Chap024.pdf

Chapter 24 - The Many Different Kinds of Debt

Chapter 24 The Many Different Kinds of Debt Multiple Choice Questions

1. A "foreign" bond is a bond: A. Sold in the United States by a company in the USA B. Sold to investors in the local market issued by a company from some other country C. Sold in Europe by a company from the United States D. None of the above

2. The largest market for foreign bonds is A. U.S.A B. Japan C. Switzerland D. none of the above

3. A "samurai bond" is a bond: A. Sold by a company from Japan B. Sold in the United States by a company from Japan C. Sold in Japan by a local company D. Sold in Japan by a company from some other country

4. A "yankee bond" is a bond A. Sold by a company from the U.S.A. B. Sold in the United States by a foreign firm C. Sold in the U.S.A. by a local company D. Sold in Japan by a company from some other country

5. Recently a high proportion of international bond issues are denominated in A. U.S. dollars B. British pounds C. Yens D. Euros

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Chapter 24 - The Many Different Kinds of Debt

6. The bonds that are sold to local investors issued by a firm from another country are called: A. Private placement B. Foreign bonds C. Junk bonds D. Investment grade bonds

7. According to SEC Rule 144A: A. Bonds issued through private placements can be bought and sold by institutional investors B. SEC registration is not needed for privately placed bonds C. SEC registration is required of all securities issued in the U.S.A. D. (A) and (B) only

8. The written agreement between a corporation and the bondholder's representative is called: A. The indenture B. The collateral maintenance agreement C. The prospectus D. The debenture

9. In case of Eurobond issues, the entity that carries out similar functions of a bond trustee is called: A. a bond trustee B. an international bank C. underwriter D. a fiscal agent

10. Very large bond issues that are marketed both internationally as well as in individual domestic markets are called: A. Eurobonds B. Foreign bonds C. Global bonds D. none of the above

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Chapter 24 - The Many Different Kinds of Debt

11. In general which of the following statement(s) is (are) true: I) Bonds issued in the United States are registered II) Bonds issued in the United States are bearer bonds III) Eurobonds are registered IV) Eurobonds are bearer bonds A. I and IV only B. II only C. III only D. II and III only

12. A type of bond that has the advantage of secrecy of ownership, but has the disadvantage of ownership not recorded by the registrar is: A. A registered bond B. A premium bond C. A par bond D. A bearer bond

13. Which of the following would not generally be included in the typical bond indenture? I) The basic terms of the bond II) Details of the protective covenants III) Sinking fund arrangements IV) Call provisions A. I only B. II only C. II and III only D. I, II, III, and IV

14. Any bond that is issued at a discount is known as: A. Pure discount bond B. Zero-coupon bond C. Original issue discount bond D. Premium bond

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Chapter 24 - The Many Different Kinds of Debt

15. In general which of the following statements is true? A. Bonds issued in the United States pay interest annually, while bonds issued in other countries pay interest semiannually B. Bonds issued in the United States and other countries pay interest semi-annually C. Bonds issued in the United States and other countries pay interest annually D. Bonds issued in the United States pay interest semi-annually, while bonds issued in other countries pay interest annually

16. The Alfa Co. has a 6% coupon bond outstanding that pays semiannual interest. Calculate the semi-annual interest payment: A. $60 B. $30 C. $10 D. None of the above

17. The Alfa Co. has a 6% coupon bond outstanding that pays annual interest. Calculate the annual interest payment: A. $60 B. $30 C. $10 D. None of the above

18. The Alfa Co. has a 12% bond outstanding that pays interest on February 1st and July 1st. Today is March 1st and you are planning to purchase one of these bonds. How much will you pay in accrued interest? A. $10 B. $20 C. $30 D. $60

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Chapter 24 - The Many Different Kinds of Debt

19. A zero-coupon bond is also called: A. an Income bond B. original issue discount bond C. pure discount bond D. none of the above

20. LIBOR means: A. London Interbank Offered Rate B. London International Bank Offered Rate C. Long-term International Bank Offered Rate D. None of the above

