Question 1

Which of these represents a special feature included with some bond issues?

Accepted Answer

Convertibility of a debt security (bond) into an equity security (stock) is a special feature included with some bond issues.

Question 2

Which of the following represents a disadvantage of issuing bonds?

Accepted Answer

Issuing bonds increases the firm's debt, which can negatively impact the firm's credit rating and increase interest expenses. Bonds are a form of long-term debt and remain on the firm's balance sheet until they are repaid or matured, which can limit the firm's financial flexibility. However, bonds do not come with voting rights for bondholders and dividends are not legally required to be paid to bondholders, making options A, B, and D incorrect.

Question 3

According to the Standard & Poor's Investor Services ratings, which of these ratings indicates a highly speculative bond?

Accepted Answer

According to Standard & Poor's, a rating of "C" indicates a highly speculative bond or one that is currently in default.

Question 4

Melodic Music, Inc., recently offered bonds for sale to the public. The unsecured corporate bond paid interest of 8% to investors for the 20-year life of the bonds. Melodic Music is obligated to

Accepted Answer

Melodic Music is obligated to pay interest semi-annually to bondholders. The other options are not obligations associated with the issuance of a corporate bond.

Question 5

The investor will receive the face value of the bond on the ________ date.

Accepted Answer

The maturity date is the date on which the bond will reach its full value and the investor will receive the face value of the bond. The purchase anniversary and annual interest dates may be important for calculating interest payments, but they do not determine when the bond will reach its full value. The declaration date is the date on which a company announces a dividend, but it is not relevant for bond investors.

Question 6

Standard & Poor's currently rates Careful Corporation bonds as a D grade. This indicates that these bonds are

Accepted Answer

Standard and Poor's rating of D indicates the lowest quality and the highest risk for Careful Corporation bonds.

Question 7

Epic Electronics decides to pay off its bonds several years before the maturity date. Apparently, the bonds

Accepted Answer

Callable bonds allow issuers to pay off the bonds before the maturity date. Therefore, Epic Electronics must have issued callable bonds.

Question 8

An unsecured bond, backed only by the well-respected name of the organization, is called a ________ bond.

Accepted Answer

A debenture bond is an unsecured bond that is not backed by any collateral, but rather only by the issuer's creditworthiness and reputation.

Question 9

Bonds perceived as high risk typically pay ________ interest rates.

Accepted Answer

Bonds perceived as high risk typically pay higher interest rates as investors demand a higher return for taking on additional risk.

Question 10

Marshall Manufacturing issues a $1,000 bond, with an interest rate of 10%, and a maturity date of 2025. This creates a liability for Marshall Manufacturing to pay the bondholder

Accepted Answer

The bond has an interest rate of 10%, which means Marshall Manufacturing is obligated to pay the bondholder $100 in interest annually ($1,000 x 0.10). The bond also has a maturity date of 2025, at which point Marshall Manufacturing will need to pay the bondholder the full $1,000 face value of the bond. Therefore, the correct choice is A.

Question 11

Teeny Toys hopes to raise long-term capital by promising in writing to repay the principal provided by potential creditors in ten years. Additionally, the certificate issued by Teeny Toys promises to pay 5% interest annually for the ten-year life of the security. Teeny Toys intends to issue

Accepted Answer

The certificate promising to repay the principal in ten years and pay annual interest for the ten-year period signifies the issuance of bonds. Stocks represent ownership in a company and do not offer a fixed return. Mutual funds are a type of investment vehicle that pools money from multiple investors to invest in stocks, bonds, and other securities. Commodities refer to raw materials or primary agricultural products that can be bought and sold, such as gold or wheat, and do not offer a fixed return.

Question 12

Corporations issuing ________ bonds pledge a tangible asset as collateral to reduce the risk incurred by a bondholder.

Accepted Answer

Secured bonds are backed by a specific asset pledged as collateral, such as property or equipment, which reduces the risk for the bondholder. Endorsement refers to the act of signing a document, and does not relate to bond issuance. Escrow refers to the depositing of funds in a third-party account for safekeeping, and is not necessarily related to bond issuance. Replacement does not relate to bond issuance or collateral.

Question 13

By buying a ________ bond, investors will have an option to exchange their bond for shares of common stock in the company at a future date.

Accepted Answer

A convertible bond gives investors the option to convert their bond into shares of common stock in the company at a predetermined future date or at a certain stock price.

Question 14

By issuing bonds with a ________, the corporation retains the right to pay off the bond prior to the maturity date.

Accepted Answer

A call provision in bonds allows the issuer to buy back or "call" the bonds before their maturity date, which gives them the ability to refinance at a lower interest rate or retire the bonds early if needed. This provides flexibility for the corporation and can result in cost savings, but it also adds risk for the bondholder.

Question 15

Mineral Mining Corporation makes regular monetary deposits that will accumulate and provide for an orderly retirement of their bonds when they come due in 2025. Mineral Mining appears to be utilizing a

Accepted Answer

Mineral Mining Corporation is utilizing a sinking fund. A sinking fund is a provision in a bond issue where the issuer deposits money on a regular basis to ensure that there will be enough funds to retire the bonds when they come due. This provides a measure of safety for the bondholders, as it reduces the risk of default.

Question 16

After owning a Maplewood Company bond for five years, Michelle exercised an option that allowed her to exchange her bond for 20 shares of the company stock. Michelle owned a

Accepted Answer

Michelle owned a convertible bond since she was able to exchange her bond for stock.

Question 17

Your Uncle Mike is approaching retirement and he asks for your advice for a safe place to invest several thousand dollars. He wants to receive some kind of payment each year for investing his money without a great deal of risk. You explain

Accepted Answer

Treasury and top-grade corporate bonds are considered safe investments and pay interest twice a year, providing a regular payment without a great deal of risk. Yankee bonds may also be a good option, but there is no guarantee that any investment will not default. Common stock does not always pay dividends, and junk bonds are considered high-risk investments that may not pay annual interest.

Question 18

Firms establish a ________ so that sufficient funds are available to repay bondholders on the maturity date.

Accepted Answer

A sinking fund is a reserve of funds set up by a corporation to ensure the repayment of bondholders upon maturity. The corporation makes periodic deposits into the sinking fund, and then uses the funds to repurchase a portion of the outstanding bonds. This reduces the overall debt burden and ensures the timely repayment of the remaining bondholders at maturity. The other options, mutual fund, retirement account, and encumbered account, are not directly related to the repayment of bondholders.

Question 19

A convertible bond allows the bondholder to exchange the bond for

Accepted Answer

A convertible bond allows the bondholder to exchange the bond for common stock. This means that the bondholder has the option to convert their bond into shares of the company's common stock, which can potentially result in a higher return if the stock price increases. The bondholder does not receive preferred stock, collateral, or debt holder privileges in exchange for the bond.

Question 20

Matthew recently invested in 15-year Bathtub Brewing Company bonds paying 8% interest annually, with a maturity date of 2035. The bonds are callable in 2030. If interest rates go down to 5.5% in the year 2030, the brewery is likely to

Accepted Answer

Since the interest rates have gone down to 5.5% in 2030, it will be cheaper for Bathtub Brewing Company to borrow money by issuing new bonds at the lower interest rate. As a result, they are likely to exercise the call option to retire the higher-interest rate bonds and replace them with lower-cost debt.

Quiz 19: Using Securities Markets for Financing and Investing Opportunities