Raising Capital

Question 1:2B6-LS04

What is the primary responsibility of a credit rating agency?

Provides advice only to investors in making investing decisions.

Assigns a credit rating for the companies entering into a debt obligation as well as specific debt instruments.

Provides advice to organizations regarding how much credit they can receive.

Provides credit to an organization seeking capital.A credit rating agency analyzes organizations and provides a credit rating so investors, issuers, investment banks, broker-dealers, governments, and other entities can utilize this information to make informed decisions as to the credit risk of an organization and their financial instrument(s).

Question 2:2B6-AT01

Which one of the following statements concerning American Depository Receipts (ADRs) is not correct?

ADRs allow foreigners to raise capital in the U.S.

ADRs facilitate the banking procedures for U.S. multinational firms.

ADRs are securities issued by American banks acting as custodians of shares of foreign firms.

ADRs allow Americans to invest abroad.

ADRs are certificates representing ownership of foreign stocks. They do not facilitate banking procedures for U.S. multinational firms.

Question 3:2B6-LS01

An investor is considering investing in companies in a particular industry. During research of different companies within this industry, the investor begins to contact their investor relations departments. Upon contacting the investor relations department of XYZ Company, they inform the investor that they are going to be purchasing a competitor, providing them with a near monopoly within the industry. The investor takes this information and purchases stock in XYZ Company, no abnormal gains result. This is an example of what form of market efficiency?

Semi-weak form.

Weak form.

Semi-strong form.

Strong form.

The strong form of the efficient market hypothesis states that all information in a market, whether public or private, is accounted for in a stock price. Not even insider information could give an investor an advantage.

Question 4:2B6-AT09

Most states have laws that provide preemptive rights for shareholders. A preemptive right is when a company must:

give existing shareholders the opportunity to maintain their proportionate ownership share in the company when issuing a new public offering.

give dividends to the common shareholders first before giving dividends to the preferred shareholders.

sell shares to existing shareholders equal to their proportionate ownership share in the company when issuing a new public offering.

give existing shareholders stock warrants equal to their proportionate ownership share in the company when issuing a new public offering.

The preemptive right gives existing shareholders stock warrants equal to their proportionate ownership share in the company when the company issues more shares of stock.

Question 5:2B6-CQ04

Manny Enterprises has 300,000 shares of common stock outstanding. Net income for the fiscal year is $700,000. The stock of Manny Enterprises also includes a price-earnings ratio of 6. The board of directors recently made public that there will be a five-for-three stock split. An investor owns 200 shares of stock before the split, and is concerned about the value of his stock diminishing because of the stock split. What will the approximate value of their investment in Manny Enterprises stock be immediately after the split?

$4,200.

$1,680.

$466.

$2,800.First calculate Earnings Per Share by taking $700,000 net income / 300,000 pre-split shares outstanding, or $2.33. Take the $2.33 and multiply it by the PE Ratio of 6.0 to get the current approximate per-share price of $13.98. Multiply this by the 200 shares owned by this investor, results in a current market value of $2,796 for their holdings. The result of the stock split will be an increase in total shares of Manny Enterprises common stock outstanding but at a proportionately lower per-share market price, (# of shares outstanding increases, price of each share decreases) with no immediate change in any investors' total investment value.

Question 6:2B6-AT03

All of the following are functions of the Securities and Exchange Commission except the:

determination of fair trading prices for the common stock of large public companies.

regulation of the American Stock Exchange.

review of stock trades by corporate insiders.

regulation of interstate offerings of new securities to the public.

The stock markets determine the values of publicly traded stocks.

Question 7:2B6-AT08

When a company desires to increase the market value per share of common stock, the company will implement:

a stock dividend.

a reverse stock split.

the sale of treasury stock.

a stock split.

A stock split does not affect the value of the firm. A reverse stock split would increase the stock price in the same proportion as the decrease in the number of shares outstanding. For example, a one-for-two split would double the price of the stock and decrease the number of shares outstanding by one half.

Question 8:2B6-LS08

When determining the amount of dividends to be declared, the most important factor to consider is the:

*Source: Retired ICMA CMA Exam Questions.

future planned uses of cash.

impact of inflation on replacement costs.

future planned uses of retained earnings.

expectations of the shareholders.When determining the amount of dividends to be declared, the most important factor to consider is the future planned uses of cash.

