WGU C214 Financial Management Practice Ultimate Certification Success Companion: In-Depth Study Guide, Updated Practice Tests, Detailed Review Questions, and Comprehensive Exam Preparation Manual

A bond has an 8% annual coupon rate, and investors require an 8% return on comparable bonds. At what price should the bond sell, assuming no unusual market conditions? A. Below its face value B. Above its face value C. At approximately its face value D. At the value of its annual coupon only Correct Answer: C. At approximately its face value Rationale: A bond sells at par when its coupon rate equals the market-required return or yield to maturity. The coupon payments provide exactly the return investors demand. A bond sells at a discount when the required return exceeds the coupon rate and at a premium when the required return is below the coupon rate. Question 2 A shareholder wants to vote for members of the board of directors. Which investment would most likely provide this right? A. Common stock B. Preferred stock C. Subordinated bond D. Secured note Correct Answer: A. Common stock Rationale: Voting rights are normally associated with common stock and allow shareholders to participate in corporate governance, including electing directors. Preferred stock generally sacrifices voting rights in exchange for dividend and liquidation priority. Bondholders and noteholders are creditors, not owners, and therefore do not ordinarily vote in corporate elections unless special default provisions apply. Question 3 Which statement best distinguishes secured bonds from unsecured bonds? A. Secured bonds have variable coupon rates B. Unsecured bonds cannot be traded C. Secured bonds are supported by specifically pledged collateral D. Unsecured bonds have no repayment obligation Correct Answer: C. Secured bonds are supported by specifically pledged collateral Rationale: Secured bonds are backed by designated assets that creditors may claim if the issuer defaults. Unsecured bonds, often called debentures in the United States, depend mainly on the issuer’s general creditworthiness. Both types can be traded and create legally enforceable repayment obligations. Coupon structure is separate from whether collateral supports the bond. Question 4 A corporation fails to pay dividends on its cumulative preferred shares for two consecutive years. Before paying dividends to common shareholders in the third year, the corporation must first: A. Repurchase all outstanding preferred shares B. Pay the accumulated preferred dividends in arrears C. Convert the preferred shares into common stock D. Obtain approval from common shareholders Correct Answer: B. Pay the accumulated preferred dividends in arrears Rationale: Cumulative preferred stock requires unpaid dividends to accumulate as dividends in arrears. These unpaid amounts must generally be satisfied before common shareholders receive dividends. The company is not required to repurchase or convert the shares. Common shareholders also do not approve payment of previously omitted preferred dividends because the preferred shareholders’ priority arises from the terms of the security. Question 5 A bond has a duration of approximately six years. If market yields increase by one percentage point, what does duration suggest, using a simple approximation? A. The bond’s price will increase by about 6% B. The bond’s price will decrease by about 6% C. The coupon rate will decrease by 6% D. The bond’s maturity will shorten by six years Correct Answer: B. The bond’s price will decrease by about 6% Rationale: Duration estimates a bond’s sensitivity to interest-rate changes. A duration of six suggests that a one-percentage-point increase in yield will produce an approximate 6% decline in price. The relationship is inverse. Duration does not change the contractual coupon rate or maturity, and the estimate becomes less exact when interest-rate movements are large. Question 6 Why is preferred stock commonly described as a hybrid security? A. It combines ownership characteristics with bond-like dividend features B. It automatically changes from debt to equity at maturity C. It pays both interest and dividends every year D. It gives investors voting rights but no ownership claim Correct Answer: A. It combines ownership characteristics with bond-like dividend features Rationale: Preferred stock is legally an equity security, but its relatively fixed dividend resembles the periodic interest paid on a bond. It normally has no maturity date, unlike most bonds, and does not automatically convert unless conversion rights are specifically included. Preferred investors receive dividends rather than interest and usually have limited or no voting rights. Question 7 What normally occurs when a traditional bond reaches its maturity date? A. The bondholder receives the bond’s face value B. The bondholder receives ownership of company assets C. The coupon rate is renegotiated permanently D. The bond automatically becomes common stock Correct Answer: A. The bondholder receives the bond’s face value Rationale: At maturity, the issuer generally repays the bond’s face or par value, commonly $1,000 for a corporate bond. Coupon payments normally