Deck 11: Long-Term Debt Finance

Question 1

Which three of the following are advantages for the firm of floating- rate, as compared with fixed- rate, borrowings?

A) At the time of arrangement fixed rates are usually above floating rates.
B) If interest rates fall the cost of the loan falls.
C) Returns on the firm's assets may go up at times of higher interest rates and fall at times of lower interest rates, therefore the risk of higher rates is offset.
D) The firm may benefit from a rise in interest rates if, as with most businesses, its profits do not rise when interest rates rise.

Answer 1

A, B, C

Question 2

From a firm's viewpoint, which of the following is an advantage of overdrafts as a source of finance?

A) The bank can withdraw the facility quickly.
B) There is generally a stated limit.
C) They are flexible.
D) The bank normally requires security.

Answer 2

C

Question 3

What is the rate of return of an irredeemable bond with an annual coupon of 10 per cent, currently trading at £90, with the next coupon due in one year?

A) 19.2%
B) 12.2%
C) 9%
D) 11.1%

Answer 3

D

Question 4

A zero- coupon bond is issued at a price of £600 and redeemable in 4 years at £1000. What is the annualised rate of return?

A) 3.3%
B) 8.8%
C) 13.6%
D) 6.6%

Question 5

Bonds in a particular company started as apparently safe investments but they have now become more risky. They are currently rated as below investment grade. What name is given to bonds of this type?

A) Junk bonds
B) CCC bonds
C) Vanilla bonds
D) Fallen angels

Question 6

A zero- coupon bond is to be issued at a price of £50, with an annualised rate of return of 5 per cent for 6 years. What would the redeemable price be?

A) £75
B) £33
C) £67
D) £45

Question 7

Which one of the following most accurately describes the information available from credit rating agencies?

A) A rating of the trustworthiness of a company's directors
B) An assessment of the likelihood of consumers defaulting on credit card debt
C) An assessment of the likelihood of a bond or loan interest and/or capital not being paid and the extent to which the lender is protected in the event of a default
D) A ranking of banks in terms of the quantity of loans made in a particular period

Question 8

What term is used for informal markets in money held outside the jurisdiction of the country of origin?

A) The Eurobond market
B) Forex
C) The foreign bond market
D) Euromarkets

Question 9

Which three of the following are the most important categories of bond market for internationally recognised firms?

A) Vanilla bonds
B) Foreign bonds
C) The domestic market
D) Eurobonds

Question 10

Which hypothesis explains why the yield curve is often 'lumpy' or 'humped'?

A) Market variability
B) Expectation
C) Market segmentation
D) Liquidity preference

Question 11

Which two of the following statements relating to finance sources are correct?

A) Mezzanine finance is that which is provided for a few months until medium- or long- term financial arrangements can be made.
B) Convertible bonds differ from vanilla bonds in that they give the holder the right to exchange bonds at some stage in the future.
C) Mezzanine debt is a loan offering a high return with a high risk.
D) Syndicate lending is undertaken by a small group of rich individuals providing a joint loan to small unquoted firms.

Question 12

Which of the following most accurately describes a debenture?

A) It is a contract in which a lender provides finance to a firm in return for promises of interest payment and capital repayment at maturity. The debenture can be unsecured.
B) It is a bond which entitles the owner to receive a share of the firm's assets in a liquidation.
C) It is a financial asset with a right to receive interest and a share of a firm's profits.
D) It is a long- term contract in which the debenture holder lends money to a company in return for promises of interest payments and capital repayment at maturity. The debenture is secured by either a fixed or a floating charge against the firm's assets.

Question 13

What price will investors pay for a bond of par value £100, redeemable after 3 years, if the coupon is 8 per cent paid at the end of each year and the market rate of interest in this risk class is 7 per cent?

A) £98.68
B) £102.62
C) £117.35
D) £115

Question 14

What are Euro securities markets?

A) Informal, unregulated markets in money held outside its country of origin and therefore beyond the regulation of the country's authorities
B) Markets where a foreign firm issues a security in the currency of the country where the issue takes place
C) The markets in financial securities denominated in the euro currency
D) Markets in which European currencies are exchanged outside the jurisdiction of the country of origin

Question 15

Which three of the following are advantages of convertible bonds to the investor?

A) The annual coupon is usually higher than the dividend yield.
B) They can wait and see how share prices move before investing in equity.
C) All tax is paid at corporation tax rates by the company.
D) There is greater security for their principal.

Question 16

Which three of the following are hypotheses relating to the term structure of interest rates?

A) Market- structure hypothesis
B) Expectation hypothesis
C) Liquidity hypothesis
D) Market- segmentation hypothesis

Question 17

Which of the following options best describes what happens when a fixed charge is made against the firm's assets?

A) Specific assets can be sold at the insistence of the debenture holder and the proceeds used as repayment.
B) The company pays the investor a stated percentage on redemption date.
C) Specific assets can be sold at the firm's discretion and the proceeds used as repayment.
D) The debenture holder agrees to make a stated further payment at a stated future date.

Question 18

What is meant by the term 'junk bond'?

A) It is a financial instrument with predominantly debt characteristics but offering high rate and high risk, and sometimes offering an equity kicker.
B) It is a financial instrument with predominantly equity characteristics but offering high dividends and high risk, and sometimes offering a linked debt kicker.
C) It is a worthless bond.
D) It is a financial security issued by retail chains selling inexpensive items.

Question 19

A convertible bond with face value £100 offers the right to convert to 60 ordinary shares. The current share price is £2. What is the conversion ratio?

