Deck 12: Debt Instruments

Question 1

Which of the following statements is incorrect?

A) Interest on debt securities is fully deductible for tax purposes.
B) Principal and interest payments are fixed contractual commitments.
C) Dividend payments are tax deductible, while interest paid on debt is not tax deductible.
D) Debt is a contract between a lender and a borrower that stipulates the terms of repayment of a loan.

Answer 1

Dividend payments are tax deductible, while interest paid on debt is not tax deductible.

Question 2

If the marginal tax rate is 50 percent, and the before-tax cost of debt is 8 percent, the after-tax cost of debt is closest to:

A) 0.40%
B) 4.0%
C) 8.0%
D) 50.0%

Answer 2

4.0%

Question 3

If the marginal tax rate is 45 percent, and the before-tax cost of debt is 11 percent, the after-tax cost of debt is closest to:

A) .0605%
B) 4.95%
C) 6.05%
D) 11.00%

Answer 3

6.05%

Question 4

If the marginal tax rate is 40 percent, and the before-tax cost of debt is 7.5 percent, the after-tax cost of debt is closest to:

A) 3.00%
B) 4.50%
C) 6.05%
D) 45.00%

Question 5

If corporate tax rates were increased, such that the marginal tax rate for most companies goes from 35 percent to 45 percent, this increase on the after-tax cost of debt:

A) increases the cost of debt.
B) decreases the cost of debt.
C) does not affect the cost of debt.

Question 6

If corporate tax rates were decreased, such that the marginal tax rate for most companies goes from 35 percent to 25 percent, this increase on the after-tax cost of debt:

A) increases the cost of debt.
B) decreases the cost of debt.
C) does not affect the cost of debt.

Question 7

All other things held constant, there is _____________ relation between the marginal tax rate and the after-tax cost of debt.

A) no
B) a positive, direct
C) a negative, inverse

Question 8

Which of the following are not sold on a discount basis?

A) Treasury bill
B) Corporate bonds
C) Commercial paper
D) Bankers' acceptance

Question 9

Which of the following is not a convention for reporting interest?

A) Prime lending rate
B) i_dy = [(FV - PV) / FV] × (360 / m)
C) i_bey = [(FV - PV) / PV] × (365 / m)
D) Discount yield (DY) method
E) Bond equivalent yield (BEY)

Question 10

Short- term debt instruments, usually unsecured, issued by companies are best described as:

A) T-bills.
B) corporate bonds.
C) commercial paper.
D) asset-backed commercial paper.

Question 11

The quoted interest rate, which is the rate received if the issuer does not default and the investor is paid off on time is best described as:

A) yield-to-call.
B) discount yield.
C) promised yield.
D) bond equivalent yield.

Question 12

If the promised yield on 60-day commercial paper is 2.5 percent and the promised yield on a 60-day T-bill is 2.0 percent, the promised yield spread is closest to:

A) 0.50%
B) 2.00%
C) 2.50%
D) 5.00%

Question 13

Which of the following statements is incorrect?

A) Default risk affects promised yields on commercial paper.
B) Investors can earn more than the promised rate if they hold the security to maturity.
C) The yield spread is compensation for the risk that the commercial paper issuer defaults.
D) The yield spread is the difference between the yield on one debt instrument and the yield on another.

Question 14

The commercial paper your firm recently issued received ratings of A-1, Prime-1, and F1. This would be considered:

A) in default.
B) fair short-term credit quality.
C) highest short-term credit quality.
D) speculative short-term credit quality.

Question 15

What is a type of asset issued by special purpose vehicles (SPV) and backed by the cash flows of specific securities?

A) Term loan
B) Line of credit
C) Bankers' acceptance
D) Revolving Line of credit
E) Asset-backed commercial paper

Question 16

Overcollateralization, insurance, and liquidity support are examples of:

A) collateral.
B) acceptance fees.
C) credit enhancements.
D) special purpose vehicles.

Question 17

This type of short-term paper was created as a result of international trade.

A) Treasury bill
B) Commercial paper
C) Bankers' acceptance
D) Revolving Line of credit
E) Asset backed commercial paper

Question 18

A minimum net working capital of $100 million, net worth in excess of $250 million, minimum interest coverage ratio of 1.75, debt ratio of less than .75, and requirement to provide a financial statement are all examples of:

A) covenants.
B) a prospectus.
C) indenture agreements.
D) special purpose vehicles.

Question 19

If the promised yield on 60-day commercial paper is 3.0 percent and the promised yield on a 60-day T-bill is 2.0 percent, the promised yield spread is closest to:

A) 1 basis point.
B) 10 basis points.
C) 100 basis points.
D) 1,000 basis points.

Question 20

Which of the following statements is incorrect?

A) The maturity of commercial paper is 1 to 170 days.
B) The commercial paper market is ideal for companies with spotted credit history.
C) Commercial paper is a promissory note, usually unsecured, but sometime backed by assets.
D) The issuer of commercial paper can either sell the paper directly to the investor or use a dealer.
E) Many companies have liquidity support of their commercial paper to ensure creditors that money is available to pay off the commercial paper if needed.

