Question 1

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

Selling bonds to raise long-term capital obligates the organization to pay interest payments throughout the life of the bond, usually semi-annually.

Question 2

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

Accepted Answer

The maturity date refers to the date the issuer of a bond must pay the principal to the bondholder.

Question 3

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 backed only by the reputation of the issuer.

Question 4

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

Accepted Answer

A sinking fund is established by firms to accumulate funds over a period of time so that there are adequate funds available to pay bondholders when the bonds mature. This provides an added layer of security for investors and lowers the risk of default for the company issuing the bonds. Mutual funds, retirement accounts, and encumbered accounts do not serve the same purpose as a sinking fund.

Question 5

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

A sinking fund requires the issuer of a bond to regularly set aside funds in a reserve account to provide for accumulated funds necessary to repay the principal of the bond.

Question 6

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 allows the corporation to redeem or pay off the bond prior to the maturity date, usually at a premium price. This gives the corporation the flexibility to retire the bond if interest rates decline or if they have excess cash flow.

Question 7

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

Convertible bonds give investors the option to convert their bonds into common stock in the company at a future date, which provides added flexibility and potential for higher returns. Discount bonds are sold at a discount to their face value, contingent bonds are dependent on a specific event occurring, and preferred bonds pay a fixed dividend but do not have the option to convert into common stock.

Question 8

Which of the following represents a disadvantage of issuing bonds?

Accepted Answer

Bonds increase debt and may adversely affect the market's perception of the firm.

Question 9

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

If interest rates go down, the brewery is likely to call in the bond issue, pay off the investors, and re-issue new bonds at the lower interest rate.

Question 10

A convertible bond allows the bondholder to exchange the bond for

Accepted Answer

Convertible bonds allow the bondholder to convert the bond into shares of common stock in the issuing company.

Question 11

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

Accepted Answer

Standard & Poor's uses a letter rating system to signify the creditworthiness of bonds. Ratings from "AAA" to "BBB" are considered investment-grade, while ratings from "BB" to "D" are considered speculative or junk bonds. Therefore, only Option C, with a rating of "C", indicates a highly speculative bond.

Question 12

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

Accepted Answer

When a bond is "callable," it contains a special call provision that permits the bond issuer to pay off the bond prior to its maturity date.

Question 13

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

Accepted Answer

The term "secured" refers to the pledging of a tangible asset as collateral to reduce the risk for bondholders. This ensures that if the corporation defaults on the bond, the bondholders have a tangible asset to recover their investment. Endorsement refers to the signing of a document to show agreement, and escrow refers to a legal arrangement where a third party holds assets or funds until certain obligations are fulfilled. Replacement does not relate to bond issuance.

Question 14

Bonds perceived as high risk typically pay ________ interest rates.

Accepted Answer

The risk/return trade-off suggests that interest rates must be sufficiently high to attract investors to an above average risky investment.

Question 15

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

The interest on most bonds is quoted as an annual rate, but it is usually issued in two increments each year.

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

A convertible bond is one that can be converted into shares of common stock in the issuing company.

Question 17

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

Accepted Answer

A D grade by Standard & Poor's indicates that Careful Corporation bonds are the lowest quality and highest risk. Highly speculative with a high likelihood of default.

Question 18

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

Accepted Answer

Convertible bondholders can choose to exchange their bonds for shares of stock in the same company.

Question 19

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

A bond is a contract of indebtedness issued by an organization that promises payment of a principal amount at a specified future time plus interest.

Question 20

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 bondholder will receive 10% of $1,000 per year. The bondholder will also receive the face value of $1,000 on the maturity date in 2025.

Quiz 19: Using Securities Markets for Financing and Investing Opportunities