Deck 16: Long-Term Debt and Lease Financing

Question 1

The fact that interest payments on debt are fixed is both an advantage and a drawback to both parties involved.

Answer 1

True

Question 2

Although the times interest earned ratio of many corporations went down tremendously during the 2007-2008 financial crisis, the ratio has been increasing steadily mainly because companies took advantage of the recent low interest rates.

Answer 2

True

Question 3

Par value and face value on a bond generally are the same.

Answer 3

True

Question 4

When a company is obligated contractually to pay interest on debt, it must pay the interest even if it shows no profit for the year, or else it may go bankrupt.

Question 5

Homebuilding companies, like
D.R. Horton Inc., realized significant losses in 2008-2009, but have realized gains since then.

Question 6

The call feature is usually advantageous to the bondholder.
The call feature allows the issuer greater control over when to prepay and retire bonds. The ability to control holding the bond for longer periods up to maturity is removed from the bondholders, placing them at a disadvantage.

Question 7

Bonds may be recalled only if there is a specific call provision in the bond.

Question 8

The call premium tends to increase with the passage of time.
The advantage of the call feature includes the time value of money on the remaining interest payments and the principal balance. Therefore, the shorter the time remaining, the less of a call premium "penalty" the issuer can be expected to make.

Question 9

Because of the legal problems associated with specific asset claims in a secured bond offering, the trend is for companies to issue more debentures.

Question 10

One of several reasons that companies might choose to issue bonds is to shift their capital structure from more equity ownership to more debt borrowing.

Question 11

A bondholder is one that buys the bond, while the bond issuer is the one that sells the bond.

Question 12

During a default situation, a bondholder is better off with a secured loan because debenture bonds don't give the bondholder any protection.
Debenture bonds can allow the bondholder claims against the entire company, rather than just one specific secured asset.

Question 13

In the U.S., bond issuers can be either corporations or the government.

Question 14

Debentures are commonly issued by small companies.
Since debentures are unsecured, investors look to the good faith and credit of the issuing corporation, therefore larger firms with high recognition are more likely to issue debentures.

Question 15

If a corporation offers greater protection to a given class of bondholders, it must raise the interest rate on its bonds to make them more attractive to investors.
In keeping with risk/return, greater protection lowers risk, therefore investors cannot expect as great a return as if that protection were absent.

Question 16

Under a sinking fund provision, money is set aside every year until the bond matures, and then the money is used to repay the principal.

Question 17

When a company defaults on a secured debt, it is rare for the secured asset to be sold and the proceeds distributed to the debtor.

Question 18

Long-term bond prices are more volatile than short-term bond prices, given an equal percentage change in the interest rate.
The longer the remaining time, the greater the impact of a change in market rates of interest affecting the price.

Question 19

A bond indenture is a bond with no specific collateral securing it.
The "indenture" is the complete text of the loan agreement, not to be confused with "debentures" or unsecured bonds.

Question 20

An after-acquired property clause means that any new property acquired is placed under the original mortgage claim.

Question 21

When interest rates rise, bond refunding becomes quite popular.
If interest rates are rising, issuers would naturally resist refunding at higher rates when they already have a lower rate locked in for existing bonds.

Question 22

The "yield to maturity" is the internal rate of return on a bond.

Question 23

The coupon rate is the actual interest that the seller pays, which may not equal the amount that the seller incurs for an expense.

Question 24

Zero-coupon bonds are sold at face value because no interest is paid.
They are sold at a deep discount and grow to maturity value.

Question 25

The prices of zero-coupon bonds tend to react violently to large swings in interest rates.

Question 26

A bond can only be easily refunded if it has a call feature.

Question 27

An advantage of the zero coupon bond is that there is no coupon, so the yield to maturity is locked in for the life of the bond.

Question 28

The costs of bond refunding are the call premium and the underwriting cost on the new bond issue.

Question 29

Zero-coupon bonds are more risky then other bonds because there is no interest payments involved during the life of the bond.

Question 30

Zero-coupon bonds are sold at a deep discount primarily because investors are not interested in owning them.
"Zeroes" are sold at a deep discount with the strategy in mind that they will grow to maturity, providing the investor with income equal to the spread.

