Question 1

What differentiates a senior debenture from a junior debenture?

Accepted Answer

Senior debentures have a higher claim on the assets and earnings of a company in the event of liquidation or bankruptcy, making them less risky compared to junior debentures.

Question 2

Which of the following is (are) a Eurobond(s)?

Accepted Answer

A Eurobond is a bond issued in a currency different from the currency of the country or market in which it is issued. An IBM bond sold in Japan denominated in U.S. Dollars fits this definition.

Question 3

Which is not true of preferred stock?

Accepted Answer

Preferred shareholders do not have priority over the creditors of the corporation; creditors are paid before equity holders in the event of liquidation.

Question 4

For a lease to be classified as a capital lease, it must:

Accepted Answer

A capital lease is classified as such if it transfers ownership of the asset to the lessee by the end of the lease term, among other criteria.

Question 5

A ________ adjusts its coupon rate at established times and according to a market index.

Accepted Answer

A variable-rate bond, also known as a floating-rate bond, adjusts its coupon rate based on a predetermined formula or benchmark, such as the LIBOR or the Treasury bill rate, ensuring that its interest payments move in line with market interest rates.

Question 6

You are considering refunding a $15,000,000 twelve year bond with a 10% annual coupon and replacing it with a $15,000,000 twelve year bond with a 7% annual coupon. Your tax rate is 40%, what would be the present value of the after tax savings? (discounted at an appropriate rate)

Accepted Answer

The present value of the after-tax savings from refunding can be calculated by finding the difference in the annual interest payments of the two bonds, adjusting for taxes, and then discounting these savings back to their present value. The original bond has an annual interest payment of $1,500,000 (10% of $15,000,000), and the new bond has an annual interest payment of $1,050,000 (7% of $15,000,000). The annual savings before taxes would be $450,000 ($1,500,000 - $1,050,000). After adjusting for a 40% tax rate, the after-tax savings per year would be $270,000 ($450,000 * (1 - 0.40)). To find the present value of these savings over 12 years, we discount them at the new interest rate (7%). The present value of an annuity formula is used here, resulting in the correct answer being $2,504,817.

Question 7

Four years ago, you purchased a convertible bond at par with a ten year maturity with an 8% coupon. The conversion ratio of the bond is 25. The current market price of the stock is $50. Calculate the conversion value.

Accepted Answer

The answer of Four years ago, you purchased a convertible...

Question 8

Using the information in the previous question, if the current market interest rate is 9.5% on similar non-convertible bonds, should you convert? Explain.

Accepted Answer

The answer of Using the information in the previous question,...

Question 9

You purchased a fifteen-year 10% coupon bond at $1,000 par five years ago. This is a putable bond that can be redeemed at par after five years. The current required rate of return on similar non-convertible bonds is 9%. Should you redeem the bond? Explain.

Accepted Answer

The answer of You purchased a fifteen-year 10% coupon bond...

Question 10

Why would anyone choose to purchase preferred stock?

Accepted Answer

The answer of Why would anyone choose to purchase preferred...

Question 11

Why are junk bonds called high-yield bonds?

Accepted Answer

The answer of Why are junk bonds called high-yield bonds?...

Question 12

Explain why preferred stock is known as a hybrid security.

Accepted Answer

The answer of Explain why preferred stock is known as...

Question 13

You are considering refunding a currently outstanding bond with a par value of $10,000,000. It has a coupon of 11% and has ten years remaining to maturity. Current yields on ten year bonds are 9%. If you call the bond, there will be a 4% call premium. Underwriting costs on a new ten year issue will be $800,000. Your tax rate is 40%. Should you proceed with the refunding? (For ease of computation assume annual coupons)

Accepted Answer

The answer of You are considering refunding a currently outstanding...

Question 14

Explain why a mortgage bond would have a lower yield than a similar debenture.

Accepted Answer

The answer of Explain why a mortgage bond would have...

Question 15

Why might a company undertake a bond refunding even if the NPV was negative?

Accepted Answer

The answer of Why might a company undertake a bond...

Question 16

What are the cash outflows associated with bond refunding?

Accepted Answer

The answer of What are the cash outflows associated with...

Question 17

What are some common restrictive covenants that limit debt issuance?

Accepted Answer

The answer of What are some common restrictive covenants that...

Question 18

What is the primary reason that corporations lease assets? What types of companies are more likely to lease rather than buy?

Accepted Answer

The answer of What is the primary reason that corporations...

Question 19

You are considering whether to rent or buy a new piece of equipment expected to last six years. You can take out a bank loan at 8% yearly interest and buy the equipment for $45,000, or, you can lease it for $8,500 per year for the six years. If you buy, it will go into the Cl.8 asset pool with a 20% CCA rate. Your tax rate is 30%. Should you rent or lease? Assume the equipment will have no value at the end of the 6 years.

Accepted Answer

The answer of You are considering whether to rent or...

Question 20

Why is a call feature rarely an advantage for the bond holder?

Accepted Answer

The answer of Why is a call feature rarely an...

Quiz 5: Long-Term Financing Decisions