Chapter 12: Long Term External Finance

1. An initial public offer (IPO) is the first issue of capital made to the public

True

False

An initial public offering (IPO) refers to the process where a company offers its shares to the public for the first time. This allows the company to raise capital by selling a portion of its ownership to investors. Therefore, the statement "An initial public offer (IPO) is the first issue of capital made to the public" is true, as it accurately describes the purpose and nature of an IPO.

Explanation

An initial public offering (IPO) refers to the process where a company offers its shares to the public for the first time. This allows the company to raise capital by selling a portion of its ownership to investors. Therefore, the statement "An initial public offer (IPO) is the first issue of capital made to the public" is true, as it accurately describes the purpose and nature of an IPO.

2. Eurobonds are debt securities that are issued

Outside the domestic capital markets of the issuer in a currency that is the domestic currency of the issuer

Eurobonds are debt securities that are issued outside the domestic capital markets of the issuer in a currency that is neither the domestic currency of the issuer nor the domestic currency of the place of issue. This means that Eurobonds are issued in a foreign currency and outside the country where the issuer is located. This allows issuers to access a larger pool of investors and diversify their funding sources. Additionally, issuing in a foreign currency can provide a hedge against currency risk for both the issuer and the investor.

Explanation

Eurobonds are debt securities that are issued outside the domestic capital markets of the issuer in a currency that is neither the domestic currency of the issuer nor the domestic currency of the place of issue. This means that Eurobonds are issued in a foreign currency and outside the country where the issuer is located. This allows issuers to access a larger pool of investors and diversify their funding sources. Additionally, issuing in a foreign currency can provide a hedge against currency risk for both the issuer and the investor.

3. Which of the following statements is false

Corporate bonds always pay semi annual coupons

The face value on corporate bonds is repaid when the bonds mature

Corporate bonds are debt instruments

The issuer of corporate bonds receives the face value of the bonds at issue

Corporate bonds do not always pay semi-annual coupons. While it is common for corporate bonds to have semi-annual coupon payments, it is not a requirement. Some corporate bonds may have quarterly, annual, or even irregular coupon payments. Therefore, the statement that "Corporate bonds always pay semi-annual coupons" is false.

Explanation

Corporate bonds do not always pay semi-annual coupons. While it is common for corporate bonds to have semi-annual coupon payments, it is not a requirement. Some corporate bonds may have quarterly, annual, or even irregular coupon payments. Therefore, the statement that "Corporate bonds always pay semi-annual coupons" is false.

4. In order for firms issuing convertible notes to claim tax deductions on interest payments, which of the following conditions must be met

The interest rate is fixed

Total funds raised from the issue of convertible notes must not exceed $500 million

Conversion must take place two and ten years from the date of issue without exception

Issuers decide when to convert notes to ordinary shares

The correct answer is that the interest rate is fixed. In order for firms issuing convertible notes to claim tax deductions on interest payments, the interest rate must be fixed. This means that the interest rate cannot fluctuate or be subject to change during the term of the notes.

Explanation

The correct answer is that the interest rate is fixed. In order for firms issuing convertible notes to claim tax deductions on interest payments, the interest rate must be fixed. This means that the interest rate cannot fluctuate or be subject to change during the term of the notes.

5. Preference shares are best described as hybrid debt instruments

True

False

Preference shares are not best described as hybrid debt instruments. They are a type of equity security that combines features of both common stock and bonds. While they do have characteristics of debt, such as a fixed dividend payment, they also represent ownership in the company and give shareholders certain voting rights. Therefore, preference shares are more accurately classified as a form of equity rather than debt.

Explanation

Preference shares are not best described as hybrid debt instruments. They are a type of equity security that combines features of both common stock and bonds. While they do have characteristics of debt, such as a fixed dividend payment, they also represent ownership in the company and give shareholders certain voting rights. Therefore, preference shares are more accurately classified as a form of equity rather than debt.

