Question 1:

2B3-LS45

Which one of the following situations would prompt a firm to issue debt, as opposed to equity,
the next time it raises external capital?
*Source: Retired ICMA CMA Exam Questions.

High breakeven point.

Significant percentage of assets under capital lease.
Low fixed-charge coverage.
High effective tax rate.

If a firm is faced with a high effective tax rate, it would prompt a firm to issue debt, as
opposed to equity the next time it raises capital as the cost of debt is reduced by that
effective tax rate.
Question 2:
2B3-LS31

All of the following accurately describe preferred stock except:

Preferred stock dividends are paid before common stock dividends.
Preferred stock dividends paid are based on earnings.
Preferred stock typically has no maturity date.
Preferred stock issues may have a stated call price.

A preferred stock generally offers a fixed dividend. The dividend amount does not fluctuate
based on earnings. The payment is discretionary if the company does not have sufficient
earning to pay. Unpaid dividends for preferred stock may accumulate.
Question 3:
2B3-LS32

The participating feature for a preferred stock means that preferred stockholders have the
opportunity to:
sell all or part of the shares back to the issuer at pre-specified call price.
increase their dividends when common stockholders dividends reach a certain amount.
convert preferred stock into a specified amount of common stock.
be granted special voting privileges if the corporation is unable to pay the fixed dividend.

By definition, a participating feature allows preferred stockholders to participate in increasing

dividends when common stockholders' dividends reach a certain amount. The exact amount
of participation varies and is determined by some predetermined formula that relates
additional preferred stockholder payouts to increases in common stockholder payouts.
Question 4:
2B3-LS08

An analyst observes a 15-year, 7% option-free bond with semiannual coupons. The required
yield on this bond was 7%, but suddenly it drops to 6.5%. The price of this bond:
will decrease.
cannot be determined without additional information.
will increase.
will stay the same.

There is an inverse relationship between price and yield. If the required yield falls, the bond's
price will rise, and vice versa.
Question 5:
2B3-LS38

A company paid a current dividend of $1.50 for a share of stock priced at $60. The
company's current tax rate is 35%. What is the after-tax cost of equity if the company projects
long-term growth in dividends to be 6%?
5.62%.
5.53%.
8.5%.
8.65%.

The after-tax cost of common stock using the dividend growth model is:
ke = D1/P0 + g
or
[$1.50(1.06)]/$60 + 0.06 = $1.59/$60 + 0.06 = 0.0865 or 8.65%.
Common stock dividends are not a tax-deductible expense, so taxes are irrelevant in this
computation.
Question 6:
2B3-AT04

All of the following are legal rights of shareholders in U.S. publicly-traded

companies except the right to:
vote on major management changes.
receive annual financial reports.
vote on charter and bylaw changes.
vote on major mergers and acquisitions.

Changes in management (the CEO and below) are the responsibility of the board of
directors. The board members are elected by the shareholders. The board is responsible for
directing the corporation. Direction includes planning, organizing, staffing, coordinating, and
controlling.

Question 7:
2B3-LS19

Which of the following best describes the meaning of an effective duration of 3.5 for a bond?
A 1% change in yield produces an exact change in the price of this bond of 3.5%.
A 1% change in price produces an approximate change in the yield of this bond of 3.5%.
A 1% change in yield produces an approximate change in the price of this bond of 3.5%.
A 1% change in price produces an exact change in the yield of this bond of 3.5%.

Effective duration refers to price sensitivity in response to a change in yield. A 1% change in

yield produces an approximate change in the price of a bond. Duration represent an
approximate price-yield relation because the relation follows a curve, not a straight line. In
fact, this curve is convex (toward the origin).
Question 8:
2B3-LS24

What is a fundamental difference between options and forwards?

Both parties are obligated to fulfill an option contract; forward terms are not binding to either party.
Options have asymmetric payouts; forwards have symmetric payouts.
Forwards are traded on organized exchanges; options are facilitated by private contracts.
Options have a specified maturity date; forwards can be sold on or before the maturity date.

Forwards are fundamentally different than options because neither party is obligated to
perform according to the terms of the contract. One or both parties can choose not to fulfill
the terms of the forward contract.
Question 9:
2B3-CQ03

Morton Starley Investment Banking is working with the management of Kell Inc. in order to
take the company public in an initial public offering. Selected information for the year just
ended for Kell is as follows.

