments if a reference interest rate falls below the specified rate on various settlement dates specified in the contract. An interest rate collar combines a cap and a floor and calls for payments if the reference interest rate exceeds the upper (cap) rate and/or falls below the lower (floor) rate on various settlement dates as specified in the contract.

A swaption provides the right to enter into an interest-rate swap at a specified interest rate before an expiration date.

Front 15

The intrinsic value of an at-the-money put option is equal to which of the following?

A- The premium paid for the put

B- The exercise price minus the stock price

C- Zero

D- The strike price

Back 15

C is correct.

For an at-the-money put option, the stock price is equal to the exercise price. The intrinsic value of an option is equal to the stock price minus the exercise price of the option. In this example, that is equal to zero.

Front 16

If a borrower wants to cap short-term floating rate bond costs, they can make a cap by purchasing a:

A- put.
B- call.
C- warrant.
D- right.

Back 16

A is correct.

Options are derivative securities that involve the right to purchase or sell assets or financing rates over a specified time period. Call options relate to purchase rights while options relate to sale of rights.

A borrower can place a cap or maximum on short-term floating bond costs by purchasing an interest rate

Front 17

You wish to devise a strategy to reduce interest-rate risk. If you are concerned with immunizing your portfolio against both favorable and interest rate movements, you could purchase ________. If you were only concerned about immunizing your portfolio against unfavorable interest rate movements, you could purchase ________.


A- a Treasury bond future; a Treasury bond

B- a Treasury bond future; an option on Treasury bonds

C- an option on Treasury bondsl; a Treasury bond future

D- a Treasury bond; an option on Treasury bonds

Back 17

Treasury bond futures contracts protect the holder against both favorable and unfavorable price movements. There is an inverse relationship between bond prices and yields (i.e., when bond prices fall, yields rise, and vice versa). If the investor purchases a T-bond future and if interest rates rise, the value of the bonds in the portfolio would decline. This would be offset by a corresponding increase in the price of the futures contract. The reverse would be true if interest rates fall. Thus, the holder of the futures contract is protected from both favorable and unfavorable interest rate moves. The holder does, however, give up the opportunity to profit from favorable interest rate moves.



If the financial manager is worried about interest rates rising before their new debt offering comes to market, it would be possible to lock in
current interest rates by purchasing a put option on a T-bond. If the financial manager is worried about rising interest rates causing a decline in the value of the bond portfolio, it would be possible to immunize the portfolio by purchasing a put option on a T-bond. In both instances, the financial manager is protected against unfavorable interest rate movements but retains the possibility of benefiting from favorable interest rate moves.

Front 18

Which of the following related to the concept of marking-to-market is true?

A- Investors in futures contracts cannot realize their profit derived from having the contract marked-to-market until the contract
matures.

B- As futures prices change, the proceeds of the gains (or losses) are immediately placed in the individual investors margin
account and are available for use.

C- Marking-to-market is required due to the convergence principle which forces the spot price to be equal to the futures price on
the day the contract matures.

D- Both B and C are correct.

Back 18

B is correct

As futures prices change, both gains and losses are immediately accrued to investor accounts daily by the clearing house.

While it is true that the spot price and futures price converge as the contract matures, this is not the reason that futures are marked-to-market on a daily basis.

Marking-to-market is designed to ensure that traders maintain sufficient margin. If, after the daily losses are charged to an individuals account, the margin balance falls below a critical value (i.e., the maintenance margin level), the investor would receive a margin call.

Front 19

Which of the following is a correct description of a strength (+) or a weakness (-) of the Black-Scholes on Binomial option pricing model?

A- Binomial option price model (+): It can be used to accurately price American options where the stock pays a dividend.

B- Black-Scholes model (+): It is fast and allows for the accurate pricing of a large number of options in a short period of time.

C- Black-Scholes model (-): It cannot be used to accurately price American options when there is a probability of early exercise.

