midterm 3 conceptual review

conceptual questions from ch 14, 15, & 29 homework's

which if the following statements is false?

• notes typically have longer maturities (more than ten years) than debentures

• although the word “bond” is commonly used to mean any kind of debt security, technically a corporate bond must be secured

• the registered bond system facilitates tax collection because the government can easily keep track of all interest payments made

• asset - backed bonds and mortgage bonds are secured debt, and specific assets are pledged as collateral that bondholders have a direct claim to in the event of bankruptcy

notes typically have longer maturities (more than ten years) than debentures

describe the kinds of securities the US government uses to finance the federal debt

all of the above

• a longer term funding instrument is the Treasury bond with semi-annual coupons and maturities longer than 10 years

• one type of security used by the US government to finance the federal debt is Treasury bills which are pure discount bonds with maturities of one year or less

• TIPS are bonds with coupon payments that adjust with the rate of inflation. the final payment is protected against deflation since the value of the final payment is the maximum between the face value and the inflation-adjusted face value

• Treasury notes, another source of debt funding, are coupon bonds with semi-annual coupon payments and maturities between 1 and 10 years

you are thinking about buying Dovia Co’s convertible bonds. you plan to convert to equity at the end of the year and you think that Dovia’s common equity will be priced at $35 per share at the point. what conversion ration should Dovia’s bonds have in order for you to expect to be able to convert them at the end of the year?

conversion ratio = (cost of conversion)/ 35

what kinds of corporate debt must be secured by real property?

mortgage bonds

which of the following statements is false?

• Eurobonds are international bonds that are denominated in European currency

• global bonds combine the features of domestic, foreign, and eurobonds, and are offered for sale in several different market simultaneously

• in a leveraged buyout (LBO), a group of private investors purchase all the equity of a public corporation

• a term ban is a bank loan that lasts for a specific term

eurobonds are international bonds that are denominated in European currency

which of the following statements is false?

• most debenture issues contain clauses restricting the company from issuing new debt with equal or lower priority than existing debt

• in the event of default, the assets not pledged as collateral for outstanding bonds cannot be used to pay off the holders of subordinated debentures until all more senior debt has been paid off

• because more than one debenture might be outstanding, the bondholders priority is claiming assets in the event of the default, known as the bonds seniority, is important

• when a firm conducts a subsequent issue that has lower priority than its outstanding debt, the new debt is known as a subordinated debenture

most debenture issues contain clauses restricting the company from issuing new debt with equal or lower priority than existing debt

in which of the following situations would the yield to worst for a certain bond be that bonds yield to call?

i. the binds coupon payments are high relative to market yields

ii. the bond price is at a discount

iii. the likelihood of the bond being called is high

I & III

which if the following statements is false?

• the major advantage of undertaking an IPO is also one of the major disadvantages of the IPO: when investors diversify their holding the equity holders of the corporation become more concentrated

• several high profile corporate scandals during the early part of the twenty-first century prompted tougher regulations designed to address corporate abuses

• organizations such as the SEC, the securities exchanges (including NYSE & NASDAQ), and Congress (through the Sarbanes-Oxley Act of 2002) adopted new standards that focused on more through financial disclosure, greater accountability, and more stringent requirements for the board of directors

the major advantage of undertaking an IPO is also one of the major disadvantages of the IPO: when investors diversify their holding the equity holders of the corporation become more concentrated

why do most people launching a start-up company acquire their funds through the venture capital industry rather than through angel investors?

most entrepreneurs do not have many relationships with individuals with substantial capital to invest

which of the following statements is NOT true regarding angel investors?

• they are typically arranged as limited partnerships

• these investors are frequently friends or acquaintances of the entrepreneur

• because their capital investment is often large relative to the amount of capital already in place of the firm, they typically receive a sizable equity share in the business in return for their funds

• for many start-ups, the first rounds of outside private equity is often obtained from them

they are typically arranged as limited partnerships

are the rights of shareholders better protected in the United States or in France?

they are better protected in the United States, the US legal system is based on British common law, which offers considerably more protection to minority shareholders than France civil law does

what are some examples of agency problems?