end at that time. Bondholders do not automatically receive company assets or common stock. Conversion occurs only when the bond includes a specific convertible feature and the investor chooses to exercise it. Question 8 A start-up company wants to attract investors while limiting the immediate dilution of founders’ voting control. Which security may be especially suitable? A. Voting common stock B. Preferred stock C. Short-term trade credit D. Treasury bonds Correct Answer: B. Preferred stock Rationale: Preferred stock can provide investors with dividend and liquidation preferences while allowing founders to preserve more voting control because preferred shares often carry limited voting rights. Voting common stock would dilute the founders’ control more directly. Trade credit is normally provided by suppliers, while Treasury bonds are issued by the federal government rather than private start-up companies. Question 9 If a corporation is liquidated, which order of claims is generally correct? A. Common shareholders, preferred shareholders, creditors B. Preferred shareholders, creditors, common shareholders C. Creditors, preferred shareholders, common shareholders D. Common shareholders, creditors, preferred shareholders Correct Answer: C. Creditors, preferred shareholders, common shareholders Rationale: Creditors have the highest priority because bonds and loans represent contractual obligations. Preferred shareholders are paid after creditors but before common shareholders. Common shareholders are residual claimants and receive assets only after all senior claims have been satisfied. Therefore, common stock offers greater potential returns but also carries the lowest liquidation priority. Question 10 An investor owns a bond that may be exchanged for a predetermined number of the issuing company’s common shares. What type of bond is this? A. Callable bond B. Convertible bond C. Zero-coupon bond D. Municipal bond Correct Answer: B. Convertible bond Rationale: A convertible bond gives its holder the right to exchange the bond for a specified number of common shares. A callable bond gives the issuer the right to redeem the bond early. A zero-coupon bond pays no periodic interest, while a municipal bond is issued by a state or local government and may offer tax advantages. Question 11 A bond agreement prohibits management from taking on excessive additional debt. What is the main purpose of this debt covenant? A. To guarantee an increase in the company’s stock price B. To protect lenders by limiting actions that increase default risk C. To allow bondholders to manage daily operations D. To eliminate the company’s interest expense Correct Answer: B. To protect lenders by limiting actions that increase default risk Rationale: Debt covenants are contractual promises designed to protect creditors by restricting activities that could weaken the borrower’s ability to repay. A limitation on additional borrowing helps preserve the firm’s financial capacity. Covenants do not guarantee stock-price increases, give bondholders routine managerial authority, or remove the company’s responsibility to pay interest. Question 12 An investor wants an ownership security that provides participation in corporate elections and the possibility of substantial capital appreciation. Which security best meets these objectives? A. Corporate bond B. Preferred stock C. Common stock D. Treasury bill Correct Answer: C. Common stock Rationale: Common shareholders generally have voting rights and benefit from increases in the company’s stock price and dividends. Preferred shareholders usually lack voting rights and receive relatively fixed dividends. Corporate bonds and Treasury bills are debt instruments rather than ownership securities, so their holders do not normally participate in corporate elections or receive unlimited upside from company growth. Question 13 After a fixed-rate bond is issued, market interest rates increase from 5% to 7%. What happens to the bond’s stated coupon rate? A. It increases to 7% B. It falls below 5% C. It remains unchanged D. It changes only if the bond sells at a discount Correct Answer: C. It remains unchanged Rationale: The coupon rate of a traditional fixed-rate bond is established when the bond is issued and does not change with market rates. Instead, the bond’s market price adjusts. When market rates rise above the coupon rate, the existing bond generally loses value. Variable-rate bonds are an exception because their interest payments can reset periodically. Question 14 Which characteristic is shared by both common stock and traditional preferred stock? A. A legally required annual dividend B. A fixed maturity date C. An ownership interest with no stated maturity D. Equal voting rights Correct Answer: C. An ownership interest with no stated maturity Rationale: Common and preferred shares normally represent permanent equity financing and therefore have no stated maturity date. Dividends are not legally guaranteed for either type of stock. Common shareholders usually possess voting rights, whereas preferred shareholders typically do not. The two classes also differ in dividend priority and claims on assets during liquidation.