Question 9:2B6-LS09

Underhall Inc.'s common stock is currently selling for $108 per share. Underhall is planning a new stock issue in the near future and would like to stimulate interest in the company. The

Board, however, does not want to distribute capital at this time. Therefore, Underhall is considering whether to offer a 2-for-1 common stock split or a 100% stock dividend on its common stock. The best reason for opting for the stock split is that:


the impact on earnings per share will not be as great.

it will not impair the company's ability to pay dividends in the future.

it will not decrease shareholders' equity.

the par value per share will remain unchanged.The best reason for opting for the stock split is that it will not impair the company's ability to pay dividends in the future.

Question 10:2B6-LS06

A multi-national firm is seeking to raise capital overseas. After much consideration, the board of directors chooses the Tokyo Stock Exchange. This type of market transaction would be referred to as:

Money market.

Secondary market.

International sales market.

Primary market.The market that is used in the trading of new securities, including bonds and stocks, is called the primary market. In the primary market, the investor typically purchases newly issued securities from the investment bank doing the underwriting for the company selling the security. No matter what country the firm has their initial public offering it is still considered the primary market. The secondary market is the market an investor uses to purchase an asset from another investor.

Question 11:2B6-AT04

The contents of the section of the annual report entitled "Management's Discussion and Analysis" (MD&A) are:

not reviewed by independent auditors.

mandated by regulations of the Securities and Exchange Commission (SEC).

mandated by pronouncements of the Financial Accounting Standards Board.

not mandated.

The SEC requires that all publicly held corporations include an MD&A in their annual financial

report. The SEC mandates coverage of liquidity, risk, and sustainability of earnings in the MD&A.


The residual theory of dividends argues that dividends:


can be paid if there is income remaining after funding all attractive investment opportunities.

are irrelevant.

can be foregone unless there is an excess demand for cash dividends.

are necessary to maintain the market price of the common stock.The residual theory of dividends argues that dividends can be paid if there is income remaining after funding all attractive investment opportunities.


Which of the following best describes the over-the-counter (OTC) market?

A market where brokers and dealers buy and sell securities on a trading floor, much like the New York Stock Exchange.

A market where investors can enter a financial institution and purchase shares of stocks directly from an organization selling stocks.

A market where brokers and dealers buy and sell securities utilizing a telecommunications system to trade securities.

A market where buyers and sellers trade securities in an auction-type atmosphere, much like that of the New York Stock Exchange.

An OTC market is the trading of financial instruments such as stocks, bonds, commodities or derivatives directly between two parties, facilitated by brokers and dealers, using telecommunications equipment. An example in the United States would be NASDAQ.


Arch Inc. has 200,000 shares of common stock outstanding. Net income for the recently ended fiscal year was $500,000, and the stock has a price/earnings (P/E) ratio of eight. The Board of Directors has just declared a three-for-two stock split. For an investor who owns 100 shares of stock before the split, the approximate value (rounded to the nearest dollar) of the investment in Arch stock immediately after the split is:

$4,000.

$2,000.

$1,333.

$3,000.

The stock split will not change the value of the firm, nor will it change the value of the investor's holding.

Original Stock price = (P/E ratio)(EPS)Where EPS = Earnings Per Share

EPS = Net Income / # share common stock outstandingEPS = $500,000 / 200,000 = $2.50

Original Stock price = (8)($2.50) = $20

Since the investment value doesn't change with the split, ($20)(100 shares) = $2,000.

After the split, the investor will have 3/2 more shares.(100 shares)(3/2) = 150 shares

Each share will be worth : $2,000 / 150 shares = $13.33.

Question 15:2B6-CQ03

Mason Inc. is considering four alternative opportunities. Required investment outlays and expected rates of return for these investments are given below.

The investments will be financed through 40% debt and 60% common equity. Internally generated funds totaling $1,000,000 are available for reinvestment. If the cost of capital is 11%, and Mason strictly follows the residual dividend policy, how much in dividends would the company likely pay?

$328,000.

$120,000.

$650,000.

$430,000.

A firm using the residual dividend policy would first reinvest earnings in the firm. Any residual amount remaining would be paid out in dividends. Given an 11% cost of capital, Mason would invest in the three projects that have IRR's greater than 11%, which would include a

total investment of $1,120,000 ($200,000 for Project A, $350,000 for Project B, and $570,000 for Project C).

Given a 60% equity financing structure, 60% of the investment would be from the $1,000,000 in earnings, ending up with $672,000.(0.6)($1,120,000) = $672,000

The remaining amount of $328,000 ($1,000,000 − $672,000) would be available for dividends.