If public companies in Kell's industry are trading at a market to book ratio of 1.5, what is the
estimated value per share of Kell?
$16.50.

$27.50.
$13.50.
$21.50.

Book value per share of common stock is calculated by taking the common stock equity and
dividing it by the number of shares of common stock outstanding.
Book value per share, common stock = (common stock equity) / (number of shares of
common stock outstanding)
The number of shares outstanding is 3,000,000, which is derived by taking the $3,000,000 in
par value common equity and dividing it by the $1 par value per share.
Therefore, book value per share of common stock can be calculated as:
Book value per share, common stock = ($3,000,000 + $24,000,000 + $6,000,000) /
(3,000,000 shares)
Book value per share, common stock = ($33,000,000) / (3,000,000 shares)
Book value per share, common stock = $11 per share
The estimated value per share of Kell would then be:
Estimated value per share = $11(1.5) = $16.50 per share.
Question 10:
2B3-AT02

Which one of the following is not a determinant in valuing a call option?

Exercise price.
Forward contract price.
Expiration date.
Interest rate.

Exercise price of an option, option expiration date, and time value of money (interest rate)
along with price volatility of the underlying security are factors affecting option valuation prior
to expiration.
Question 11:
2B3-CQ01

Cox Company has sold 1,000 shares of $100 par, 8% preferred stock at an issue price of $92
per share. Stock issue costs were $5 per share. Cox pays taxes at the rate of 40%. What is
Cox's cost of preferred stock capital?
8%.

8.7%.
9.2%.
8.25%.

The cost of preferred stock capital is calculated as follows:

Cost of preferred stock capital = (preferred stock dividend per share) / (net price of the
preferred stock)
The dividend per share is calculated as follows:
Dividend per share = (dividend rate)(par value of stock)
Dividend per share = (0.08)($100) = $8 per share
Issue price of preferred stock = $92 per share
Stock issue cost = $5 per share
Net price of preferred stock = $92 $5 = $87
Cost of preferred stock capital = $8 / $87 = 0.09195, which rounds to 9.2%.
Question 12:
2B3-LS33

A $1,000 bond that costs $500 when issued and pays the full par value at
maturity best describes a:
junk bond.
zero coupon bond.
fixed interest rate bond.
floating rate bond.

Zero coupon bonds have no ongoing interest payments. The bond is sold at a deep discount
and redeemed at full value as compound interest accrues to par value.
Question 13:
2B3-LS47

Which one of the following best describes the record date as it pertains to common stock?
*Source: Retired ICMA CMA Exam Questions.

Four business days prior to the payment of a dividend.

The 52-week high for a stock published in the Wall Street Journal.
The date that is chosen to determine the ownership of shares.
The date on which a prospectus is declared effective by the Securities and Exchange Commission.

The date chosen by the issuer of the common stock (which ultimately determines who the
owners of the outstanding shares are on that date).
Question 14:
2B3-LS43

Dorsy Manufacturing plans to issue mortgage bonds subject to an indenture. Which of the
following restrictions or requirements are likely to be contained in the indenture?
I. Receiving the trustee's permission prior to selling the property.
II. Maintain the property in good operating condition.
III. Insuring plant and equipment at certain minimum levels.
IV. Including a negative pledge clause.
*Source: Retired ICMA CMA Exam Questions.

I, II, III and IV.

I, III, and IV only.
I and IV only.
II and III only.

Protective covenants set limits (restrictions) on certain actions the company might be taking
during the term of the agreement. They are a particularly important feature in a bond
indenture.
Question 15:
2B3-LS12

Which of the following statements concerning bond ratings is correct?

Bond ratings may be adjusted only down (but not up) during the life of a bond.
U.S. Treasury bonds are rated AAA.
Bond ratings apply to the bond issue and the company.
Bonds rated as junk bonds have a lower-than-average chance of high yields.

U.S. Treasury bonds are rated AAA since they are backed by the full faith and credit of the
federal government.
Question 16:
2B3-LS39

A company's current dividend is $2 for a share of stock currently selling at $50. If the
company issues new common stock, it expects to pay flotation costs of 10%. The company's
marginal tax rate is 40%. If the company projects a long-term growth in dividends of 8%, its
after-tax cost of new equity is closest to:
12.32%.
12%.

