Deck 20: Debt Financing

Question 1

Suppose that a bond is issued at its par value or face value.If market interest rates rise after the issue,the price of the bond will likely:

A)rise significantly above its par value.
B)rise slightly above its par value.
C)remain equal to its par value.
D)fall below its par value.
E)rise or fall,depending on the bond's maturity.

Answer 1

fall below its par value.

Question 2

Which of the following bonds is secured by corporate assets?

A)Mortgage bond.
B)Collateral trust bond.
C)Debenture.
D)Two of the above.
E)All of the above.

Answer 2

Two of the above.

Question 3

Zeros are bonds that have zero:

A)maturity.
B)call dates.
C)sinking funds.
D)coupon rates.
E)return.

Answer 3

coupon rates.

Question 4

Bonds that sell for much less than face value and pay no coupon are called:

A)original issue discount bonds.
B)deep discount bonds.
C)pure discount bonds.
D)zero coupon bonds.
E)All of the above.

Question 5

The written agreement between a corporation and the bondholder's representative is called:

A)the call provision.
B)the collateral maintenance agreement (CMA).
C)the indenture.
D)the prospectus.
E)None of the above.

Question 6

The trustee's job as agent for the bondholders is to:

A)represent the bondholders if the company defaults,manage any sinking fund,and see that the indenture terms are obeyed.
B)advise the company on debt disposition,manage any sinking fund,and minimize indenture covenants.
C)represent the bondholders if the company defaults,call the bond issue and minimize indenture covenants.
D)advise the company on debt disposition,call the bond issue and see that the terms of the indenture are obeyed.
E)None of the above.

Question 7

A bearer bond has the disadvantage(s)of:

A)being easily transferable if lost or stolen.
B)having to remit the coupon to a paying agent to collect.
C)no direct communication as it is held by an unidentified owner.
D)All of the above.
E)None of the above.

Question 8

Most public debentures are issued by _________ companies and are _______ .

A)utility and railroad; secured by a pledge on specific assets
B)industrial and finance; unsecured general obligations
C)utility and railroad; unsecured general obligations
D)industrial and finance; secured by a pledge on specific assets
E)None of the above.

Question 9

Put provisions in bonds allow the:

A)issuer to call the bond at par on the coupon payment date.
B)holder to redeem the bond at par at the coupon payment date.
C)issuer to extend the maturity of the bond.
D)holder to extend the maturity of the bond.
E)issuer to change the coupon rate at the coupon payment date.

Question 10

A description of the property in security and the details of the protective covenants are:

A)key terms in a rights agreement.
B)the basic terms of a bond.
C)key parts of a typical bond indenture.
D)key parts of a typical bond debenture.
E)None of the above.

Question 11

Short-term debt is sometimes referred to as:

A)secured debt.
B)hybrid debt.
C)unfunded debt.
D)equity.
E)None of the above.

Question 12

Bonds below BBB or Baa are called:

A)income bonds.
B)deep-discount bonds.
C)junk bonds.
D)investment grade bonds.
E)None of the above.

Question 13

The main difference between an open-end and closed-end mortgage trust indenture is that:

A)the mutual fund carries a no load fee.
B)an open-end trust indenture allows for unlimited bond issuance.
C)a closed-end trust indenture allows for unlimited bond issuance.
D)the mortgage trust company does not have any security.
E)None of the above.

Question 14

The length of time debt remains outstanding with some unpaid balance is called the:

A)funded period.
B)sinking fund period.
C)deferred call period.
D)maturity.
E)None of the above.

Question 15

As a part of a bond issue,a corporation makes annual payments into an account managed by a trustee for the purpose of repaying bonds.This arrangement is called a:

A)call provision.
B)sinking fund.
C)funding provision.
D)trust maintenance fund.
E)None of the above.

Question 16

Floating rate bonds are bonds with:

A)floating par values tied to the stock par value.
B)floating maturities tied to the expected corporate life.
C)floating call provisions indexed by relative interest rates.
D)floating coupon rates tied to an interest rate index.
E)All of the above.

Question 17

If a bond was issued at par,the quoted price of the bond will not necessarily equal the par value of the bond after issuance because:

A)time to maturity has shortened and the company is older.
B)time to maturity has shortened and interest has accrued.
C)interest has accrued and the company is older.
D)market interest rates have changes and/or interest has accrued.
E)market interest rates have changes and the company is older.

Question 18

Long-term debt is sometimes called:

A)funded debt.
B)hybrid debt.
C)unfunded debt.
D)preference shares.
E)None of the above.

Question 19

The price of a €1,000 face value bond is usually quoted:

A)in euros and cents.
B)in thousands of euros.
C)in percentage of face.
D)in principal amount.
E)None of the above.

Question 20

Long term debt that is privately placed debt is directly placed with:

A)an investment banker.
B)another manufacturing corporation.
C)a lending institution.
D)the federal government.
E)None of the above.

Question 21

A key difference between a direct placement and a public issue of debt:

A)is there is no cost of registration with the Stock Exchange.
B)issue costs are lower in the private placement market.
C)direct placements usually have more restrictive covenants.
D)All of the above.
E)None of the above.

