According to Friedman’s view on Corporate Social Responsibility, it is the firm’s social responsibility to pro-actively engage in actions aimed at furthering some social good, beyond the interests of the firm, its owners and the requirements of the law.
FALSE (”The social responsibility of business is to increase its profits”, according to Friedman.)
The Greenshoe Provision is an option that allows the underwriter to return shares to the issuing company that the underwriter wasn’t able to sell at the IPO at a price that is usually 15% below the original IPO offer price.
FALSE (Greenshoe provision = Option that allows the underwriter to issue more stock, usually amounting to 15% of the original offer size, at the IPO offer price)
Modigliani and Miller's results about the irrelevance of capital structure for firm value hold in a perfect market even when debt is risky and the firm may default.
True.
The Pecking Order Theory of Capital Structure is the idea that managers will prefer to fund investments by first using retained earnings, then equity, and debt only as a last resort.
FALSE (Pecking order theory is the idea that managers will prefer to fund investments by first using retained earnings, then debt, and equity only as a last resort.)
A dividend-paying company that experiences an unexpected temporary decline in profits will most likely distribute a relatively low proportion of current earnings.
FALSE (The company will try to smooth the dividends, given that the shock is temporary. This means it will distribute a high fraction of current earnings.)
In capital budgeting, when debt levels are set according to a predetermined schedule, we can discount the interest tax shield with the cost of debt.
TRUE
Rights offers protect existing shareholders from underpricing.
True.
Subordinated Debentures are a form of debt that, in the event of a default, has a lower priority claim to the firm’s assets than outstanding equity.
FALSE (They have lower priority than senior bonds, but higher priority than equity claims.)
The issuer of a callable bond will likely choose to “call” the bond issue if interest rates have fallen.
True.
A conflict of interest that arises when a shareholder who has a controlling interest in multiple firms moves profits away from companies in which he has relatively less cash flow rights toward firms in which he has relatively more cash flow rights (“up the pyramid”) is called “upstreaming”.
FALSE (It is called “tunneling”.)
Two firms have the exact same free cash-flows and those cash-flows have identical covariance with the market returns. In a Modigliani-Miller world (i.e., perfect capital markets), they must have the same equity Beta.
False (The equity betas can be different if leverage ratios of these firms are different. MM says that for these firms, the required return on assets is equal. This implies that they must have the same asset betas (βA), but equity betas can be different.)
A share of a stock can be thought of as a call option on the assets of the firm.
True
The Red Herring prospectus is part of the final registration statement prepared by a company prior to an IPO that contains all the details of the offering, including the number of shares offered and the offer price.
False (Red herring is the preliminary prospectus: part of the registration statement prepared by a company prior to an IPO that is circulated to investors before the stock is offered)
The fees charged by underwriters in IPOs tend to be higher than fees charged for debt issues.
True
When a takeover bid is announced, acquiring shareholders on average enjoy a gain of 15% in their stock price.
False (When a bid is announced, target shareholders on average enjoy a gain of 15% in their stock price)
A Poison Pill is a provision in the target’s Corporate Charter that gives the acquiring shareholders the right to buy shares in the target at a deeply discounted price.
False (Poison pill is a rights offering that gives the target shareholders the right to buy shares in the target at a deeply discounted price)
Evidence from empirical studies supports the Entrenchment View of perquisites (perks) and finds little support for the Optimal Contracting View.
True
The Sarbanes-Oxley (SOX) Act was passed in the United Kingdom (UK) with the goal of improving the accuracy of information given to boards and shareholders.
False (SOX was passed in the US.)
In a levered firm, an increased probability of financial distress will only affect the company’s bondholders, while the firm’s cost of capital remains unchanged.
False (An increased probability of financial distress will decrease the market value of debt outstanding, thereby increasing the yield-to-maturity (cost of debt) and with it the firm’s cost of capital.)
Depreciation is an accounting expense and does not represent a cash-flow. Therefore, it is unimportant for capital budgeting decisions.
False (depreciation tax shield)
In perfect capital markets, levered equity has a higher return sensitivity to the systematic risk of the economy than unlevered equity.
True
Assume that you have a convertible bond with a $1000 face value and a conversion ratio of 17. If the price of the corresponding stock is $52, a rational investor will choose to convert the bond into stock.
False (conversion price=1000/17=58.8 > 52, so don’t convert)
The most common exit route in private equity transactions is that the portfolio company is taken public.
False (sale to another firm)
According to the FCF Hypothesis, leverage increases firm value because it commits the firm to making future interest payments, thereby reducing excess cash flows and wasteful investment by managers.
