Chapter 06

Question 1

2 categories into which “financial markets” are divided

Answer 1

1. money mkts - maturities of < 1 yr
2. capital mkts - maturities > 1 yr (largest)
   
   • debt - “fixed-income” capital (bonds, term loans)
   • equity - no maturity (pref/comm stock)

Question 2

“state-owned enterprises” (SOE)

Answer 2

firm nat’nl govt. creates and owns (wholly/partially) to participate/support commercial activities on govt’s behalf; raises capital via debt securities (no stock)

• US: Freddie Mac, Fannie Mae
• Canada: Canada Post, VIA Rail Canada
• China: Sinosteel Corp

Question 3

sub-sovereign bonds

Answer 3

bond issued by govt., below nat’nl/ central govt.

• US: issues municipal bonds (aka “munis”)
  
  • interest paid to investors is tax exempt to the entity
• Revenue bonds: funds a special project (stadium, toll road) and is repaid via revenues generated from the project/svcs. (i.e. Term loans Tax increment financing (TIF) bonds (mortgage bonds))

Question 4

Key capital mkt regulators in the US include:

Answer 4

1. SEC
2. FINRA
3. MSRB (Municipal Securities Rulemaking Board)

Question 5

Private mkt (or direct placement)

Answer 5

• securities are not underwritten but are sold to a limited group of institutional investors
• provisions: can be tailored to meet all’s needs
• typically do not require a detailed prospectus; thus, may be exempt from regist. with local authorities (i.e. SEC in US, Fin. Conduct Authority in UK)
• completed more rapidly than a public offering

Question 6

Mortgage bonds

Answer 6

• to finance specific assets (e.g. real estate), usually pledged as collateral
• usually include substantial financial covenants or indenture agreements (protect bondholders’ interests by restricting mgmt’s actions)

Question 7

Warrants

Answer 7

attached to bonds to increase investors’ interest in the purchase but may be traded separately from the bonds on a secondary market

Question 8

Why have FIs been heavy issuers of preferred stock?

Answer 8

• most regulatory authorities count preferred stock as regulatory capital, helps the FI
• rating agencies like use of pref. stock.

who else likes pref. stock? companies that are young, high growth, in financial distress.

Question 9

Bond call provisions

Answer 9

allows bond issuer to “call” (redeem) a bond/security prior to its original maturity.

• investors require higher coupon rates
• call premium usually paid when bond is called (usually set on a sliding scale; earlier = larger)
• great for issuers expecting rates to drop

Question 10

Floating rate debt

Answer 10

investors prefer during periods of rising interest rates

• FRN provides stable market value
• matches current interest rates.

Borrowers prefer floating-rate debt when they expect future rate drops

Question 11

Securitization

Answer 11

assets (e.g. inventory, AR) can be bundled to collateralize securities

• more liquid = more attractive, to investors
• e.g. CP and high-yield (junk) bonds

Question 12

qualified institutional investors (QIIs)

(aka “qualified institutional buyers (QIBs)” in the US)

Question 13

Guarantee of payment or collection

Answer 13

guaranteeing party (usually parent entity) guarantees to repay the loan or collect payment from the subsidiary, only when subsidiary formally defaults on the loan.

usually requires lenders initiate default proceedings on subsidiary and attempt collection efforts before

Question 14

bond indenture

Answer 14

legal doc/contract, outlines borrower’s and creditor’s rights/obligations

• provisions (e.g. representations, warranties) - conditions that existed @ time of execution
• est. covenants (limits mgmt’s actions); may be
  
  • negative (i.e., actions company cannot take, like double pledging collateral) or
  • affirmative (i.e., actions company must take, like provide regular fin stmts, maintain certain ratios)
    *

Question 15

Eurobonds (sometimes called External Bonds)

Answer 15

an int’nl bond, denominated in a ccy other than that of the country in which it is issued

• named per face ccy (e.g. Euroyen, Eurodollar)
  e. g.: a Eurodollar bond, dominated in USD, issued in India, by a UK-based company.

Question 16

Foreign bond

Question 17

Multicurrency bond

Answer 17

gives investor a choice of ccy for redemption

protects investor from possible, negative changes in FX rates between investment and redemption

(CHECK THIS)

Question 18

Income bonds

Answer 18

pay interest only if a company has profits, thus reducing some of the issuer’s risk of issuing debt.

Question 19

From the issuer’s POV, the main advantages of issuing pref. stock is…

Answer 19

• raise new capital
• lock in financing costs
• potentially leverage the return to comm shareholders due to fixed nature of the preferred dividends
• avoid increasing default risk

Question 20

promissory note

Answer 20

legal portion of the debt contract

an unconditional promise to pay a specified amount plus interest at a defined rate either on demand or on a certain date

Question 21

Key benefits of preferred stockholders

Answer 21

• dividends usually accumulate in arrears (must pay before any returns to comm shareholders)
• most have a provision to grant voting rights and/or right to elect a rep. to the board, if a specified sequence of dividends is missed.
• Participation in earnings usually granted only if earnings > certain level.
• more predictable revenue stream for an investor, vs. comm stock.

Question 22

Organized exchanges: list 4 principal benefits

Answer 22

• fair
• competitive (price set by supply &demand)
• minimal price volatility due to frequent trading
• deeper capital mkts. (i.e. issuers can raise large $ capital via securities offerings)

Question 23

high-yield bonds

Answer 23

aka “junk” or “below-investment-grade” bonds

higher interest rate bonds, issued by less credit worthy entities

• Rated BB or less (S&P) or
• Ba1 or less (Moody’s)

Question 24

convertible debt

Answer 24

• investor may convert bonds into shares of issuer’s stock
• advantageous for the issuer since they usually provide for lower interest rates and fewer restrictive covenants on the debt, in exchange

Question 25

Book value per share =

Answer 25

**= total book value of common equity / # of comm. shares outstanding** ## Footnote (e.g. par value of $200 + $400 in RE + $4,000 APIC = $4,600... / 200 shares outstanding = $2.30 book value per share.

Question 26

Over-the-counter (OTC) markets

Answer 26

securities firms conduct auction-style trading btwn. broker/dealers via e-comms. * govt., municipal, corp debt, and some equity issuances not traded on formal exchanges * common in developing countries or EM * *members/securities firms may elect to maintain an inventory of debt/equity securities and stand ready to buy/sell those same securities from investors/other dealers wishing to buy/sell them*