Question

While the agency conflicts between managers and shareholders tend to receive the most press, they are not the only agency conflict affecting the modern corporation. another equally important agency conflict is sometimes observed between a firm's comon shareholders and its condholders. as before the basis of this conflict is divergent concerns and motives. in general, condholders purchase corporate securites that provide a ____________ (fixed, variable) return wheras shareholders purchase share that are likely to provide a return that fluctuates with the riskiness of the firm.If managers undertake projects that increase the riskiness of the firm and its cash flows, then the wealth of the firms condholders will be _____________ (increased, decreased) while that of the firms shareholders will be _______________ (increased, decreased)Which of the following are restrictive convenants often used to protect the firms Bond value and bondholder wealth? Check all that applya) provisions that prohicit borrowing fund to pay dividendsb) provisions that limit issuing new debt securitiesc) provisions that limit dividends paid to stockholdersd) provisions that require firing the firms CEO whenever the firms bond price decreases by more than 15%IN addition, potential condholders may require a __________ (lower, higher) interest rate on the firms soon to be issued cond as compensation for the risks that cannot be adequately protected against using the restrictive covenants.

Answer 1

Answer:

1. Fixed.

2. Decreased.

3. Increased.

4. A and B.

5. Higher.

Explanation:

While the agency conflicts between managers and shareholders tend to receive the most press, they are not the only agency conflict affecting the modern corporation. Another equally important agency conflict is sometimes observed between a firm's common shareholders and its bondholders. As before the basis of this conflict is divergent concerns and motives.

In general, bondholders purchase corporate securities that provide a fixed return whereas shareholders purchase shares that are likely to provide a return that fluctuates with the riskiness of the firm.

If managers undertake projects that increase the riskiness of the firm and its cash flows, then the wealth of the firm's bondholders will be decreased while that of the firms shareholders will be increased.

The following are two (2) restrictive covenants often used to protect the firms bond value and bondholder wealth;

a) provisions that prohibit borrowing fund to pay dividends.

b) provisions that limit issuing new debt securities.

In addition, potential bondholders may require a higher interest rate on the firms soon to be issued bond as compensation for the risks that cannot be adequately protected against using the restrictive covenants.

In a nutshell, you should note that bond can be defined as a fixed income instrument that signifies the indebtedness of the bond issuer to the bond holder (investor or creditor).

Also, a restrictive covenant is a document that states certain actions that are forbidden to the bond issuer as highlighted above.