21. Which of the following bonds is secured by assets? A. A mortgage bond B. A floating rate bond C. A debenture D. All of the above

22. Which of the following bonds is typically secured? A. Sinking fund debenture B. Mortgage bond C. Floating rate note D. Eurobond E. None of the above

23. Long-term Bonds that are unsecured obligations of a company are called: A. Indentures B. Debentures C. Mortgage bonds D. Bearer bonds

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Chapter 24 - The Many Different Kinds of Debt

24. The following are secured bonds except: A. Mortgage bonds B. Debentures C. Collateral trust bonds D. Equipment trust certificate

25. The following are various types of secured debt: I) Mortgage bonds II) Collateral trust bonds III) Equipment trust certificate IV) Debentures A. I only B. I and II only C. I, II and III only D. I, II, III and IV

26. Floating-rate bonds have adjustable rates to protect real rates of return against inflation. The rates paid are limited by: A. The put provisions of the issues B. A floor rate which sets the minimum C. A cap rate which sets the maximum D. B and C

27. Which of the following bonds is typically not secured? A. Collateral trust bond B. Mortgage bond C. Debentures D. Equipment trust certificate

28. The recovery rate on defaulting debt is the highest for the following type of debt: A. Bank debt B. Senior secured bonds C. Senior subordinated bonds D. Junior subordinated bonds

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Chapter 24 - The Many Different Kinds of Debt

29. The recovery rate on defaulting debt is the least for the following type of debt: A. Bank debt B. Senior secured bonds C. Senior subordinated bonds D. Junior subordinated bonds

30. Which of the following provisions would often be included in the indenture for a firstmortgage bond? A. A limit on officer salaries B. A negative pledge clause C. A limit on new issues of subordinated debt D. A limit on the amount of senior debt that can be issued

31. Firms often bundle up a group of assets and then sell the cash flows from these assets in the form of securities. They are called: A. Debentures B. Subordinated issues C. Asset-backed securities D. All of the above

32. 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

33. Corporations typically have the right to repurchase a debt issue prior to maturity at a fixed price. Such debt issues are said to be: A. Indentured B. Protected C. Convertible D. Callable

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Chapter 24 - The Many Different Kinds of Debt

34. Even though many bonds have deferred sinking funds, the sinking fund has the following effects on bondholders: I) Provides extra protection to bondholders as both an early warning system and perhaps some collateral cash II) Provides an option to the firm to buy bonds at the lower of market or face value III) Puts the bondholders at added risk due to potential inability to meet sinking fund payments A. I and II only B. III only C. II only D. II and III only

35. The following are some of the complications associated with call provisions of bonds: I) the firm may be prevented from calling bond because of non-refunding clause from issuing new debt. II) the call premium is a tax-deductible expense for the firm but is taxed as capital gains to bondholders. III) there may be other tax consequences to both the firm and the bondholders from replacing a low-coupon bond with a higher-coupon bond. IV) there are costs and delays associated with calling and reissuing debt. A. I only B. I and II only C. I, II and III only D. I, II, III and IV

36. A 5% debenture (face value = $1000) pays interest on June 30 and December 31. It is callable at a price of 105% together with accrued interest. Suppose the company decides to call the bonds on September 30. What price must it pay for each bond? A. $1000.00 B. $1037.50 C. $1062.50 D. $1050.00

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Chapter 24 - The Many Different Kinds of Debt

37. An 8% debenture has 5 years of call protection and is thereafter callable at 100%, except that it is non-refundable below interest cost. Which of the following statements is correct? A. The debenture may be called any time during the next 5 years B. The debenture may not be called during the next 5 years C. The lender has the option to demand early repayment D. The bond should be called when the yield on similar non-callable bonds falls to 8%

38. Puttable provision in bonds allows: A. The issuer to call the bond at par on the coupon payment date B. The holder to redeem the bond at par before maturity C. The issuer to extend the maturity of the bond D. The holder to extend the maturity of the bond

