Question 1

A bond sells at a discount when the:

Accepted Answer

A bond sells at a discount when the contract rate (also known as the coupon rate) is below the market rate, as investors are not willing to pay full price for a bond that pays out less than what they could get elsewhere.

Question 2

When a bond sells at a premium:

Accepted Answer

When a bond sells at a premium, it means that the contract rate (or coupon rate) is higher than the current market interest rate. This occurs because investors are willing to pay more for a bond with a higher interest rate.

Question 3

Bonds owned by investors whose names and addresses are recorded by the issuing company and for which interest payments are made with checks to the bondholders, are called:

Accepted Answer

Registered bonds have the owners' names and addresses recorded by the issuing company and interest payments are made by checks to the bondholders. Callable bonds can be redeemed by the issuer before maturity, while serial bonds have different maturity dates for different portions of the bond issuance. Coupon bonds pay interest to whoever holds the physical coupon attached to the bond, and bearer bonds are unregistered bonds that are payable to whoever holds them.

Question 4

Secured bonds:

Accepted Answer

Secured bonds have specific assets of the issuing company pledged as collateral, making them less risky for investors. Debentures are unsecured bonds and are not backed by collateral. Secured bonds are not necessarily backed by the issuer's bank and can have different terms and conditions compared to sinking fund bonds. Secured bonds can also have a higher priority than other unsecured liabilities in case of default.

Question 5

Mark and Holly Melton, the owners of Melton Franchise Systems, say the key to their success is planning the financing for each individual franchise owner. Using the debt to equity ratio, which of the following franchises would be assessed as having the riskiest financing structure?
$\begin{array} { | l | r | r | r | r | r | } 
\hline & \text { Franchise } & \text { Franchise } & \text { Franchise } & \text { Franchise } & \text { Franchise } \
& \mathrm { A } & \mathrm { B } & \mathrm { C } & \mathrm { D } & \mathrm { E } \
\hline \text { Total Liabilities } & \$ 240,000 & \$ 120,000 & \$ 300,000 & \$ 500,000 & \$ 270,000 \
\hline \text { Total Equity } & \$ 60,000 & \$ 20,000 & \$ 150,000 & \$ 100,000 & \$ 90,000 \
\hline
\end{array}$

Accepted Answer

The answer of Mark and Holly Melton, the owners of...

Question 6

The contract between the bond issuer and the bondholders, which identifies the rights and obligations of the parties is called a(n):

Accepted Answer

A bond indenture is a legal document that outlines the terms and conditions under which a company issues bonds. The bond indenture includes information such as the bond's maturity date, coupon rate, and any security pledged as collateral. The bond indenture is a contract between the issuer and the bondholders, and it establishes the rights and obligations of each party.

Question 7

A company purchased equipment and signed a 7-year installment loan at 9% annual interest. The annual payments equal $9,000. The present value factor for an annuity for 7 years at 9% is 5.0330. The present value of the loan is:

Accepted Answer

$9,000 x 5.0330 = $45,297

Question 8

Bonds with a par value of less than $1,000 are known as:

Accepted Answer

Bonds with a par value of less than $1,000 are known as baby bonds. Junk bonds are high-risk, high-yield bonds; Callable bonds can be redeemed early by the issuer; Unsecured bonds are not backed by collateral; and Convertible bonds can be exchanged for common stock.

Question 9

Which of the following statements is true?

Accepted Answer

Interest on bonds is tax deductible, which means that companies can deduct the interest expense from their taxable income, resulting in a lower tax bill. This makes borrowing through bonds a more attractive option than other forms of financing, such as issuing stock.

Question 10

A company issues at par 7% bonds with a par value of $500,000 on June 1, which is 5 months after the most recent interest date. How much total cash interest is received on May 1 by the bond issuer?

Accepted Answer

The interest payment for one year is calculated as:

$500,000 par value x 7% coupon rate = $35,000

Since the interest is payable semi-annually, the interest payment for six months is:

$35,000/2 = $17,500

However, since the bonds were issued on June 1, and the most recent interest payment was made on December 1 of the previous year, only 5 months have elapsed between the interest payments. Therefore, the interest payment received on May 1 is:

$17,500 x (5/6) = $14,583.33

So, the correct answer is D) $14,583.33.

Question 11

A bond traded at 102 ½ means that:

Accepted Answer

The bond is trading at a premium of $25 ($1,025 - $1,000) per $1,000 bond. This means that the bond traded at $1,025 per $1,000 bond.

Question 12

If an issuer sells a bond at any other date than the interest payment date:

Accepted Answer

If an issuer sells a bond at any other date than the interest payment date, the buyer normally pays the issuer the purchase price plus any interest accrued since the prior interest payment date. This is because the bond has earned interest from the last payment date until the date of purchase, and the buyer needs to compensate the issuer for that accrued interest. This is known as the accrued interest and is normally added to the purchase price of the bond. Therefore, the bond is not sold at a premium or discount, and the issuing company does not report a gain or loss on the sale.

Question 13

Bonds that have an option exercisable by the issuer to retire them at a stated dollar amount prior to maturity are known as:

Accepted Answer

Bonds that have an option exercisable by the issuer to retire them at a stated dollar amount prior to maturity are known as callable bonds.

Question 14

Bonds that mature at different dates and end up with the total principal repaid gradually over a number of periods are referred to as:

Accepted Answer

Serial bonds have different maturity dates and their principal is repaid gradually over a number of periods, hence, making this the correct answer. Registered bonds refer to bonds registered under the owner's name, bearer bonds do not have registered owner's name, callable bonds can be called back by the issuer before maturity, and sinking fund bonds require companies to put aside funds to redeem bonds at maturity.

Question 15

Operating leases differ from capital leases in that

Accepted Answer

Operating leases do not transfer ownership of the asset under the lease, but capital leases often do. The other options listed do not accurately describe the differences between operating and capital leases.

Question 16

A company issues at 9% bonds at par with a par value of $100,000 on April 1, which is 4 months after the most recent interest date. How much total cash interest is received on April 1 by the bond issuer?

Accepted Answer

$100,000 x .09 x 4/12 year = $3,000

Question 17

A bondholder that owns a $1,000, 10%, 10-year bond has:

Accepted Answer

The answer of A bondholder that owns a $1,000, 10%,...

Question 18

What is the debt to equity ratio for a company who has $700,000 in total liabilities and $3,500,000 in total equity?

Accepted Answer

$700,000/$3,500,000 = .20

Question 19

Bonds that have interest coupons attached to their certificates, which the bondholders detach during each interest period and present to a bank for collection, are called:

Accepted Answer

Coupon bonds have interest coupons attached that bondholders detach and present for collection, making A the correct answer. Callable bonds can be redeemed by the issuer before maturity, serial bonds mature in installments, convertible bonds can be exchanged for a specified number of shares of stock, and registered bonds have the bondholder's name recorded by the issuer.

Question 20

Sinking fund bonds:

Accepted Answer

Sinking fund bonds require the issuer to set aside funds or assets regularly to retire the bonds at maturity. This provides investors with additional security and reduces the risk of default.

Quiz 10: Long-Term Liabilities