A company wishes to raise capital in the capital markets. They file the appropriate paperwork and come to the point where they are ready to issue new shares of stock, commonly known as in Initial Public Offering, or IPO. The market that the organization uses to sell these new shares of stock is known as the:

Money market.

Sales market.

Primary market.

Secondary market.The market that is used in the selling of new securities, including bonds and stocks, is called the primary market. In the primary market, the investor typically purchases the newly issued securities from the investment bank or syndicate underwriting the issue of the security for the issuing company. The secondary market is the market an investor uses to purchase an asset from another investor.


In practice, dividends:

fluctuate more widely than earnings.

are usually set as a fixed percentage of earnings.

are usually changed every year to reflect earnings changes.

usually exhibit greater stability than earnings.

The price of a stock is the present value of its dividend stream at the market's required rate of return. The price of the stock is directly proportional to the level of dividends. To help prevent excessive stock price fluctuations, corporations try to maintain relatively constant dividend levels.


A large public company that is well-known can reduce the time required to register and issue securities by using a(n):

secondary market registration.

shelf registration.

red herring registration.

Subchapter S filing.

The Securities and Exchange Commission (SEC) Rule 415 allows companies that have a one-year history of timely SEC filings to file an SEC Form S-3ASR shelf registration. The Form S-3ASR as well as the Form S-3 and S-2 allow for a streamlined registration process. The Form S-1 is used for those who do not qualify for streamlined registration such as an initial public offering.


Kalamazoo Inc. has issued 25,000 shares of its authorized 50,000 shares of common stock. There are 5,000 shares of common stock that have been repurchased and are classified as treasury stock. Kalamazoo has 10,000 shares of preferred stock. If a $0.60 per share dividend has been authorized on its common stock, what will be the total common stock dividend payment?

$21,000.

$15,000.

$30,000.

$12,000.

The dividend paid would be $0.60 per share, multiplied by the number of shares outstanding. The number of outstanding shares is calculated by taking the number of issued shares and subtracting the number of share that were repurchased and held in treasury.

Number of shares = # shares issued − # shares of treasury stockNumber of shares = 25,000 − 5,000 = 20,000

Dividend: ($0.60 per share)(20,000 shares) = $12,000.


Brady Corporation has 6,000 shares of 5%, cumulative, $100 par value preferred stock outstanding and 200,000 shares of common stock outstanding. Brady's Board of Directors last declared dividends for the year ended May 31, Year 1, and there were no dividends in arrears. For the year ended May 31, Year 3, Brady had net income of $1,750,000. The Board

of Directors is declaring a dividend for common shareholders equivalent to 20% of net income. The total amount of dividends to be paid by Brady at May 31, Year 3, is:

$60,000.

$410,000.

$380,000.

$350,000.

The total dividend is $410,000 made up of $350,000 in common stock dividends plus $60,000 in preferred stock dividends.

The 350,000 in common stock dividends is calculated by taking the $1,750,000 in net income and multiplying it by the 20% dividend payout ratio.

The $60,000 in preferred stock dividends is derived by taking the Year 3 dividend [(6,000)($100)(0.05) = $30,000] and adding to it the $30,000 dividend missed in Year 2.

Note that the last dividends were paid in Year 1.


James Hemming, the chief financial officer of a Midwestern machine parts manufacturer, is considering splitting the company's stock, which is currently selling at $80.00 per share. The stock currently pays a $1.00 per share dividend. If the split is two-for-one, Mr. Hemming may expect the post split price to be:

greater than $40.00, if the dividend is changed to $0.55 per new share.

exactly $40.00, regardless of dividend policy.

less than $40.00, regardless of dividend policy.

greater than $40.00, if the dividend is changed to $0.45 per new share.The price of a common stock is calculated by taking the present value of its projected dividend stream, computed using the expected return on the stock. If, during a two-for-one stock split, the dividend is split two-for-one to $0.50 per share, then the stock price will become half of its current value, or $40. If the dividend is cut by less than 50%, to $0.55 in this case, then the stock price after the split will be greater than $40 per share.


Which of the following markets is involved with the trading of debt securities with maturities of less than one year?

Primary markets.

Capital markets.

Money markets.

Secondary markets.The market that is involved in the trading of debt securities with maturities of less than one year is called a money market.

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Raising Capital