12.8%.
7.76%.

The after-tax cost of common stock using the dividend growth model is ke = D1/P0 + g or
[$2.00(1.08)]/$50(1 0.10) + 0.08 = $2.16/$45 + 0.08 = 0.1280 or 12.80%. Common stock
dividends are not a tax-deductible expense so taxes are irrelevant in this computation.
Question 17:
2B3-LS07

Which of the following statements accurately describes a bond instrument?

A bond is generally considered a conservative equity instrument.
Short-term bonds normally provide higher yields than do long-term bonds.
Most bonds are sold in multiples of $1,000.
The trustee defines the details of the bond issue.

Although there are many types of bonds, the principal amount of most bonds is $1,000.
Question 18:
2B3-LS17

How does a firm's tax rate influence its after-tax cost of debt?
The higher the tax rate, the greater the after-tax cost of debt.
The sooner the debt is paid off, the lower the tax rate.
The higher the tax rate, the lower the after-tax cost of debt.
The longer the debt is carried, the lower the tax rate.

By definition, the cost of debt represents the interest rate a company pays on all of its capital
debt (e.g., loans and bonds). The stated interest rate is greater than the after-tax cost of debt
because a firm can deduct interest payments when determining taxable income. The higher
the tax rate, the lower the after-tax cost of debt.
Question 19:
2B3-LS11

Standard & Poor's downgrades an A-rated bond to a BB rating. What is the likely impact of
this downgrade if the corporation issues future bonds?
The issuer will need to offer higher interest rates.
The principal will yield higher returns.
The issuer will need to offer lower interest rates.
Future returns will be highly speculative.

Credit rating services may adjust ratings up or down during the life of a bond. A downgraded
rating means that future issues will need to offer higher interest rates to attract buyers.
Question 20:

2B3-LS35

A 15-year, 8% annual-pay bond has a par value of $1,000. What should this bond be trading
for if it were being priced to yield 9% on an annual rate?
1,000.00.
$935.61.
$919.39.
$1085.60.

The value of the bond should be $919.39. The bond will sell at a discount because the
required rate of return exceeds the coupon rate of the bond.

Using an HP 12C, N = 15; I = 9; FV = 1,000; PMT = 80; PV = $919.39.

Question 21:
2B3-LS48

Preferred stock may be retired through the use of any one of the following except a:
*Source: Retired ICMA CMA Exam Questions.

sinking fund.
call provision.
refunding.
conversion.

Preferred stock may be retired through the use of conversion, call provision, or sinking fund.
Preferred stock is not retired through refunding.
Question 22:
2B3-LS36

A company has $50 million in debt outstanding with a coupon rate of 10%. Currently, the yield
to maturity on these bonds is 8%. If the firm's tax rate is 40%, what is the company's after-tax
cost of debt?
10%.
6%.
8%.
4.8%.

The after-tax cost of debt is kd(1 t) = (0.08)(1 0.40) = 0.048 or 4.8%.

Question 23:

2B3-LS27

Which of the following statements describes an option that is in-the-money?

Payment must be made to the owner if the contract is exercised.
The owner of the contract decides not to sell the underlying asset.
The strike price exceeds the price of the underlying asset.
The owner can exercise the option at any time before maturity.

Different payoffs are possible with options. An option generally referred to as being in-themoney requires immediate payment to the owner if the contract is exercised.
Question 24:
2B3-LS34

Legal responsibilities of a bond trustee include all of the following except:

defining sinking fund terms.
ensuring that interest payments are properly paid and applied.
authenticating the bond issue's legality.
administering redemption.

An indenture defines the details of the bond issue, including sinking fund terms that the
borrower pays to a separate custodial account and assures creditors that adequate funds are
available.
Question 25:
2B3-LS29

All of the following factors influence the theoretical value of an option except the:
time until expiration of the option.
strike price of the option.
current price of the underlying asset.
net settlement specifications.

To a degree, the price or value of an option depends on the expected future value of the
underlying asset. Several factors influence the theoretical value of an option. But whether or
not the net settlement must be a cash payment, delivery of an asset that can be easily
converted to cash or another derivative does not change the value.
Question 26:
2B3-LS09

Which of the following statements about an option is not correct?