D- Binomial option pricing model (-): When the number of time periods increase, the results of the binomial option pricing model
approximates that of the Black-Scholes model.

Back 19

D is correct.

While Answer D describes a relationship between the Black-Scholes and binomial option pricing model, it is neither a strength or a weakness of the model. This result is strictly a mathematical relationship.

Answer A describes a strength of the binomial option pricing model since when the stock pays a dividend there is a possibility of early exercise, and the binomial model makes it possible to check every point in the option's life and to adjust the price to equal the intrinsic value of the option at that point.

Answer B describes a strength of the Black-Scholes model.

Answer C describes a limitation of the Black-Scholes model since it calculates the option price only at one point in time its expiration. It does not consider points along the way when early expiration might occur. Since all exchange traded options are American-style and can be exercised prior to maturity, this is a significant limitation. An American-style call option on a nondividend paying asset is the equivalent of a

Front 20

The holder of a put option for a particular common stock would make a profit if the option is:

A- exercised during the option term after the stock price has declined below the strike price of the put.

B- exercised during the option term after the stock price has risen above the put price.

C- held through the term of the option, at which time the stock price is lower than at the time of purchase.

D- held through the term of the option, at which time the stock price is higher than at the time of purchase.

Back 20

A is correct

A put is an option to sell a specific security at a specified price within a designated period. Thus, the holder of a put option for a particular common stock would make a profit if the option is exercised during the option term after the stock price has declined below the put price.

If the stock price rises, the put option has no value and is simply allowed to expire.
The put option is exercisable only during a predetermined period. It has no value after its term has expired.

Front 21

Which of the following is true about the value of the call feature within an option pricing context?

A- Value is constrained on the upside by the call price for a callable bond.

B- The greater the volatility of future interest rates, the smaller the value of the call option to the issuing firm.

C- The company issuing callable debt will want to have a policy that minimizes the value of the bonds to the bondholders.

D- The greater the volatility of future interest rates, the greater the value of the call option to the issuing firm.

Back 21

D is correct

The greater the volatility of future interest rates, the greater the value of the call option to the issuing firm.

Front 22

A call option gives the holder the right to purchase an asset at a specified price, called the ________ price, before some specified date. The purchase price of the option is called the ________, while the exercise price of the option minus the current stock price is known as ________. Finally, the difference between the actual call price and its intrinsic value is known as the ________ of the option.


A- Exercise; premium; intrinsic value; time value

B- Exercise; cost; time value; intrinsic value

C- Strike; premium; market value; intrinsic value

D- Strike; cost; intrinsic value; exercise value

Back 22

The of an option is the specified price at which the holder of a call option has a right to purchase the asset. The purchase price of the option is known as the and the difference between the exercise price and the current stock price is know as the of the option. The difference between the current price of the option and its intrinsic value is the of the option.

Front 23

Great Tiger Shops has a convertible debenture outstanding with a conversion ratio of 25. The call premium on the debenture is 10%, the current market price of the stock would have to be ________ for the company to force conversion.


A- $30.00
B- $36.67
C- $40.00
D- $45.00

Back 23

D is correct.

Current Market Value =

(Face Value of Debenture x 1.10) / Conversion Ratio

= $1,000 x 1.10) / 25
= $1,100 / 25
= $44.00

Of the answer choices given, only the $45 price is higher than the required market price to force conversion, so it is the only correct answer.

Front 24

Which of the following is a statement about leveraged leases?

A- They include a third-party creditor in addition to the lessee and the lessor.

B- They would be classified as a sales-type lease if they were not a leveraged lease.

C- They are leases where the purchase of the leased asset is financed largely by the lessee with nonrecourse debt.

D- They provide depreciation expense, interest expense, and tax benefits for the lessee.

Back 24

A is correct.

A leveraged lease is one that involves a lessee, a lessor, and a third-party creditor. The lessor obtains financing from the third-party creditor, purchases the property to be leased, and immediately leases it to the lessee.

