Deck 16: Long-Term Debt and Lease Financing

Question 1

Over the decades, the times interest earned ratio of the Standard & Poor's 500 corporations has held fairly steady.

Answer 1

False

Question 2

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.
In keeping with risk/return, greater protection lowers risk, therefore investors cannot expect as great a return as if that protection were absent.

Answer 2

False

Question 3

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.

Answer 3

False

Question 4

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 5

The value of bonds will move opposite general market interest rates.

Question 6

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

Question 7

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

Question 8

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 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

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 11

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

Question 12

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

Question 13

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 14

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 15

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 16

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 17

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

Question 18

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

Question 19

Homebuilding companies, like
D.R.Horton Inc., realized significant losses in 2008-2009.

Question 20

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

Question 23

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 24

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

Question 25

A bondholder may have paper losses as large as 30-40% or more at some point between the time of issue and redemption.

Question 26

In an inflationary economy, debt 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 27

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 28

Zero-coupon bonds are sold at face value.
They are sold at a deep discount and grow to maturity value.

Question 29

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 30

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 31

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

Question 32

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

Question 33

A floating rate bond's price is inversely related to the changes in interest rates.

Question 34

The advantage of a zero-coupon bond to an investor is that the annual increase in the bond is taxable as ordinary income.
This is a major disadvantage since the bond has yielded no payments of interest with which tax can be paid.

Question 35

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 36

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

Question 37

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 38

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

Question 39

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

Question 40

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 41

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 42

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

Question 43

The term debenture refers to

A)long-term, secured debt.
B)long-term, unsecured debt.
C)the after-acquired property clause.
D)a 100-page document covering the specific terms of the offering.

Question 44

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

Question 45

A capital lease is the same as an operating lease.

Question 46

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 47

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

Question 48

The coupon rate of the bond varies indirectly with changes in 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 49

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

Question 50

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 51

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

Question 52

Bond refunding is generally advantageous to the investor because they get 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 53

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

A)rapid business expansion.
B)inflationary impacts.
C)inadequate internally raised funds.
D)All of these options

Question 54

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 55

Lease obligations 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 56

The inclusion of leases on the balance sheet as an asset and liability has lowered firms' debt-to-asset ratios.
Generally, the impact is greater upon the smaller of the numerator or denominator. The numerator is smaller in the debt/asset ratio. By adding the same amount to both the top and bottom of the calculation, the numerator is magnified, leading to a greater number. The ratio increases.

Question 57

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 58

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 59

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 60

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

Question 61

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)None of these options is a valid hierarchy.

Question 62

With regard to interest rates and bond prices, it can be said that

A)a 1% change in interest rates will cause a greater change in long-term bond prices than short-term prices.
B)a 1% change in interest rates will cause a greater change in short-term bond prices than long-term prices.
C)long-term rates are more volatile than short-term rates.
D)a decrease in interest rates will cause bond prices to fall.

Question 63

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

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

Question 64

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 65

The "call" provision on some bonds allows

A)the bondholder to redeem the bond earlier than maturity, but usually involves a call premium.
B)the corporation to request additional capital contributions from the bondholder.
C)the corporation to redeem the bonds earlier than maturity but usually for a premium over the par value.
D)the bondholder to convert the bond into preferred stock.

Question 66

Buchanan Corp. is refunding $10 million worth of 10% debt. The new bonds will be issued for 8%. The corporation's tax rate is 35%. The call premium is 9%. What is the net cost of the call premium after taxes?

A)$390,000
B)$1,080,000
C)$585,000
D)$702,000

Question 67

Prices of existing bonds move _________ as market interest rates move _______.

A)down; down
B)up; up
C)up; down
D)Bond prices don't move as market interest rates move.

Question 68

A bond with a coupon rate of 6.5% (assume it is paid once annually), maturing in 10 years at a value of $1,000 and a current market price of $695, will have a current yield of

A)11.3%.
B)10.2%.
C)9.4%.
D)8.5%.

Question 69

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.

Question 70

Which company is a leader in rating bonds?

A)Goldman Sachs
B)Bloomberg
C)ValueLine
D)Moody's Investor Service

Question 71

Short-term bond yields are generally ______ than long-term bond yields, whereas long-term bond prices are generally ________ than short-term bond prices.

A)more volatile, less volatile
B)less volatile, more volatile
C)less volatile, less volatile
D)more volatile, more volatile

Question 72

A conversion 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 bondholder to convert the bond to common stock.
D)the bondholder to demand increased collateral.

Question 73

A debenture represents

A)unsecured debt.
B)secured debt.
C)a long document covering every detail of a bond issue.
D)debt that is subordinate to preferred stock.

Question 74

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

A)A junior mortgage bond
B)A senior debenture
C)Common stock
D)A subordinated debenture

Question 75

Many bonds have some orderly, preplanned, 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 76

The dollar interest received divided by the market price of the bond is called the

A)par value.
B)coupon rate.
C)current yield.
D)yield to maturity.

Question 77

Which of the following is not a form of yield on a bond?

A)Coupon rate (nominal yield)
B)Current yield
C)Dividend yield
D)Yield to maturity

Question 78

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 79

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 80

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