Canadian Securities Course (CSC) Level 1 Practice Exam

Why do companies issue preferred shares instead of debt?

1. It is not feasible for the company to market new debt because existing assets are heavily mortgaged.

2. Market conditions are unreceptive to new debt issues.

3. The company has enough short and long term debt outstanding.

4. The directors decide that paying preferred dividends will not be expensive.

The correct answer is: It is not feasible for the company to market new debt because existing assets are heavily mortgaged.

Companies may choose to issue preferred shares instead of debt for various reasons. In this scenario, the correct answer is A because if a company's existing assets are heavily mortgaged, it may not be feasible for the company to market new debt. When assets are heavily mortgaged, lenders may be reluctant to provide additional debt, making preferred shares a more attractive financing option. Options B, C, and D are not directly related to the decision to issue preferred shares instead of debt. Market conditions being unreceptive to new debt issues (option B), the company having enough short and long term debt outstanding (option C), or directors deciding that paying preferred dividends will not be expensive (option D) are not necessarily reasons why companies might choose to issue preferred shares instead of debt.