A) 60 shares
B) 30 shares
C) 1.63 shares
D) 3.33 shares

Question 20

Which three of the following are advantages of convertible bonds to the issuing company?

A) It offers a lower coupon than on a similar debenture.
B) It can be self- liquidating.
C) It does not contribute to the overall borrowing levels.
D) The interest is tax deductible.

Question 21

Which three of the following are advantages of Eurobonds as a source of finance for firms?

A) Often a lower rate of return is required by lenders than for domestic bonds.
B) They are relatively safe instruments to hold, as ownership rights of bonds are registered with the company.
C) Large loans for long periods of time are available.
D) They provide the possibility of hedging interest rate and exchange rate risk.

Question 22

What is meant by the term 'negative covenant'?

A) It is the right of a lender to take over the operation of the firm, should an interest payment be missed.
B) It is an undertaking by management never to invest in negative NPV projects.
C) It is a restriction in a loan agreement which limits the actions and rights of the borrower until the debt has been repaid in full.
D) It is a promise made by a borrower to a lender to repay all the debt immediately should profits become negative.

Question 23

A convertible bond with face value £100 offers the right to convert to 50 ordinary shares. The current share price is £1.60. What is the conversion premium?

A) 33%
B) 36%
C) 40%
D) 25%

Question 24

What name is used for bonds in which the coupon varies depending on the level of short- term interest rates?

A) Straight
B) Zero coupon
C) Unsecured debenture
D) Floating

Question 25

Which one of the following methods ensures that firms repay the principal on bonds entirely at maturity?

A) By setting up a sinking fund that receives regular sums from the firm that will be sufficient to redeem the bonds
B) By ensuring that all bonds have the same redemption date
C) By creating a limited liability company
D) By insisting that investors agree to invest in future bonds

Question 26

Why does the liquidity- preference hypothesis help to explain the commonly occurring upward slope of yield curves?

A) It assumes that companies will try to equally balance their equity- bond borrowing.
B) It points out that investors require an extra return for lending long- term.
C) It assumes that investors will try to equally balance their equity- bond exposure.
D) It points out that investors require an extra return for lending short- term.

Question 27

Which three of the following are advantages of bank borrowing, when compared with selling bonds?

A) A bank is generally more flexible in altering conditions and repayment schedules if the economic circumstances facing the firm change.
B) A bank loan can be arranged very quickly.
C) Administrative and legal costs are lower.
D) The rate of interest is usually lower.

Question 28

Which two of the following statements relating to credit ratings is correct?

A) Investment grade debt is rated at B or above by Moody's.
B) Non- investment grade bonds have ratings at, or below, Standard and Poors' rating BB+ (or Moody rating Ba1).
C) Eurobonds have a Standard & Poors' rating of under ABB.
D) Junk bonds are those which have a Standard & Poors' rating of under BBB (or a Moody rating of less than Baa).

Question 29

What does the acronym LBO represent?

A) A long- term borrowing origination
B) A leveraged buy- out
C) A loss buying opportunity
D) Of legally- binding origin

Question 30

Which three of the following are benefits of operating leases?

A) Reduced risk of obsolescence
B) Initial outlay is small
C) Tax relief
D) A variable rate of finance

Question 31

Which three of the following are reasons why borrowing from the bank is attractive to companies?

A) Administrative and legal costs are low.
B) If the economic circumstances change during the life of the loan banks are generally more willing to alter the terms.
C) Banks are more likely to loan large amounts.
D) The process is quick.

Question 32

Which of the following best explains what is meant by 'term loan'?

A) A fixed amount for an agreed time
B) A loan on which terms can be redefined by either party at any time
C) A loan of a fixed amount for an agreed time and on specified terms
D) A loan made on agreed terms

Question 33

Which three of the following are included when yield to maturity is calculated?

A) Annual coupon returns
B) Capital gains
C) Nominal value
D) Capital losses

Question 34

Which three of the following accurately apply to bonds?

A) The company (usually) promises to pay the bond owners a series of interest payments, known as coupons, until the bond matures.
B) The bank makes a fixed charge on the asset, generally 1 per cent above base rate.
C) A bond is a long- term contract in which the bondholders lend money to a company.
D) At maturity the bondholder receives a specified principal sum called the par (face or nominal) value of the bond.

Question 35

Which three of the following are the main types of Eurobond?

A) Equity- related bonds
B) Straight fixed- rate bonds
C) Floating- rate notes
D) Medium- term notes

Question 36

What is the gross income yield on a £100 bond with a current market price of £90 if the gross interest is £6, assuming that taxation is chargeable at a rate of 20 per cent?

A) 5.36%
B) 6.67%
C) 4.8%
D) 6%

Question 37

A convertible bond with face value £100 offers the right to convert to 25 ordinary shares. The current share price is £3. What is the conversion price?

A) £7
B) £1
C) £4
D) £3.50

Question 38

Which two statements apply to debentures?

A) They are usually secured by a charge against the firm's assets.
B) They are secured against property.
C) They always offer a fixed rate coupon.
D) They are the most secured type of bond.

Question 39

What would you expect to happen to the yield curve when short- term spot interest rates are expected to fall?

A) It will be upward sloping.
B) It will curve upwards at an increasing rate.
C) It will be roughly horizontal.
D) It will be downward sloping.

Question 40

What name is given to an interest rate fixed today on a loan that is made today?

A) Current rate
B) One- day rate
C) Spot rate
D) Bond rate