Deck 19: Corporate Bond Pricing, Market Development, and Financing Strategies

Question 1

Businesses usually derive a majority of the funds they need for daily operations and for long-term capital investment from the money and capital markets; a lesser proportion of their total need for funds comes from internally generated cash.

Answer 1

False

Question 2

In an expanding economy in a boom period businesses rely less upon the money and capital markets for funds, as measured by the total volume of funds they borrow, because their net cash flow rises due to growing sales and profits.

Answer 2

False

Question 3

Rising interest rates usually lead to an expanded volume of business investment, according to your text, because periods of rising rates soon lead to greater business profits and therefore more funds available for investment purposes.

Answer 3

False

Question 4

Business fund-raising activity in the money and capital markets tends to be highly stable from one year to the next because, according to your text, businesses generally draft their borrowing and investing plans well in advance; in contrast, consumer and government borrowing is highly unstable.

Question 5

Debt instruments used mainly in corporate reorganizations that earn interest for the holder only when the issuing company has sufficient earnings are known as income funds.

Question 6

Corporate bonds which resemble a lease in form are called equipment trust certificates.

Question 7

The two principal investor groups in the corporate bond market today, as measured by the volume of bonds purchased, are insurance companies and commercial banks.

Question 8

A term loan granted by a commercial bank has a minimum maturity of six months and is collateralized by plant and equipment.

Question 9

Private placements of corporate bonds generally exceed the volume of public sales of such bonds.

Question 10

When interest rates are increasing, business loan rates will rise the fastest under the prime-plus method rather than the times-prime method of bank loan pricing.

Question 11

Indexing affects the price of a corporate debt security but not its annual interest rate.

Question 12

With an equity kicker the lender of funds receives a portion of the net earnings from an investment project but no fixed interest return.

Question 13

A flexible prime interest rate benefits banks by helping to protect their interest margins; it benefits borrowers because more credit is readily available.

Question 14

According to the Federal Reserve's periodic surveys of business loans longer-term loans tend to carry higher average interest rates than short-term business loans.

Question 15

In a leveraged buyout a business firm is acquired by one or a small group of investors with 80 to 90 percent of the purchase price covered by borrowing.

Question 16

Junk bonds are unsecured debt obligations with low credit ratings and low yields relative to higher-rated securities.

Question 17

The total performance concept is an investment strategy followed by many institutional investors today in which long-term bonds are purchased on or close to date of issue and held until maturity.

Question 18

Zero-coupon bonds pay no interest.

Question 19

Commodity-backed bonds are securities backed by collateral that consists of a reserve of internationally traded commodities such as gold, silver or oil.

Question 20

A short-term unsecured corporate IOU underwritten by a group of banks and sold in overseas markets is called a Euro note.

Question 21

A rise in stock trading volume generally makes stock-indexed corporate bonds more attractive to investors according to the textbook.

Question 22

A bond that has warrants attached to purchase the issuing company's stock is known as a reset bond.

Question 23

Medium-term notes have become popular in recent years because they make it easier for corporations to match the maturity of assets they wish to acquire with the maturity of their liabilities.

Question 24

Payment-in-kind bonds grant the issuing firm the options of either paying interest owed on the bonds or calling in those bonds and retiring them.

Question 25

A security aimed at granting a business firm more time to improve its credit rating or time to correct cash shortages is known as a reset bond.

Question 26

Defenses against takeover used by some corporations in recent years, including the taking on of additional debt, are known as poison pills.

Question 27

Commercial banks have begun to make longer-term commercial mortgage loans with a 5 to 7-year maturity range known as "mini-perms."

Question 28

Most secondary market trading in bonds is conducted over the telephone and through electronic networks.

Question 29

Bond brokers commit themselves to take on large blocks of bonds and earn their profit on the spread between the buying and selling prices.

Question 30

Commercial banks cannot engage in any investment banking.

Question 31

The larger and longer-term a business loan is, the more likely its rate will float with market conditions.

Question 32

Most business loans are priced as prime-plus, where the plus reflects default risk and term risk.

Question 33

One reason call privileges on corporate bonds are declining in usage is the increased availability of hedging instruments.

Question 34

Most business borrowers in the private placement market are medium-size corporations.

Question 35

Recent revisions in the SEC's Rule 144a have decreased the interest of investment banks in entering the private placement market to provide underwriting services.

