Deck 21: Long-Term Debt

Question 1

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.

Answer 1

market interest rates have changes and/or interest has accrued.

Question 2

Suppose that a bond is issued at its par value or face value and 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.

Answer 2

fall below its par value.

Question 3

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

A) the funded period.
B) the sinking fund period.
C) the deferred call period.
D) the maturity.

Answer 3

the maturity.

Question 4

A public issue of bonds approved by the board of directors (and shareholders if necessary) can be sold when:

A) the registration statement has been filed with the OSC and the syndicate is set.
B) the investment banker's have accepted the offer for sale and have held it for 20 days from announcement.
C) the registration statement has been filed with the OSC, approved and the 20 day waiting period has elapsed.
D) the role of the trustee has been determined and an indenture has been written and signed.

Question 5

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

A) with an investment banker.
B) with another manufacturing corporation.
C) with a lending institution.
D) with the federal government.

Question 6

Short-term debt is sometimes referred to as:

A) secured debt.
B) funded debt.
C) unfunded debt.
D) unsecured debt.

Question 7

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
D) investor; call
E) trustee; sell back

Question 8

Most 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.

Question 9

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

A) in dollars and cents.
B) in thousands of dollars.
C) in percentage of face.
D) in principal amount.

Question 10

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.

Question 11

A description of property used as 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.

Question 12

A sinking fund is useful to bondholders because:

A) it stops the company from going under or into default.
B) the funds are usable at the option of the bondholders.
C) when a firm has difficulty making payments this sends a signal of potential default.
D) a balloon payment is necessary to fully pay off the bonds at maturity.

Question 13

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

A) the mutual fund carries a no load fee.
B) security can be diminished as an open-end trust indenture allows for unlimited bond issuance.
C) security can be diminished as a closed-end trust indenture allows for unlimited bond issuance.
D) the mortgage trust company does not have any security.

Question 14

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.

Question 15

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

A) a call provision.
B) a collateral maintenance agreement (CMA).
C) an indenture.
D) a prospectus.

Question 16

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 17

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

A) a call provision.
B) a sinking fund.
C) a funding provision.
D) a trust maintenance fund.

Question 18

Long-term debt is sometimes called:

A) funded debt.
B) secured debt.
C) unfunded debt.
D) unsecured debt.

Question 19

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.

Question 20

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.

Question 21

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 22

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

A) the bond's price is above par.
B) the callable bond value is above par, but below the call price.
C) the bond's price exceeds the call premium.
D) the callable bond value exceeds the call price.

Question 23

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.

Question 24

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 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.

Question 25

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 stockholders.

Question 26

Put provisions in bonds allow:

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

Question 27

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) $77.41.
D) $178.57.

Question 28

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) $1000.00.
E) $1031.74.

Question 29

Zeros are bonds that:

A) have zero maturity.
B) have zero call dates.
C) have zero sinking funds.
D) have zero coupon rates.

Question 30

The popularity of floating rate bonds is likely tied to protection against:

A) default risk.
B) marketability risk.
C) inflation risk.
D) systematic risk.

Question 31

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.

Question 32

If a firm retires or extinguishes a debt issue before maturity, the specific amount they pay is:

A) the amortization amount.
B) the call price.
C) the sinking fund amount.
D) the spread premium.

Question 33

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) $200.
B) $20.
C) $180.
D) $18.

Question 34

Bonds below BBB or Baa are called:

A) income bonds.
B) deep-discount bonds.
C) zero coupon bonds.
D) investment grade bonds.

Question 35

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 36

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.

Question 37

Owers Divestiture Corporation, a firm speculating in corporate reorganizations, has bonds outstanding that were originally issued at par but are now selling, on September 19, 2012, for $1,050 per $1,000 face value. The bonds have a stated interest rate of 8% and mature on January 1, 2022. 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, 2012. What dollar amount will the investor pay to the seller on September 1? How much interest will the investor receive on January 1, 2013?

Question 38

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.

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.

Question 40

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.

Question 41

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 42

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?

Question 43

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?

Question 44

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?

Question 45

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 46

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?

Question 47

Milonas 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 Milonas is forced to liquidate its property for $20 million, and the company has no other assets, how much will the original bondholders receive?

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?

Question 49

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 50

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?