Question 21

Which of the following statements is incorrect?

A) Bankers' acceptances are created by international trade.
B) Bankers' acceptances are sold in large amounts, usually $1 million or more.
C) The cost of financing using a bankers' acceptance is calculated by : i_BA = [(Discount + Fee) / (Face Value - discount - fee)] × (365 / maturity in days)
D) The cost to the bank that guarantees a company's bankers' acceptances is the yield on the bankers' acceptances plus the stamping fee.

Question 22

Which of the following is not a characteristic of a line of credit?

A) Issued at a discount
B) Type of bank financing
C) Carries interest on the amount borrowed plus a commitment fee on the unused balance
D) Can be one of several different types including operating line of credit, revolving line of credit

Question 23

A 30-day Treasury bill that has a price of 99.5 has a discount yield closest to:

A) 6%
B) 6.03%
C) 6.08%
D) 6.11%

Question 24

A 30-day Treasury bill that has a price of 99.5 has a bond equivalent yield closest to:

A) 6%
B) 6.03%
C) 6.08%
D) 6.11%

Question 25

A 60-day Treasury bill that has a price of 99.5 has a discount yield closest to:

A) 3%
B) 3.015%
C) 3.042%
D) 3.057%

Question 26

A 60-day Treasury bill that has a price of 99.5 has a bond equivalent yield closest to:

A) 3%
B) 3.015%
C) 3.042%
D) 3.057%

Question 27

Which of the following is not a characteristic of commercial paper?

A) Can be interest bearing
B) Can be issued at a discount
C) Type of money market financing
D) Carries a maturity of from 364 days to 5 years

Question 28

Which of the following is not a characteristic of commercial paper?

A) Can be interest bearing
B) Can be issued at a discount
C) Type of money market financing
D) Carries a maturity of from 364 days to 5 years

Question 29

Given two Treasury bills with identical face values and discount yields, the bill with the shorter term to maturity will have the:

A) higher price.
B) lower price.
C) same price as the other bill.

Question 30

A 30-day Treasury bill that has discount yield of 9 percent. Therefore its price is closest to:

A) 99
B) 99.15
C) 99.20
D) 99.25

Question 31

A 90-day Treasury bill that has bond equivalent yield of 4.0965 percent. Therefore its price is closest to:

A) 99
B) 99.15
C) 99.20
D) 99.25

Question 32

A 60-day Treasury bill that has bond equivalent yield of 1.2191 percent. Therefore its price is closest to:

A) 99
B) 99.2
C) 99.4
D) 99.6
E) 99.8

Question 33

A debt obligation with a maturity of between 4 and 10 years is best described as:

A) a bill.
B) a long term bond.
C) a medium term note.
D) an intermediate bond.

Question 34

A debt obligation backed with collateral is best described as:

A) a debenture.
B) secured debt.
C) subordinated debt.
D) unsubordinated debt.

Question 35

A debenture is best described as being backed by:

A) leases.
B) equipment.
C) real property.
D) general credit of the issuer.

Question 36

The requirement that the issuer of a bond maintain a current ratio of 2.0 or above is beset described as:

A) a debenture.
B) a negative covenant.
C) an affirmative covenant.

Question 37

Which of the following is an example of an affirmative covenant?

A) The issuing company must not issue additional debt without approval of the lender.
B) The issuing company agrees to timely payment of interest and repayment of principal.
C) The issuing company must not issue any additional debt with existing assets as collateral.
D) The issuing company must not pay dividends to shareholders if the company experiences a net loss.

Question 38

Consider a convertible bond with a face value of $1,000 and a conversion ratio of 40. If the bond is convertible into common stock of the issuer, and the common stock is trading for $36 per share, the conversion value of this bond is closest to:

A) $1,000
B) $1,440
C) $36,000
D) $40,000

Question 39

Consider a convertible bond with a face value of $1,000 and a conversion ratio of 25. If the bond is convertible into common stock of the issuer, and the common stock is trading for $36 per share, the conversion value of this bond is closest to:

A) $900
B) $1,000
C) $25,000
D) $36,000

Question 40

Which of the following debt instruments would have the highest cost of debt to the borrower?

A) Debenture
B) Commercial paper
C) Senior, secured debt

Question 41

The value of a share of stock that considering the conversion ratio of the convertible bond, is the equivalent to the value of the bond is best described as:

A) straight value.
B) conversion ratio.
C) conversion value.
D) market conversion price.

Question 42

Which of the following ratings represents the highest rating possible?

A) A | A
B) AA | Aa
C) AAA | Aaa
D) BBB | Baa
E) CCC | Caa

Question 43

A bond rating of "B" indicates that the bond is:

A) investment grade.
B) a speculative bond.

Question 44

A bond rating of "A" indicates that the bond is:

A) investment grade.
B) a speculative bond.