The owner of a put option has the right to sell the underlying asset at a fixed price.
The buyer of an option contract receives an up-front premium from the seller of the option contract.
The owner of a call option has the right to buy the underlying asset from the seller.

The seller (writer) of an option contract receives an up-front premium from the owner of the option
contract.

By definition, a premium is the initial purchase price of an option and it is usually stated on a
per unit basis. The writer (seller) of an option contract receives an up-front premium from the
buyer (owner) of the option contract. This premium obligates the writer to fulfill the contract
(sell or buy the underlying asset) if the buyer chooses to exercise the option.
Question 27:
2B3-LS06

A long-term call option to buy common stock directly from a corporation is a:

forward contract.
convertible security.
futures contract.
warrant.

By definition, a warrant is a long-term call option to buy common stock directly from a
corporation. It gives bond or preferred stockholders the right to purchase shares of common
stock at a given price.
Question 28:
2B3-LS21

A firm is considering the purchase of a federal agency security. Which of the following
statements is most likely to be true?
The firm has poor liquidity.
Tax exposure is limited.
The securities may be discounted.
The rate is regularly reset.

Federal agency interest-bearing securities have limited tax exposure. Many are exempt from
state and local income taxes but not state franchise taxes.
Question 29:
2B3-LS50

Which one of the following describes a disadvantage to a firm that issues preferred stock?
*Source: Retired ICMA CMA Exam Questions.

Preferred stock dividends are legal obligations of the corporation.

Most preferred stock is owned by corporate investors.
Preferred stock typically has no maturity date.
Preferred stock is usually sold on a higher yield basis than bonds.

A disadvantage of preferred stock is that preferred stock is usually sold on a higher yield
basis than bonds. Preferred stock has a higher seniority risk than bonds.
Question 30:
2B3-LS26

Which of the following statements describes an option that is at-the-money?

The owner of the contract decides not to sell the underlying asset.
The owner can exercise the option at any time before maturity.
The underlying asset price equals the strike price.
The strike price exceeds the price of the underlying asset.

Different payoffs are possible with options. An option is referred to as being at-the-money if
the underlying asset price equals the strike price.
Question 1:
2B3-LS40

The call provision in some bond indentures allows:

*Source: Retired ICMA CMA Exam Questions.

the bondholder to redeem the bond early by paying a call premium.

the issuer to pay a premium in order to prevent bondholders from redeeming bonds.
the bondholder to exchange the bond, at no additional cost, for common shares.
the issuer to exercise an option to redeem the bonds.

A call provision grants the right to buy back (or call) all or part of an issue at the call price
rather than attempting to retire the issue by more expensive methods.
Question 2:
2B3-LS14

A stock undergoes a 3-for-1 stock split. What is the most likely outcome for a stockholder
currently holding 3,000 shares trading at $30 per share?
The holder will have 9,000 shares at $10 per share.
There will be a decrease in total market value of the shares.
The holder will have 1,000 shares at $90 per share.
There will be an increase in total market value of the shares.

In a 3-for-1 stock split, 3,000 shares would receive another 6,000 shares. At $30 a share, the
price should drop down to about $10 a share. The total market value should remain the same
(9,000 shares at $10 a share versus the original 3,000 shares at $30; both equal $90,000).
While the total market value initially remains the same, stockholders may profit if the price
eventually goes up.
Question 3:
2B3-LS04

What is a primary difference between stock splits and cash dividends?

Stock splits are usually paid quarterly; cash dividends are awarded annually.
Cash dividends are usually paid quarterly; stock splits are awarded annually.
Cash dividends do not result in any taxable gain or loss; stock splits are taxable.
Stock splits do not result in any taxable gain or loss; cash dividends are taxable.

A cash dividend is paid in the form of cash, usually a check. Cash dividends are taxable.
Stock splits do not result in any taxable gain or loss.
Question 4:
2B3-LS46

Which one of the following is a debt instrument that generally has a maturity of ten years or
more?
*Source: Retired ICMA CMA Exam Questions.

A financial lease.
A chattel mortgage.
A bond.
A treasury note.