True
The impetus (trigger) for the passage of the Dodd-Frank Act were the accounting scandals involving Enron and WorldCom.
False (financial crisis)
In an M&A transaction: An exchange ratio of 1.5 means that for the transaction to still have a positive NPV for the bidder, it could offer up to 1.5 of its own shares for each share of the target.
True
Corporate Governance is typically based on the stakeholder-value view: Management should maximize the value of the firm to all stakeholders (shareholders, debtholders, employees, customers etc.).
False (shareholder value view, maximize value to shareholders)
The most common share repurchase method in the US is by Tender Offer.
False (open market repurchase)
Pension funds typically invest in corporate bonds which have ratings below investment grade, as these have higher yields than investment grade bonds.
False (invest in bonds above investment grade)
In the APV method of valuation (adjusted present value), when the firm maintains a constant leverage ratio (D/E), its future interest tax shields should be discounted at the project’s unlevered cost of capital.
True
A firm that operates in the pharmaceutical industry has $2mn in cash, $8mn in non-cash assets, and $5mn in debt and equity, respectively. The company decides to use its cash to pay a $2mn cash dividend. True or False: As a result of this transaction, the systematic risk of the total assets held by the firm increases.
True
Suppose you do a regression of excess returns of a stock (dependent variable) against excess returns of a proxy of the market portfolio (the explanatory variable). True or False: The intercept of this regression represents a risk-adjusted performance measure for the historical returns; if it is positive, the stock has performed better than predicted by the CAPM.
True
Corporate bonds can be classified into bearer bonds and registered bonds; almost all corporate bonds today are registered bonds.
True
In a perfect capital market, a leveraged recapitalization will leave the expected earnings per share and the share price unaffected.
False (EPS changes)
There is a trade-off when designing a bankruptcy code. A creditorfriendly bankruptcy code tends to lead to large numbers of inefficient continuations of businesses, while a debtor-friendly code tends to lead to a large number of inefficient liquidations.
The “lemons problem” arising from adverse selection in the equity market is of central importance to the Pecking Order Theory of capital structure.
True
Consider the valuation method based on comparable firms. For valuation purposes, the trailing P/E ratio is generally preferred, since it is based on actual not expected earnings.
False (forward P/E is generally preferes p. 334)
In the U.S., the value of aggregate dividend payments as a percentage of total payouts has decreased considerably in recent decades.
True
An often-voiced criticism of the system of ratings assignments to bonds by credit rating agencies relates to the conflicts of interest stemming from the “investor-pays” model used in the ratings business.
False (Most criticism of credit raters centers on the "issuer pays" model—employed by each of the Big Three—whereby a bond's issuer pays the rating agencies for the initial rating of a security, as well as ongoing ratings. The public (and investors) can then access these ratings free of charge.)
The majority of hedge funds nowadays engage in activist campaigns.
False (minority)
The dividend discount model does not take into account the opportunity to sell the stock in the future.
False (The shares can be sold any time, that is perfectly compatible with the model.)
The S&P 500 is an equal-weighted portfolio of 500 of the largest U.S. stocks.
False (value weighted)
If a firm maintains a constant interest coverage ratio policy, future interest tax shields from the project should be discounted at the project's cost of debt.
False (return on assets)
According to empirical studies, the long-run performance of newly public companies (three to five years from the date of issue) tends to be inferior to the overall market return.
True
If there is significant risk of default, the yield-to-maturity of a bond will overstate investors’ expected return.
Modigliani-Miller Proposition II implies that as the firm adds debt, the remaining equity becomes more risky.
True
With personal taxation, the gains to corporate leverage can be negative: for example, when debt is taxed more heavily at the personal level than equity, the firm value of the levered firm can be lower than the firm value of the unlevered firm.
True
Private equity funds have limited contractual life during which companies are bought, turned around, and then “exited”. According to the lecture, the most common exit route is that the portfolio company is taken public.
False (sale to other company)
Assume perfect capital markets. A company makes a rights issue at $3 a share, of one new share per four rights and one right for every old share. Before the issue there were 10 million shares outstanding and the share price was $6. True or False: The value of each right is $0.60.
True
The study by Grinstein et al. (2008) found that around the date of disclosure of a corporate perk, firms experience on average a positive abnormal return of 1.77% around the time of filing of the disclosure statement. The findings are consistent with the “Optimal Contracting View” that perks may motivate executives to work hard, thus increasing firm value.
False (negative announcement return, inconsistent with optimal contracting view)