Question 45

A rating that indicates maximum safety in terms of credit risk is best described as a bond with a rating of:

A) A | A
B) AA | Aa
C) AAA | Aaa
D) BBB | Baa
E) CCC | Caa

Question 46

If a bond rating company does not change its ratings in response to temporary changes in the economy, but only on clear structural changes in a company's credit, the bond rating company is following:

A) credit watch
B) the hierarchy principle
C) a stable rating philosophy
D) a standard financial analysis
E) a conservative rating philosophy

Question 47

If a bond rating company rates a company's first mortgage bonds higher than the same company's junior subordinated bonds, that bond rating company is following:

A) credit watch
B) the hierarchy principle
C) a stable rating philosophy
D) a standard financial analysis
E) a conservative rating philosophy

Question 48

Which of the following is not one of the six basic factors that bond ratings firms look at in determining their ratings?

A) Asset quality
B) Core profitability
C) Balance sheet strength
D) Strategy and management strength
E) Bond ratings of the company's competitors

Question 49

Which of the following statements is incorrect?

A) Credit ratings are performed by a large number of firms.
B) The default experience with bonds is consistent with ratings.
C) One problem with the current bond rating system is the way bond ratings firms are compensated.
D) The SEC requires Nationally Recognized Statistical Rating Organizations (NRSROs) to evaluate risk.
E) One problem with bond ratings is they tend to follow changes in a company's financial condition instead of predict the changes.

Question 50

Which of the following is not a problem with bond ratings?

A) The default experience on bonds is not consistent with bond ratings.
B) The present system of compensating bond ratings firms presents possible conflicts of interest.
C) Bond ratings firms tend to understate the risk associated with asset-backed securities, specifically subprime mortgages.
D) The speed which bond rating agencies reflect a change in a company's condition. Bond ratings tend to follow changes in a company's financial condition instead of predict the changes.

Question 51

A major difference between debt and equity is that principal and interest payments on debt are fixed contractual commitments.

Question 52

r_d^* ₌ r_d (1-T) is the formula for after-tax cost of debt.

Question 53

If the before-tax cost of debt is 6 percent and the after-tax cost of debt is 3.6 percent, the marginal tax rate must be 30 percent.

Question 54

Any debt instrument with a maturity of less than a year is called a note.

Question 55

On a 91-day T-bill issued at 99, the discount yield will be higher than the bond equivalent yield.

Question 56

Having a back-up line of credit to ensure the company has money to pay off commercial paper is call liquidity support.

Question 57

The line of credit that can be called at any time is best described as a revolving line of credit.

Question 58

A full or partial payment paid at the maturity of a loan is a balloon payment.

Question 59

The line of credit that is extended by a bank to a company for a specific amount that automatically adjusts as payments are made or received is best described as an operating line of credit.

Question 60

The detailed document that describes the security offering, which is required by the Securities and Exchange Commission for all public offerings is best described as an offering memorandum.

Question 61

Offering memorandum is used for private placements of securities.

Question 62

A debt obligation that matures in less than 10 years is best described as a note or a medium-term note.

Question 63

Debt that has preference over other debt obligation in terms of the issuer's capitalization is senior debt.

Question 64

Subordinated debt is unsecured debt that ranks first with the company; no other unsecured debt ranks ahead of it.

Question 65

The legal agreement that describes a debt obligation's interest, maturity, any collateral, and other features such as callability and convertibility is best described as an affirmative covenant.

Question 66

The agreement for the issuing company to maintain a current ratio of more than 2.5 is an affirmative covenant.

Question 67

Callability and convertibility are examples of embedded options in the debt contract.

Question 68

A period of time in which the bond may not be called back from the issuer is a waiting period.

Question 69

A debt obligation that is exchangeable into another security at the option of the investor is best described as a convertible bond.

Question 70

Borrowers' agreement to debt covenants lowers their cost of borrowing.

Question 71

The lowest investment grade bond is B | B so CCC | Caa and below are considered junk bonds or high-yield bonds.

Question 72

A bond in your portfolio has just been placed on credit watch. This means its bond rating has been downgraded.

Question 73

Once its bonds are issued, a company should not be concerned about its debt rating.

Question 74

Marginal tax rates are expected to rise in the New Year. Company ABC currently has an 8 percent before-tax rate on its debt and a marginal tax rate of 40 percent. Company ABC is expecting its marginal tax rate to increase to 45 percent. How will this change Company ABCs after-tax cost of debt?

Question 75

Consider a 91-day T-bill issued at 99. What is the discount yield on this T-bill?

Question 76

Consider a 91-day T-bill issued at 99. What is the bond equivalent yield on this T-bill?

Question 77

Consider a 91-day T-bill issued at 98. What is the discount yield on this T-bill?

Question 78

Consider a 91-day T-bill issued at 98. What is the bond equivalent yield on this T-bill?

Question 79

The discount yield of a 26-week T-bill is 3 percent. What is the bond -equivalent yield for this T-bill?

Question 80

The discount yield of a 26-week T-bill is 2 percent. What is the bond -equivalent yield for this T-bill?