A bond is a promise to pay a specified amount of interest over time and to repay principal at
maturity. These instruments generally have long-term maturities. Treasury notes have
maturities of one to ten years. Treasury bill maturities are less than one year. A financial lease
is a contract.
Question 5:
2B3-LS01

A company holds as an investment a three-year $1,000,000 note bearing interest at 8%. If

the market rate for a similar investment is 9%, a potential purchaser of the note will:
get the maker of the note to add a discount equal to the 1% difference.
get the maker of the note to add a premium equal to the 1% difference.
add a premium to the amount they pay the seller to make the effective rate equal to 9%.
discount the amount they pay the seller to make the effective rate equal to 9%.

The purchaser would receive the principal and interest equal to 8%. However, since the
market rate for such an investment is 9%, the 1% difference will be deducted as a discount
from the amount of cash the purchaser pays the current owner so that the effective rate of
return will become 9%.
Question 6:
2B3-LS18

What is the after-tax cost of debt for a 6% interest-bearing bond at an anticipated tax rate of
33%?

4.65%.
6%.
4.02%.
3.3%.

The formula for determining the after-tax cost of debt is:

Where:
kd = interest rate
t = firm's applicable tax rate.
Question 7:
2B3-LS22

Viable short-term financing options for a pharmaceutical company include all of the
following except:
issues of preferred stock.
trade credit.
bankers' acceptances.
commercial paper.

By definition, short-term financing refers to the use of debt instruments that mature in one
year or less. Stock is an equity investment instrument.
Question 8:
2B3-LS20

Which of the following statements about option payoffs is false? Assume S = stock price and
X = strike price.
S = X, a put option is at-the-money.
S > X, a put option is in-the-money.
S - X > 0, a call option is in-the-money.
S - X = 0, a call option is at-the-money.

A put option is in-the-money if X - S > 0. X - S is the amount of the payoff from immediate
exercise, buying a share for S and selling it in the market for a great price at X. When the

stock's price (S) is greater than the strike price, a put option is said to be out-of-the-money. If
X - S < 0, a put option is out-of-the-money. The other statements are true.
Question 9:
2B3-LS30

A common stock referred to as a defensive stock implies that the stock:

seems inexpensive when compared to earnings and other performance measures.
is relatively stable and resistant to most economic conditions.
is a solid performer with a good track record and usually generates a steady income.
has earnings growing faster than the overall economy.

The common stock classification of a defensive stock implies a conservative stock that is
relatively stable and resistant to most economic conditions (e.g., economic upturns and
slowdowns).
Question 10:
2B3-LS03

If interest rates are expected to increase, which of the following bonds is most attractive to
buy on the secondary market when interest rates are low?
US Treasury bond.
Bond with a rating of Aaa or AAA.
Floating rate bonds.
Zero coupon bonds.

A floating bond interest rate pays an interest rate that varies from time to time (generally
based on some benchmark interest rate). Such a bond is attractive because the rate should
go up and reset at higher levels as rates rise. That is, bond prices move inversely with
changes in interest rates.
Question 11:
2B3-LS05

A private agreement between two parties to exchange future cash payments is a(n):
warrant.
convertible security.
option.
swap.

By definition, a swap is a private agreement between two parties to exchange (or swap)
future cash payments. A swap is usually facilitated by an intermediary. Swaps are
characterized by series of forward contracts and the exchange of payments on specified
payment dates.
Question 12:

2B3-LS10

A corporate bond trades on the secondary market. The return now required by investors for
this bond exceeds its coupon rate. Thus, the bond will:
pay a lump sum of interest and principal at maturity.
be sold below par value.
pay additional interest at maturity.
be sold above par value

After the initial issue, bonds are bought and sold through brokers in the secondary market
(similar to how stocks are traded). In the secondary market, a bond's price fluctuates
inversely with interest rates. If interest rates fall, the price will be sold above par value. But in
this case, the interest rates are higher than the bond's stated interest (coupon) rate and the
bond will be sold below par value (at a discount).
Question 13:
2B3-AT03

Debentures are:
bonds backed by the full faith and credit of the issuing firm.
subordinated debt and rank behind convertible bonds.
income bonds that require interest payments only when earnings permit.
mortgage bonds secured by a lien on specific assets of the firm.