Question 22

Accrued interest must be paid annually on a 7% coupon paying €1,000 par bond bought between interest dates.On January 1st you bought a bond issues by the Hardy Can Company.with interest dates of April 15th and September 15th.Approximately how much of the amount you paid for the bond was accrued interest?

A)€17.50
B)€20.42
C)€24.50
D)€40.84
E)None of the above.

Question 23

Junk bond market financing became more important in mergers and corporate restructurings because:

A)firms can issue only limited amounts of debt.
B)there was a large supply of junk bonds.
C)the marketability of junk bonds increased.
D)this permitted firms to have much higher debt-equity ratios.
E)None of the above.

Question 24

A bond has a call provision.The call provision allows the ________ to _________ the bonds before maturity.

A)investor; sell back
B)trustee; buyback
C)issuer; call in
D)investor; call in
E)trustee; sell back

Question 25

Corporations typically have the right to repurchase a debt issue prior to maturity by paying the face value of the bond plus:

A)a call premium.
B)the amortized value.
C)the principal discount.
D)a balloon payment.
E)None of the above.

Question 26

The written agreement between a corporation and its bondholders contains a limitation on the dividends that the corporation can pay.This limitation is:

A)a nonrecourse covenant.
B)a recourse covenant.
C)a negative covenant.
D)a positive covenant.
E)more than one of the above.

Question 27

Income bonds provide the same tax advantage as regular coupon paying bonds but have an advantage of:

A)not being in default if a coupon payment is omitted due to a lack of corporate income.
B)lacking the "Smell of Death" from financial distress.
C)being easier to sell in the marketplace given the lower risk of default.
D)not having any agency costs between bondholders and shareholders.
E)None of the above.

Question 28

A positive covenant to an indenture or loan agreement would:

A)set a condition the company must follow such as not pledge any assets to other lenders.
B)set a condition that the trustee can eliminate sinking fund payments.
C)allow the trustee to call the bonds in.
D)allow the company to pay dividends only semi-annually.
E)set a condition that the company must follow such as providing regular (periodic)financial statements to the lender.

Question 29

From the corporate perspective,callable bonds may have value over non-callable bonds because:

A)the corporation has the option to control market interest rates.
B)interest rates may rise prohibiting the holders from earning higher returns.
C)call prices vary inversely with the interest rates.
D)the corporation has the option to call the bond if interest rates fall.
E)the corporation has the option to call the bond if interest rates rise.

Question 30

Studies have shown that around the announcement of bond rating changes:

A)bond values increase,and equity values decrease.
B)bond values decrease,and equity values increase.
C)bond values increase,and equity values do not change.
D)bond values decrease,and equity values do not change.
E)no unusual behavior occurs in bond or equity values.

Question 31

Corporations typically have the right to repurchase a debt issue prior to maturity at a fixed price,but only after some number of years have passed.Such debt is said to feature:

A)a sinking fund.
B)a balloon payment.
C)a redeemable-at-par provision.
D)a deferred call.
E)None of the above.

Question 32

Zero coupon bonds eliminate interest rate risk in some cases by:

A)removing default risk.
B)removing marketability risk.
C)removing reinvestment rate risk.
D)removing call risk.
E)All of the above.

Question 33

A sinking fund is useful to a corporation because:

A)the corporation does not have to worry about paying the bondholders.
B)it provides the corporation with the option to buy the bonds back at the lower of face value or market price.
C)the payments to the sinking fund are not necessary when the firm is in financial difficulty.
D)they are simple and easy to monitor.
E)None of the above.

Question 34

A firm wishes to issue a perpetual callable bond.The current interest rate is 7%.Next year,the interest rate will be 6.5% or 8.25% with equal probability.The bond is callable at €1,075,and it will be called if the interest rate drops to 6.5%. What is the correct coupon amount if the bond is priced to sell at par?

A)€ 65.00
B)€ 75.42
C)€ 82.50
D)€ 87.86
E)None of the above.

Question 35

The call policy that maximizes shareholder wealth is to call a bond issue when the:

A)bond's price is above par.
B)bond's price is above par,but below the call price.
C)bond's price exceeds the call premium.
D)bond's price equals or exceeds the call price.
E)None of the above.

Question 36

A firm wishes to issue a perpetual callable bond.The current interest rate is 7%.Next year,the interest rate will be 6.5% or 8.25% with equal probability.The bond is callable at €1,075,and it will be called if the interest rate drops to 6.5%. If the coupon were set to €70 what would the bond sell for?

A)€ 824.61
B)€ 898.82
C)€ 964.25
D)€1,000.00
E)€1,031.74

Question 37

Chevalier Manufacturing issued a callable bond with a 2020 maturity date.The bond was sold at par and the call premium was set equal to the coupon rate of 20%.A declining call premium was also in place so that the premium declined evenly over the last ten years of premium to zero.What would be the call premium if the bond was called in 2011?

A)€ 18
B)€ 20
C)€180
D)€200
E)Cannot calculate without market price.

