Question

In about 200 words (total), answer one of the following questions:

1. When would issuing bonds be a better option? When would issuing stocks be a better option?

2. An owner of 2,500 shares of Simmons Company common stock receives a stock dividend of 50 shares. How does the total equity of 2,550 shares compare with the total equity of 2,500 shares before the stock dividend?

3. If you asked your broker to buy you a 12% bond when the market interest rate for such bonds was 11%, would you expect to pay more or less than the face amount for the bond? Explain.

Answer 1

Q3.

Answer.

The Contract rate of interest of bonds issued is 12% and the market rate of interest is 11%. This means while investing in the bonds of the company, the investors will get the interest income of 12% on the total amount invested. however, when the same amount is invested in the markets, it will yield an interest income at the rate of 11%.

As the investors will be getting the higher income ffrom the bonds as compared to the market, they will be demanding more of the bonds of the company than any other market instruments so as to yield more interest income. Thus, the demand of the bonds will go up as compared to the number of issuance of bonds. The investors now will be ready to pay more price for the purchase of the bonds, resulting in the bonds prices to go up and the bonds will be issued at premium. The prices will goup till the time, the additional income so earned by the investors will be compensated with the additional premium paid by the investors.

Thus, when the stated rate of interest is more than market rate of interest, then the company will expect to received more funds than the face value of the bonds.