Front 25

Initial direct costs are incurred by the lessor and may be classified as incremental direct costs and initial direct costs. According to SFAS 13, Accounting for Leases, all of the following costs are examples of initial direct costs the costs of:

A- evaluating the prospective lessee's financial condition.

B- evaluating collateral and security arrangements.

C- establishing and monitoring credit policies.

D- negotiating lease terms.

Back 25

C is correct

Establishing and monitoring credit policies is considered a direct cost as it does not apply to a particular lease but to company policies.

The following costs examples of initial direct costs for leases:


1- Evaluating the prospective lessee's financial condition
2- Evaluating collateral and security arrangements
3- Negotiating lease terms
4- Closing the lease transaction

Front 26

The market value of a warrant approaches its theoretical value:

A- the shorter the time to expiration of the warrant.

B- the smaller the dividend paid on the stock.

C- the lower the market price of the stock.

D- the higher the exercise price.

Back 26

A is correct.

The market value of a stock warrant approaches its theoretical value as the time to expiration becomes shorter.

Front 27

What does a dated retained earnings mean?


A- The total amount of earnings since incorporation

B- The total amount of undistributed earnings since incorporation

C- The total amount of distributed earnings since incorporation

D- The total amount of undistributed earnings since corporate restructuring

Back 27

D is correct.

The total amount of undistributed earnings since corporate restructuring

Front 28

When convertible debt is converted into common stock:

Back 28

Unamortized bond premium or discount, unamortized issue costs, and conversion costs are charged to the paid-in capital
account in excess of the par value of the common stock issued.

Front 29

There are many similarities between lessee and lessor accounting for the capitalization of leases. Which one of the following is a criterion for the capitalization of a lease by a lessee?

A- The lease transfers ownership of the property to the lessee by the end of the lease term.

B- The lease term is at least 90% of the remaining life of the asset at the beginning of the lease.

C- The present value of the minimum lease payments is 75% or more of the fair market value of the leased asset.

D- Future costs are reasonably predictable.

Back 29

A is correct.

The following four criteria apply to both the lessee and the lessor. If a lease meets any one of the criteria, it is classified as a capital lease by the lessee and by the lessor, assuming that the other two criteria for lessors are met.

1. The lease transfers ownership of the property to the lessee by the end of the lease term.
2. The lease contains a bargain purchase option.
3. The lease term is equal to 75% or more of the estimated economic life of the leased property.
4. The present value of the minimum lease payments excluding that portion representing executory costs equals or exceeds 90% of the fair
market value of the property.

The following two criteria must be met by lessors in order to capitalize a lease:

1. Collectibility of the minimum lease payments is reasonably predictable.
2. No important uncertainties surround the amount of unreimbursed costs yet to be incurred by the lessor.

Front 30

A firm is planning to issue a callable bond with an 8% coupon rate and 10 years to maturity. A straight bond with a similar rate is priced at $1,000. If the value of the issuer’s call option is estimated to be $50, what is the value of the callable bond?

A. $1,000
B. $1,050
C. $950
D. $900
 

Back 30

Answer (C) is correct.

A callable bond is not as valuable to an investor as a straight bond. Thus, the $50 call option is subtracted from the $1,000 value of a straight bond to arrive at a $950 value for the callable bond.

Front 31

Growl Corporation’s $1,000 par value convertible debentures are selling at $1,040 when its stock is selling for $46.00 per share. If the conversion ratio is 20,

what will be the conversion price?

A. $22.61
B. $52.00
C. $50.00
D. $46.00

Back 31

Answer (C) is correct . The conversion price is the assumed price of the stock, which was set at the time the bonds were issued. Dividing the $1,000 face value by the 20 shares results in a conversion price of $50.

Front 32

Which one of the following describes a disadvantage to a firm that issues preferred stock?

A- PS dividends are legal obligation.

B- PS typically have no maturity data.

C- PS is usually sold on a higher yield basis than bonds.

D- Most PS are owned by corporate investors.

Back 32

C is correct.