• excessive perquisite consumption (more company jets/company jet travel, than needed, nicer office than necessary, etc.)

• value destroying acquisitions (that nonetheless increase the pecuniary or non-pecuniary benefits to the CEO on net)

what is a whistle-blower?

an employee who reports internal fraud to authorities

what are the advantages and disadvantages of increasing the options granted to CEOs?

• the disadvantage is that option grants can increase a CEOs incentives to game the system by timing the release of information to fit the option granting schedule or to artificially smooth earnings

• the advantages are that, since options increase in value when the firms stock price increase, the CEOs wealth and incentives will be more closely tied to the shareholders wealth

how can proxy contests be used to overcome a captured board?

• proxy contests are simply contested elections for directors

• in a proxy contest, two competing slates of directors rather than just one slate are proposed by the company

• if a board has become captured or is unresponsive to shareholder demands, shareholders can put their own slate of new directors up for election

• if the dissident slate win, then shareholders will have succeeded in placing new directors, presumably not beholden to the CEO, on the board

what are the boards options when confronted with dissident shareholders?

all of the above

• ignore shareholders, which will result in either the shareholder going away or launching a proxy fight, in which case the board will need to expand resources in an attempt to convince shareholders not to slide with the dissident

• negotiate with dissident shareholder to come to a solution on which the board and the shareholder can agree

• buy out the shareholder

how do laws on insider trading differ from merger-versus non-merger-related trading?

the laws are much stricter for merger-related trading anyone who has information about a pending merger is restricted from trading. non-merger restrictions depend on the source of the material non-public information. if the source is fiduciary duty to the shareholders, then the trading is prohibited

examples of cross-holdings include: I. Japanese heiretsu II. German Gruppe III. Australian foundations IV. korean chaebol

I & IV

how can controlling family use a pyramidal structure to benefit itself at the expense of other shareholders?

because pyramidal structures allow a controlling family to control firms in which they have little actual cash flow rights, the family can use their control to move profits away from firms where they get a small percentage of cash flows to firms in which they can claim a larger fraction of cash flows. for example, they can have one firm sell to another at a reduced price

what are the advantages and disadvantages of the corporate organizational structure?

• the corporate organizational structure form allows those who are the capital to fund an enterprise to be different from those who have the expertise to manage the enterprise

• the critical separation of management and ownership allows a wide class of investors to share the risk of the enterprise

• the separation of management and ownership comes at a cost — the managers will act in their own interest, not in the best interests of the shareholders who own the firm

which of the following statements is false?

• academic studies do not support the notion that greater managerial ownership is associated with fewer value — reducing actions by managers

• while increasing managerial ownership may reduce perquisite consumption, it also makes managers hard to fire — thus reducing the incentive effect of the threat of dismissal

• the relationship between managerial ownership and firm value is unlikely to be the same for every firm or even for different executives of the same firm

• even with the risk benefits of separating ownership and control, there are still examples of corporates in which the top managers have substantial ownership interests

academic studies do not support the notion that greater managerial ownership is associated with fewer value — reducing actions by managers

while the Sarbanes-Oxley Act (SOX) contains many provisions, the overall intent of the legislation was to improve the accuracy of information given to both boards and to shareholders. SOX attempted to achieve this goal in all of the following ways EXCEPT ____.

• mandating the separation of the positions of CEO and chairman of the board

• overhauling incentives and independence in the auditing process

• stiffening penalties from providing false information

• forcing companies to validate their internal financial control processes

mandating the separation of the positions of CEO and chairman of the board

which of the following statements regarding auditors is FALSE?

• in the post Sarbanes-Oxley world, accounting firms are no longer allowed to offer both audit and non-audit services to the same firm

• most accounting firms have developed large and extremely profitable consulting divisions

• in the post Sarbanes-Oxley world, accounting firms are no longer allowed to offer both audit and non-audit services to the same firm