BKM Ch 02 Answers W CFA 1 
CHAPTER 2: ASSET CLASSES & FINANCIAL INSTRUMENTS
1. In what ways is preferred stock like long-term debt? In what ways is it like equity?
Note: The question is using the term equity to strictly mean common stock. Preferred stock is a type of equity.
Preferred stock is like long-term debt in that it typically promises a fixed payment each year. In this way, it is a perpetuity. Preferred stock is also like long-term debt in that it does not give the holder voting rights in the firm.
Preferred stock is like common stock (and other equity claims) in that failure to make a preferred stock payment does not set trigger corporate bankruptcy.
In the event of corporate bankruptcy, preferred stock has a higher priority claim to the assets of the firm than common equity but a lower priority than bonds.
2. Why are money market securities sometimes referred to as “cash equivalents”?
Money market securities are called “cash equivalents” because of their liquidity and low (zero?) default risk. The prices of money market securities are very stable (low duration) and they can be converted to cash (i.e., sold) on very short notice and with very low transaction costs.
3. Which of the following correctly describes a repurchase agreement?
Answer a. A repurchase agreement is an agreement whereby the seller of a security agrees to “repurchase” it from the buyer on an agreed upon date at an agreed upon price. It is effectively a loan collateralized by the asset sold and repurchased.
4. What would you expect to happen to the spread between yields on commercial paper and Treasury bills if the economy were to enter a steep recession?
Like the TED spread (the spread between the yield on Treasury bills and Eurodollar bank deposits shown in class) the spread between the yield on Treasury bills and commercial paper (the rate paid by corporations) will widen. Deterioration of the economy increases credit risk (the likelihood of default). Investors will demand a greater premium on debt
1. In what ways is preferred stock like long-term debt? In what ways is it like equity?
Note: The question is using the term equity to strictly mean common stock. Preferred stock is a type of equity.
Preferred stock is like long-term debt in that it typically promises a fixed payment each year. In this way, it is a perpetuity. Preferred stock is also like long-term debt in that it does not give the holder voting rights in the firm.
Preferred stock is like common stock (and other equity claims) in that failure to make a preferred stock payment does not set trigger corporate bankruptcy.
In the event of corporate bankruptcy, preferred stock has a higher priority claim to the assets of the firm than common equity but a lower priority than bonds.
2. Why are money market securities sometimes referred to as “cash equivalents”?
Money market securities are called “cash equivalents” because of their liquidity and low (zero?) default risk. The prices of money market securities are very stable (low duration) and they can be converted to cash (i.e., sold) on very short notice and with very low transaction costs.
3. Which of the following correctly describes a repurchase agreement?
Answer a. A repurchase agreement is an agreement whereby the seller of a security agrees to “repurchase” it from the buyer on an agreed upon date at an agreed upon price. It is effectively a loan collateralized by the asset sold and repurchased.
4. What would you expect to happen to the spread between yields on commercial paper and Treasury bills if the economy were to enter a steep recession?
Like the TED spread (the spread between the yield on Treasury bills and Eurodollar bank deposits shown in class) the spread between the yield on Treasury bills and commercial paper (the rate paid by corporations) will widen. Deterioration of the economy increases credit risk (the likelihood of default). Investors will demand a greater premium on debt