Question 36

Since 1990 life insurance companies have sharply curtailed their purchases of privately placed securities due to public pressure on life insurers to strengthen their balance sheets.

Question 37

Many borrowers in the private placement market have experienced low credit ratings.

Question 38

Private placements are exempt from registration with the SEC.

Question 39

One of the distinguishing hallmarks of U.S. corporate debt markets is their ability to provide funds to businesses from start-up to mature companies.

Question 40

Bond pricing in some parts of the market is inefficient due to information asymmetries.

Question 41

The trading of bonds on organized exchanges is older and even more fully developed than organized exchange stock trading.

Question 42

The 1999 Financial Services Modernization (Gramm-Leach-Bliley) Act gave U.S. commercial banks greater freedom to underwrite corporate bonds and stock through holding companies.

Question 43

In 2001, as corporate bond rates dropped to some of the lowest levels seen in decades, several of the largest corporate debt offerings in history quickly came to market.

Question 44

Medium-term notes (MTN), carrying maturities of one to 10 years, were used as far back as the 1970s, but literally exploded onto the corporate fund-raising scene in the past 25 years, emerging as a major funding total.

Question 45

Financial corporations have issued the lion's share, almost 50%, of medium-term notes outstanding.

Question 46

Between 1993 and 2005 outstanding medium-term notes (MTN) increased from $500 billion to nearly $713 million.

Question 47

The recent global credit crisis has shown that asset backed securities may have some very large drawbacks.

Question 48

Between 1995 and 2009 the value of bonds outstanding issued by U.S. financial and nonfinancial companies more than quadrupled from $2.5 trillion to more than $11.6 trillion.

Question 49

Banks are among the heaviest investors in corporate bonds.

Question 50

Foreign investors have increased their holdings of U.S. corporate bonds by nearly fivefold.

Question 51

Mergers and acquisitions (M&A) have been on the increase in recent decades due, in part, to a more lenient antitrust policy adopted by federal regulators that reduces the government challenges to M&A.

Question 52

In February 2009 the average maturity of commercial and industrial loans, weighted by loan amount, was 700 days.

Question 53

In February 2007 the average maturity of commercial and industrial loans with maturities exceeding one year averaged 5 ½ years.

Question 54

A corporate debt contract with an original maturity of five years or less is called a:

A) Bond
B) Note
C) Commercial paper
D) Commercial mortgage
E) None of the above

Question 55

The contract accompanying a bond that lists the rights, privileges and obligations of the borrower and investor is known as a (an):

A) Mortgage
B) Trust certificate
C) Debenture
D) Indenture
E) None of the above

Question 56

The majority of corporate bond issues today contain securities which mature on single date; by definition then, such bonds are:

A) Serial bonds
B) Matched-maturity bonds
C) Term bonds
D) Closed-end bonds
E) None of the above

Question 57

A corporation issues a bond with a before-tax annual cost to the company of 12.5 percent. This corporation has a marginal tax rate (bracket) of 30 percent. What is the after-tax cost of this bond?

A) 8.75 percent
B) 3.75 percent
C) 6.25 percent
D) 7.25 percent
E) None of the above

Question 58

A corporate bond secured only by the earning power of the issuing corporation and not by any specific property is known as a (an):

A) Collateral trust bond
B) Debenture
C) Convertible bond
D) Income bond
E) Trust certificate
F) None of the above

Question 59

A leveraged buyout is:

A) The purchase of the stock of a business firm by a small group of investors using heavy borrowing to finance the transaction
B) The transfer of ownership between partners in a business venture in which one partner acquires the ownership interest of the one or more remaining partners
C) Use of borrowed funds by investment bankers in order to win the bid on a new security being offered in the open market
D) The sale of assets of a corporation in order to reduce that corporation's outstanding indebtedness
E) None of the above

Question 60

The method of financing a corporate merger that results in the issue of high-yielding unsecured and low-credit-rated debt obligations is called:

A) Privately placed bonds
B) Equity kickers
C) Discount bonds
D) Warrant bonds
E) Junk bonds

Question 61

Corporate bonds that pay a return solely due to their price appreciation as they approach maturity are called:

A) Stock-indexed bonds
B) Warrant bonds
C) Debentures
D) Zeros
E) None of the above

Question 62

A provision in a bond indenture aimed at protecting the interests of bondholders that may restrict the issuing corporation's dividend rate, the taking on of added debt or limit the sale of the company's assets is known as a:

A) Sinking-fund requirement
B) Refunding provision
C) Restrictive covenant
D) Redemption provision
E) None of the above

Question 63

The requirement in a bank loan agreement that obligates a borrower to keep a deposit at the lending bank equal to a specified percentage of the amount of the loan is known as the:

A) Times-prime method
B) Equity kicker
C) Right-of-offset balance
D) Collateral deposit
E) Compensating balance

Question 64

A corporate debt security whose interest rate is tied to stock-market trends is known as a:

A) Equipment trust certificate
B) Reset bond
C) Warrant bond
D) Floating-rate bond
E) None of the above

Question 65

A security that allows an investor to acquire additional bonds bearing the same yield as the original bond or sell detachable certificates to another investor is called a (or an):

A) Warrant bond
B) Reset bond
C) Supplemental financing bond
D) Payment-in-kind bonds
E) None of the above

Question 66

Securities that are designed to give a company time to strengthen its credit rating or cover cash shortages is called a:

A) Discount bond
B) Floating-rate bond
C) Reset bond
D) Usable bond
E) None of the above

Question 67

Securities with maturities ranging from one to 10 years that are generally noncallable, unsecured, fixed-rate obligations are known as:

A) Debentures
B) MTNs
C) Euro notes
D) Reset bonds
E) None of the above

Question 68

Debt securities that grant the issuing corporation the option of either paying the interest owed or issuing additional bonds are called:

A) Reset bonds
B) Discount bonds
C) Warrant bonds
D) Payment-in-kind bonds
E) None of the above

Question 69

A bond with attached warrants that allows an investor to purchase at par the issuing company's stock is referred to as a(n):

A) Reset bond
B) Indexed bond
C) Usable bond
D) Discount bond
E) None of the above

Question 70

The construction of office buildings and shopping centers is generally financed with a/an:

A) Commercial mortgage
B) Corporate bond
C) Common stock
D) Commercial paper
E) Acceptance

Question 71

The majority of funds used by business firms to finance their working capital and investment needs come from:

A) New issues of common stock
B) New issues of bonds
C) Bank loans
D) Internal cash flow
E) Commercial paper

Question 72

Most term loans offered by U.S. banks are priced as:

A) Prime-minus
B) Prime-plus
C) LIBOR-plus
D) Paper-plus
E) Acceptance-minus

Question 73

The after-tax cost of debt to a corporation is less than the after-tax cost of equity because:

A) Dividends are tax deductible to the corporation and so the corporation can offer investors a higher return
B) Interest expense is tax deductible to the corporation
C) Debt includes depreciation which is a pre-tax charge against earnings
D) Dividends are paid out of pre-tax dollars
E) None of the above

Question 74

What is the effective rate of interest on a loan of $1 million if the bank charges 9% interest and requires a 10% compensating balance?

A) 9%
B) 9.5%
C) 10%
D) 8%
E) 10.5%

Question 75

Most of the borrowers in the private placement market for corporate bonds are:

A) Companies with the highest credit ratings
B) Medium-size corporations
C) The largest corporations in each industry
D) QIRs
E) None of the above

Question 76

The major contribution of the SEC's Rule 144A was to:

A) Get even the smallest investors actively involved in the private placement market for corporate bonds
B) Create a secondary market for privately placed bonds
C) Increase the numbers of corporate divestitures
D) Enhance direct negotiation between corporate borrowers and investors
E) None of the above

Question 77

Thus far in the 1990s U.S. life insurance companies have:

A) Curtailed their purchases of privately placed corporate bonds
B) Become more active buyers of privately placed corporate bonds
C) Sought out lower-rated corporate bonds
D) Reduced their holdings of publicly traded corporate bonds
E) None of the above

Question 78

Large institutional investors eligible to buy privately placed corporate bonds are labeled by the SEC as:

A) ECIs
B) CMBs
C) QIRs
D) PCBs
E) None of the above

Question 79

A bond issue can send "signals" to the marketplace. Whether or not the marketplace perceives a bond issue to be positive or negative depends on the __________ of the issue.

A) Price
B) Features of the bond, e.g., callable, etc
C) Perceived motivation
D) All of the above
E) None of the above

Question 80

Since the advent of the European Community (EC), European bond dealers are finding that differences in bond yields issued from different EC members are:

A) Creating plentiful arbitrage opportunities
B) Lessening arbitrage opportunities
C) Tied to differences in the equity markets
D) All of the above
E) None of the above