Question 31

The costs of bond refunding are the call premium and the underwriting costs on the old and new bond issue.
The underwriting cost on the OLD issue is not a cost of bond refunding.

Question 32

During economic upswings, spreads between bonds of different ratings tend to widen.

Question 33

Refunding a bond occurs when the company sells more bonds of the same series with maturity and a coupon equal to the bonds sold earlier.
Refunding is the calling and elimination of the old bond by the issuing company.

Question 34

The payment of a call premium may generally be taken as an immediate tax write-off.

Question 35

As interest rates decline, bond refunding should become more common.
Bond issuers will seek to call bonds early and refinance them at declining lower rates in the same fashion that homeowners might refinance the mortgage on their home.

Question 36

The difference between the initial bond price and the maturity value is amortized for tax purposes over the life of a zero-coupon bond.

Question 37

If you expect interest rates to go up, you should buy a long-term bond now.
Since bonds competing in the market are at fixed interest rates, you are better advised to lock in your money later when rates are higher.

Question 38

The weighted average cost of capital is generally used as the discount rate in a bond-refunding decision.
The after-tax cost of new debt is used as the discount rate since the savings are certain, unlike in a capital budgeting situation.

Question 39

The value of bonds will move in the opposite direction from the market interest rates.

Question 40

If you expect interest rates to go up, you should sell a long-term bond now.
Selling means you are the one paying the interest, so locking in on a lower interest rate now would be best.

Question 41

The primary advantage of investing in floating rate bonds is that the bonds will maintain a more stable market value within a reasonable limit.

Question 42

The lessee is the one making the rental payments, while the lessor is the one receiving the rental payments.

Question 43

Lease obligations, whether capital or operating, currently appear only in the footnotes of U.S. corporate financial statements.
If a lease is a capital lease, obligations under that lease will appear on the balance sheet as well.

Question 44

The initial floating rate bond price is inversely related to changes in interest rates.

Question 45

Bond ratings start with Aaa and end with C or Aaa1 and end with C3.

Question 46

In an inflationary economy, debt is adjusted for inflation and must be paid back with "more expensive dollars."
Debt repayment in dollars is governed by the original contract, and unless specified as such, is not adjusted for inflation.

Question 47

A capital lease has many of the characteristics of a long-term debt obligation.

Question 48

The essence of the treatment of long-term, non-cancelable capital leases is the same as if the company had borrowed the money and bought the asset.

Question 49

Leasing land through an operating lease provides a tax advantage to the lessee in that lease payments are tax-deductible, while there is no deduction for the landowner.

Question 50

A capital (or "financing") lease usually calls for an annual expense deduction equal to the lease payment.
This is more indicative of an "operating" lease.

Question 51

A Eurobond is a bond payable in the borrower's currency but sold outside the borrower's country.

Question 52

Many companies try to maintain investment grade status due to the significant yield differential when rated with a junk-bond status.

Question 53

An operating lease is generally a long-term, non-cancelable obligation.
This is more indicative of a capital lease.

Question 54

Bond refunding is generally advantageous to the investor because the investor gets a higher future interest rate.
Their higher-interest investment is called away, and they must seek to replace that investment with a comparable obligation, which will likely not return as much as the old obligation.

Question 55

In an operating lease situation, the lessee shows the asset and the debt on its financial statements.

Question 56

The inclusion of leases on the balance sheet as an asset and liability has lowered firm's debt-to-equity ratio.

Question 57

A floating rate bond has a reasonably stable price, but actual interest payments received change often over the life of the bond.

Question 58

Yield spreads between investment grade and junk bond ratings are usually greater during economic boom periods.

Question 59

The disadvantage of a zero-coupon bond to an investor is that the annual increase in the bond is taxable as ordinary income and no annual cash pay mentsare received to pay for the tax charges.

Question 60

A low bond ratings during a bad economic time means that the company will have to pay higher interest.

Question 61

A serial bond repayment plan involves a(n)

A) lump-sum payment at maturity.
B) conversion of debt to common stock.
C) early redemption of all debt.
D) series of installments to retire the debt over the life of the issue.