Question 38

Callable bonds may be issued in the real world because:

A)bondholders have lower tax rates than the corporation.
B)management may have better information about future interest rates.
C)interest rate risk of callable bonds are lower.
D)callable bonds provide the option to reduce restrictive covenants.
E)All of the above.

Question 39

The growth of junk bond markets can be traced to:

A)the issuance of callable debt.
B)the small difference between the return on high yield versus the return on low yield bonds.
C)the large difference between the return on high yield versus the return on low yield bonds.
D)the fact that there is virtually no difference between the return on high vs low yield bonds.
E)the emergence of junk yards as a force in the late 1970's.

Question 40

Debt ratings issued by companies such as Moody's and Standard and Poor's depend on:

A)the probability of firm default and protection given in the indenture in case of default.
B)how large the company is and the number of restrictive covenants.
C)the size of the fee paid by the issuer and their industry.
D)the issue size,type of issue and their industry.
E)None of the above.

Question 41

Miller Mining has €30 million in land value and €15 in mortgage bonds issued on the property.Given that the indenture does not limit the amount of additional bonds that can be issued,the company issues an additional €10 million in mortgage bonds against the property.If Miller is forced to liquidate its property for €20 million,and the company has no other assets,how much will the original bondholders receive?

Question 42

An income bond is unique in at least one characteristic.Explain what is different about income bonds and why they exist.Why are they not more popular?

Question 43

A firm wishes to issue a perpetual callable bond.The current interest rate is 6%.Next year,there is a 30% chance that the interest rate will be 4.5% and a 70% chance that the rate will be 8.0%.The bond is callable at €1,000 plus an additional coupon payment and it will be called if the interest rate drops to 4.5%. If the bond is priced at €1,000,what is the cost to the firm of the call provision?

A)€70.00
B)€75.62
C)€140.00
D)€198.40
E)€260.33

Question 44

A firm wishes to issue a perpetual callable bond.The current interest rate is 9%.Next year,there is a 40% chance that the interest rate will be 5% and a 60% chance that the rate will be 13.3333%.The bond is callable at €1,090,and it will be called if the interest rate drops to 5%. If the bond sells for par today,what is the coupon?

A)€90.00
B)€118.67
C)€130.00
D)€133.33
E)€144.33

Question 45

A firm wishes to issue a perpetual callable bond.The current interest rate is 9%.Next year,there is a 40% chance that the interest rate will be 5% and a 60% chance that the rate will be 13.3333%.The bond is callable at €1,090,and it will be called if the interest rate drops to 5%. What is the bond's value today if the coupon is set at €100?

A)€867.54
B)€900.00
C)€905.62
D)€945.57
E)€1000.00

Question 46

A firm wishes to issue a perpetual callable bond.The current interest rate is 6%.Next year,there is a 30% chance that the interest rate will be 4.5% and a 70% chance that the rate will be 8.0%.The bond is callable at €1,000 plus an additional coupon payment and it will be called if the interest rate drops to 4.5%. If the bond sells for par today,what is the coupon?

A)€45.00
B)€45.87
C)€70.00
D)€75.62
E)€80.00

Question 47

The choice of whether a private placement or a public bond issue is undertaken depends on many factors.Three elements of primary concern are registration,interest rates and covenants.How do these affect the choice and why might a private placement be chosen?

Question 48

A firm wishes to issue a perpetual callable bond.The current interest rate is 6%.Next year,there is a 30% chance that the interest rate will be 4.5% and a 70% chance that the rate will be 8.0%.The bond is callable at €1,000 plus an additional coupon payment and it will be called if the interest rate drops to 4.5%. What is the bond's value today if the coupon is set at €70?

A)€935.75
B)€946.70
C)€950.00
D)€980.00
E)€982.55

Question 49

A firm wishes to issue a perpetual callable bond.The current interest rate is 7%.Next year,the interest rate will be 6.5% or 8.25% with equal probability.The bond is callable at €1,075,and it will be called if the interest rate drops to 6.5%. What is the cost of the call provision to the firm if the bond sells for €1,000 today?

A)€-71.43
B)€ 0.00
C)€ 77.43
D)€178.57
E)None of the above.

Question 50

A firm wishes to issue a perpetual callable bond.The current interest rate is 9%.Next year,there is a 40% chance that the interest rate will be 5% and a 60% chance that the rate will be 13.3333%.The bond is callable at €1,090,and it will be called if the interest rate drops to 5%. If the bond is priced at €1,000,what is the cost to the firm of the call provision?

A)€118.67
B)€292.43
C)€300.00
D)€318.56
E)€350.00

Question 51

Aspen Divestiture Corporation,a firm speculating in corporate reorganizations,has bonds outstanding that were originally issued at par,but are now selling,on September 19,2006,for €1,050 per €1,000 face value.The bonds have a stated interest rate of 8% and mature on January 1,2016.The bonds pay interest semi-annually on July 1 and January 1 each year.Suppose that an investor buys a €1,000 face value bond on September 1,2006.What euro amount will the investor pay to the seller on September 1?
How much interest will the investor receive on January 1,2007?