hinsafdar

Preference shares will have the most risk for the investor if the shares are:

A) non-callable and non-cumulative.

B) callable and cumulative.

C) callable and non-cumulative.

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Preference shares (preferred stock) has more risk for the investor if they are non-cumulative than if they are cumulative, because with cumulative preference shares the firm must pay the holder any omitted dividends before it can pay any dividends to common shareholders. Callable shares have more risk for the investor than non-callable shares because the call option limits their potential for price appreciation.

hinsafdar

Other things equal, which of the following types of stock has the most risk from the investor’s perspective?

A) Callable preferred share.

B) Callable common share.

C) Putable common share.

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Callable shares have more risk than putable shares because the issuer can exercise the call option (which limits the investor’s potential gains) while the investor can exercise the put option (which limits the investor’s potential losses, assuming the firm is able to meet its obligation). Preferred shares have less risk for the investor than common shares because preferred shares have a higher priority claim on the firm’s assets in the event of liquidation, and because preferred dividends typically must be paid before common dividends may be paid.

hinsafdar

The primary reason for a firm to issue equity securities is to:

A) improve its solvency ratios.

B) increase publicity for the firm’s products.

C) acquire the assets necessary to carry out its operations.

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While issuing equity securities can improve a company’s solvency ratios and increase the firm’s visibility with the public, the primary reason to issue equity is to raise the capital needed to acquire operating assets.

hinsafdar

Pearl River Heavy Industries shows the following information in its financial statements:

Total Assets	HK$146,000,000
Total Liabilities	HK$87,000,000
Net Income	HK$27,000,000
Price per Share	HK$312
Shares Outstanding	200,000

The equity securities of Pearl River have a:

A) book value of HK$62,400,000.

B) market value of HK$146,000,000.

C) book value of HK$59,000,000.

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Book value = Total assets − total liabilities = 146,000,000 − 87,000,000 = HK$59,000,000
Market value of equity = Market price per share × shares outstanding = HK$312 × 200,000 = HK$62,400,000

prashantsahni

A firm’s cost of equity capital is least accurately described as the:

A) minimum rate of return investors require to invest in the firm’s equity securities.

B) ratio of the firm’s net income to its average book value.

C) expected total return on the firm’s equity shares in equilibrium.

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The ratio of the firm’s net income to its average book value is the firm’s return on equity, which can be greater than, equal to, or less than the firm’s cost of equity. Cost of equity for a firm can be defined as the expected equilibrium total return in the market on its equity shares, or as minimum rate of return that investors require as compensation for the risk of the firm’s equity securities.

prashantsahni

Which of the following changes would most likely cause a firm’s return on equity to increase?

A) Net income increases by 5% and average book value of equity increases by 10%.

B) Net income increases by 5% and average book value of equity increases by 5%.

C) Net income decreases by 5% and average book value of equity decreases by 10%.

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Return on equity is net income divided by average book value of equity. If the book value of equity decreases relatively more than net income decreases, return on equity will increase. This illustrates that an increase in ROE is not necessarily positive for the firm. An analyst must examine the reasons for changes in ROE.

prashantsahni

When analyzing an industry characterized by increasing book values of equity, return on equity for a period is most appropriately calculated based on:

A) beginning book value.

B) ending book value.

C) average book value.

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When book values are not stable, analysts should calculate ROE based on the average book value for the period. When book values are more stable, beginning book value is appropriate.