Question 62

Which of the following is the lowest in priority of claims against a bankrupt firm?

A) An unsecured bond
B) A senior debenture
C) Common stock
D) Federal taxes

Question 63

An indenture is

A) the section of a corporation's bylaws pertaining to bond issues.
B) the summary of the essential features of a stock issue.
C) the contract between a corporation and a trustee acting for bondholders.
D) the underwriting contract.

Question 64

A bond with a call provision would generally be sold to yield

A) less than a non callable bond of similar character.
B) the same as a similar non callable bond.
C) more than a non callable bond of similar character.
D) the same as similar convertible bonds.

Question 65

The greater use of debt by corporations since the late 1970s is best shown by the

A) declining "times interest covered" ratio.
B) small amount of common stock sold.
C) rising cost of interest.
D) inability of earnings to keep up with inflation.

Question 66

The coupon rate of the bond varies indirectly with changes in market interest rates.
The coupon rate of a bond remains constant; however, the PRICE of the bond will vary with changes in the current market.

Question 67

The term debenture refers to

A) long-term, secured debt.
B) long-term, unsecured debt.
C) the after-acquired property clause.
D) a document covering the specific terms of the offering.

Question 68

The main cause for the increase in corporate debt in America is

A) rapid business expansion.
B) inflationary impacts.
C) drop in interest rates.
D) all of these options are true.

Question 69

Which of the following best represents the hierarchy of creditor and stockholder claims?

A) Common stock, senior secured debt, subordinated debentures
B) Senior debentures, subordinated debentures, junior secured debt
C) Senior secured debt, subordinated debentures, common stock
D) Preferred stock, secured debt, debentures

Question 70

A call provision, which allows the corporation to force an early maturity on a bond issue, usually contains all but which of the following characteristics?

A) Most bonds must be outstanding at least five years before being called.
B) After the call date, the call premium tends to decline over time.
C) The provision typically calls for debt conversion into common stock.
D) The corporation will pay a premium over par for the bonds.

Question 71

A debenture represents

A) debt not secured by a specific asset.
B) secured debt.
C) a long document covering every detail of a bond issue.
D) debt that is subordinate to preferred stock.

Question 72

A "subordinated debenture"

A) must be transferred with the bond to which it is attached.
B) is used mainly by railroad companies and usually specifies equipment as collateral.
C) entitles the bondholder to purchase shares of common stock at a specific price.
D) is an unsecured bond with an inferior claim on assets in the event of liquidation.

Question 73

A challenge for multinational corporations is trying to get the right financing for certain operating activity expectations.

Question 74

Many bonds have some orderly, pre planned, alternative system of repayment. Which of the following apply?

A) Sinking funds
B) Serial bonds
C) Income bonds
D) Sinking funds and serial bonds

Question 75

Which of the following properly represents the hierarchy of creditor and stockholder claims?

A) Common stock, senior secured debt, subordinated debentures
B) Preferred stock, common stock, subordinated debentures
C) Debentures, preferred stock, common stock
D) State taxes, preferred stockholders, wages due to workers

Question 76

Senior debentures usually provide lower interest rates than junior secured debt.
All things being equal, any secured debt is less risky than any unsecured debt, regardless of junior or senior status; therefore, debentures must pay a higher rate of interest.

Question 77

The document that outlines the covenants and duties existing between bondholders and the issuing corporation is called

A) an indenture.
B) a debenture.
C) secured debt.
D) protective covenants.

Question 78

Which of the following bonds offers the most security to the bondholder?

A) Junior mortgage bonds
B) Senior mortgage bonds
C) Debenture bonds
D) Income bonds

Question 79

Bonds provide stable pricing because they offer a fixed coupon rate and maturity date unlike stocks.
The pricing of bonds fluctuates with changes in the current market, or "yield to maturity."

Question 80

A call feature allows

A) the bondholder to redeem the bond before the maturity date.
B) the corporation to redeem the bond before the maturity date.
C) the corporation to convert the bond to common stock.
D) the bondholder to demand increased collateral.