Debentures are unsecured bonds. They are backed by the full faith and credit of the issuing
firm.
Question 14:
2B3-LS23

Which of the following statements is true about using preferred stock issues as a source of
equity capital?
The cost of preferred stock is a function of the stock's market price and the firm's tax rate.
Dividends are not tax deductible to the issuer.
A firm can deduct taxes on dividends payments, so the after-tax costs are reduced when determining
taxable income.
The cost of preferred stock is a function of the stock's beta.

Because preferred stock dividends are not tax deductible, they represent an outflow of aftertax funds. A preferred stock dividend costs the firm in after-tax earnings, so the firm must
earn additional capital before taxes for each dividend dollar paid.
Question 15:
2B3-LS44

Which one of the following statements concerning debt instruments is correct?

*Source: Retired ICMA CMA Exam Questions.

The coupon rate and yield of an outstanding long-term bond will change over time as economic
factors change.
A 25-year bond with a coupon rate of 9% and one year to maturity has more interest rate risk than a
10-year bond with a 9% coupon issued by the same firm with one year to maturity.
For long-term bonds, price sensitivity to a given change in interest rates is greater the longer the
maturity of the bond.
A bond with one year to maturity would have more interest rate risk than a bond with 15 years to
maturity.

The coupon rate is constant. It is the fixed contractual rate.

Question 16:
2B3-LS02

Which of the following statements accurately describes bond yields assuming an upward
sloping yield curve?
Higher-quality bonds typically have lower yields than lower-grade bonds of the same maturity.
Short-term bonds have higher yields than do long-term bonds.
Secured bonds have higher yields than do unsecured bonds.
Fixed interest rate bonds earn more than do zero coupon bonds.

Higher-quality bonds are sold at the lowest rates of interest. Because of the risk associated
with lower-grade, non-investment quality (junk) bonds, they are typically higher-yield bonds.
Junk bonds have a greater chance of defaulting, but in some circumstances they may also be
an emerging entity or become a star and provide a highly profitable return.
Question 17:
2B3-AT01

If a bond sells at a premium, the:

stated coupon rate must be more than the required market rate.
nominal rate must be less than the yield rate.
bond purchase price must be more than the fair market value of the bond.
stated coupon rate must be less than the required market rate.

If a bond sells for more than its face value, it is sold at a premium. Buyers are willing to pay
higher price for the bond expecting higher returns. Thus, the stated rate must be higher than
the market rate.
Question 18:
2B3-LS13

The notional amount of a derivative refers to the:

initial purchase price of the contract.
specified quantity of the underlying asset.
fee for exercising the contract before maturity.
fixed price of the contract.

A derivative involves a contract between two parties. A payment (or multiple payments) is
exchanged between the two parties. The notional amount (or face amount) of the contract
may be a predetermined amount triggered by a specific event or it may be an amount
resulting from the change in value of a specified quantity of the underlying asset.
Question 19:
2B3-LS42

A requirement specified in an indenture agreement which states that a company cannot

acquire or sell major assets without prior creditor approval is known as a
*Source: Retired ICMA CMA Exam Questions.

put option.
protective covenant.
warrant.
call provision.

Protective covenants set limits (restrictions) on certain actions the company might be taking
during the term of the agreement. They are a particularly important feature in a bond
indenture.
Question 20:
2B3-LS49

All of the following are characteristics of preferred stock except that:

*Source: Retired ICMA CMA Exam Questions.

its dividends are tax deductible to the issuer.

it may be converted into common stock.
it may be callable at the option of the corporation.
it usually has no voting rights.

Preferred stock dividends are not tax deductible to the issuer.

Question 21:
2B3-LS28

Which of the following statements describes a put option that is out-of-the-money?

The price of the underlying asset exceeds the strike price.

The strike price exceeds the price of the underlying asset.

The owner can exercise the option at any time before maturity.
The owner of the contract decides not to sell the underlying asset.

Different payoffs are possible with options. A put option is referred to as out-of-the-money if
the price of the underlying asset exceeds the strike price.
Question 22:
2B3-AT06

If a $1,000 bond sells for $1,125, which of the following statements are correct?
I. The market rate of interest is greater than the coupon rate on the bond.
II. The coupon rate on the bond is greater than the market rate of interest.
III. The coupon rate and the market rate are equal.
IV. The bond sells at a premium.
V. The bond sells at a discount.
I and V.
II and V.
II and IV.
I and IV.