6. Hybrid securities are equity securities which act like debt

True

False

Hybrid securities are financial instruments that combine characteristics of both equity and debt. They typically have features of both stocks and bonds, allowing investors to benefit from potential capital appreciation while also receiving regular income payments. Therefore, the statement that hybrid securities act like debt is incorrect. Instead, they possess characteristics of both equity and debt securities.

Explanation

Hybrid securities are financial instruments that combine characteristics of both equity and debt. They typically have features of both stocks and bonds, allowing investors to benefit from potential capital appreciation while also receiving regular income payments. Therefore, the statement that hybrid securities act like debt is incorrect. Instead, they possess characteristics of both equity and debt securities.

7. Which of the following is not a potential benefit of leasing

Taxation benefits

Increased turnover

Speed in acquisition of assets

Avoidance of obsolescence

Increased turnover is not a potential benefit of leasing because leasing does not directly contribute to increasing sales or revenue. Leasing primarily provides benefits such as taxation advantages, faster acquisition of assets, and avoiding obsolescence. However, increased turnover refers to the ability to generate more sales and is not directly related to leasing.

Explanation

Increased turnover is not a potential benefit of leasing because leasing does not directly contribute to increasing sales or revenue. Leasing primarily provides benefits such as taxation advantages, faster acquisition of assets, and avoiding obsolescence. However, increased turnover refers to the ability to generate more sales and is not directly related to leasing.

8. A person who applies for and buys shares issued under a prospectus and sells them on the first day of trade on the market for a profit is a

Bear

Bull

Stag

Dead cat

A person who applies for and buys shares issued under a prospectus and sells them on the first day of trade on the market for a profit is referred to as a "stag". Stag is a term used in finance to describe an individual who participates in an initial public offering (IPO) by purchasing shares and then quickly selling them for a profit on the first day of trading. Stags aim to take advantage of the potential price increase that often occurs when a company goes public.

Explanation

A person who applies for and buys shares issued under a prospectus and sells them on the first day of trade on the market for a profit is referred to as a "stag". Stag is a term used in finance to describe an individual who participates in an initial public offering (IPO) by purchasing shares and then quickly selling them for a profit on the first day of trading. Stags aim to take advantage of the potential price increase that often occurs when a company goes public.

9. An option is an obligation to undertake a trade by a given date at a given price

True

False

An option is a financial derivative that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified time period. It is not an obligation to undertake a trade, but rather a choice that the holder can exercise if it is advantageous. Therefore, the statement that an option is an obligation to undertake a trade is false.

Explanation

An option is a financial derivative that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified time period. It is not an obligation to undertake a trade, but rather a choice that the holder can exercise if it is advantageous. Therefore, the statement that an option is an obligation to undertake a trade is false.

10. Which of the following statements is true

Subordinated debt ranks above ordinary shareholders in the event of liquidation

Subordinated debt ranks above other similar classes of debt in the event that a firm is liquidated

All of the above

Unsubordinated debt takes a lower ranking than other debt of similar characteristics

Subordinated debt ranks above ordinary shareholders in the event of liquidation because subordinated debt holders have a higher claim on the assets of the company compared to ordinary shareholders. In the event of liquidation, the company's assets are used to repay its debts, and subordinated debt holders are given priority over ordinary shareholders in receiving their share of the remaining assets. This means that subordinated debt holders are more likely to receive some form of repayment compared to ordinary shareholders, who are typically the last to receive any remaining assets after all other debts have been settled.

Explanation

Subordinated debt ranks above ordinary shareholders in the event of liquidation because subordinated debt holders have a higher claim on the assets of the company compared to ordinary shareholders. In the event of liquidation, the company's assets are used to repay its debts, and subordinated debt holders are given priority over ordinary shareholders in receiving their share of the remaining assets. This means that subordinated debt holders are more likely to receive some form of repayment compared to ordinary shareholders, who are typically the last to receive any remaining assets after all other debts have been settled.