If the coupon (stated) rate on a bond is greater than the market rate of interest, the price of
the bond will be greater than its maturity value and the bonds will sell at a premium (price is
greater than the maturity value). The market rate of interest is the rate required by the
market. If the coupon rate is greater than the market rate, the market will bid up the price to
obtain the higher rate (the coupon).
Question 23:
2B3-LS41

Protective clauses set forth in an indenture are known as:

*Source: Retired ICMA CMA Exam Questions.

requirements.
covenants.
addenda.
provisions.

Protective covenants set limits (restrictions) on certain actions the company might be taking
during the term of the agreement. They are a particularly important feature in a bond
indenture.
Question 24:
2B3-LS25

Which of the following statements accurately describes a put option?

The exercise date is the last day on which the writer can exercise the underlying asset.
The holder of the put option has lower risk than the option writer.
The holder of an option contract receives an up-front premium from the seller of the option contract.
The seller of the put option raises money; the holder gains leverage against adverse changes in
market factors.

A put option is a type of option contract giving the holder the right but not the obligation to sell
the underlying asset to the writer. Option holders have the opportunity for unlimited gain with
limited possible losses. Option writers may experience unlimited potential losses (unless the
contract is covered, which means that the writer already owns the underlying asset).
Question 25:
2B3-LS15

Which of the following gives minority shareholders more choice in corporate governance?
Traditional voting.
Cumulative voting.
Proxy voting.
Preemptive voting.

By definition, a cumulative voting system allows shareholders to cast different numbers of

votes for different candidates. Cumulative voting attempts to give minority shareholders more
voice in corporate governance by increasing their chances to elect a certain number of
directors.
Question 26:
2B3-LS16

What is the after-tax cost of debt for a 6% interest-bearing bond at an anticipated tax rate of
38%?
3.72%.
4.4%.
3.8%.
6%.

The formula for determining the after-tax cost of debt is:

After-tax cost of debt = kd(1 t)
After-tax cost of debt = (0.06) (1 0.38) = .0372 = 3.72%.
Question 27:
2B3-CQ02

Bull & Bear Investment Banking is working with the management of Clark Inc. in order to take
the company public in an initial public offering. Selected financial information for Clark is as
follows.

If public companies in Clark's industry are trading at twelve times earnings, what is the
estimated value per share of Clark?
$24.00.
$12.00.
$15.00.
$9.00.

The earnings per share (EPS) for Clark is calculated as:

EPS = (net income preferred stock dividends) / (weighted average number of common
stock shares outstanding)
The number of shares outstanding is 3,000,000, which is derived by taking the $3,000,000 in
par value common equity and dividing it by the $1 par value per share.
EPS = ($3,750,000 $0) / (3,000,000 shares) = $1.25 per share
The estimated value per share of Clark stock can then be calculated as:
Estimated value per share = 12($1.25) = $15.00 per share.
Question 28:
2B3-LS37

A company's $100, 10% preferred stock is currently selling for $90. If the company issues
new shares, the flotation costs will be 7%. The company's tax rate is 40%. What is the
company's after-tax cost of new preferred stock?
6%.
11.95%.
7.17%.

9%.

The after-tax cost of preferred stock including flotation costs is:

kp = Dp/Pnet
or
$10/[($90)(1 0.07)] = $10/$83.70 = 0.1195 or 11.95%.
Dividends are not a tax-deductible expense for preferred stock, so taxes are irrelevant in the
computation.
Question 29:
2B3-AT05

Which one of the following statements is correct when comparing bond financing
alternatives?
A call provision is generally considered detrimental to the investor.
A call premium requires the investor to pay an amount greater than par at the time of purchase.
A convertible bond must be converted to common stock prior to its maturity.
A bond with a call provision typically has a lower yield to maturity than a similar bond without a call
provision.

A call provision allows the issuer of the bonds to buy back the bonds at a set price (the call
price) after some specified date. Calls are used to redeem bonds when interest rates drop
significantly or to force the conversion of convertible bonds. When the bonds are called for
redemption, the holder (investor) must sell them back to the issuer. The holder, however, may
want to hold the bonds to earn interest to improve the conversion gain.