39. The call policy that maximizes shareholder wealth is to call a bond issue when: A. The bond's price is above par B. The bond's price is above par, but below the call price C. The bond's price exceeds the call premium D. The bond's price equals or exceeds the call price

40. Which of the following is not an example of an affirmative (positive) covenant? A. Requirement to maintain a minimum level of working capital B. Requirement to furnish bondholders with a copy of the firm's annual accounts C. Requirement to limit dividends to net income D. Requirement to maintain a minimum level of net worth

41. 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 non-recourse covenant B. A recourse covenant C. A positive covenant D. A negative covenant

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Chapter 24 - The Many Different Kinds of Debt

42. If a corporate security can be exchange for a fixed number of shares of stock, the security is said to be: A. Callable B. Convertible C. Protected D. None of the above

43. The holder of a $1,000 face value bond has the right to exchange the bond anytime before maturity for shares of stock priced at $50 per share. The $50 is called the: A. Conversion price. B. Stated price. C. Exercise price. D. Striking price.

44. The holder of a $1,000 face value bond can exchange the bond any time for 25 shares of stock. Then the conversion ratio: A. is $40 B. is $25 C. is $100 D. depends on the current market price of the bond.

45. The holder of a $1,000 face value bond can be exchanged any time for 25 shares of stock. Then the conversion price is: A. $40 B. $25 C. $100 D. None of the above.

46. The holders of ZZZ Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $25.00. What is the conversion price? A. $35 B. $7.70 C. $28.57 D. None of the above

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Chapter 24 - The Many Different Kinds of Debt

47. The holders of ZZZ Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $25.00. What is the conversion value of the bond? A. $1,000 B. $875 C. $1,200 D. None of the above

48. A convertible bond is selling for $993. It has 15 years to maturity, $1,000 face value, and pays 8% coupon interest payments annually. Similar straight bonds (non-convertible) are priced to yield 8.5%. The conversion ratio is 20. The stock is currently selling for $45. Calculate the convertible bond's option value. A. $34.52 B. $93.00 C. $7.00 D. None of the above

49. Which of the following statements about convertible bonds is (are) true? A. A convertible bond cannot have call feature. B. A callable bond cannot have a convertible feature. C. A convertible bond can also have call feature. D. all of the above statements about convertible bonds are false

50. A convertible bond issue by a firm can be thought of as: A. selling straight bonds B. selling straight bond and a call option C. selling put options D. selling common stock

51. A convertible bond issue by a firm can be thought of as: A. selling straight bonds B. selling a call options C. selling the common stock plus a put option D. selling common stock

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52. Issuing convertible bonds or bonds with warrants is useful for a company of unknown risk because A. The effects of risk are opposite on the two value components and tend to cancel each other out. B. If the firm is high risk, the option premium will be higher while the straight bond value is fixed. C. Only risky companies issued these instruments. D. The equity value is dependent on current risks only, not the future risk at conversion.

53. Generally, convertible bonds are issued by: A. smaller and more speculative firms B. mature and profitable firms C. very large firms D. none of the above

54. Issuing convertible bond is better than issuing equity by a firm because: I) a convertible issue sends a better signal to investors than an issue of common stock. II) an announcement of a stock issue generates worries of overvaluation and usually depresses stock price. III) a convertible issue shows the management's willingness to take chance that the stock price will rise enough to lead to conversion also signals management's confidence in the future. A. I only B. III only C. I and II only D. I, II and III

55. Which of the following could be a sensible reason for issuing convertibles? A. Convertibles are convenient and flexible - they're usually unsecured and subordinated, and cash requirements for debt service are relatively low B. Interest rates on convertible issues are significantly less than on straight debt C. Firms that need equity capital use convertibles as a roundabout way of issuing stock D. Firms prefer to issue convertibles when their shares are under-valued

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Chapter 24 - The Many Different Kinds of Debt

56. The following are problems specific to valuation of convertible bonds: A. dividends B. dilution C. changing bond value| D. all of the above

57. Warrants are sometimes issued: I) With private placement bonds. II) To investment bankers as compensation. III) To creditors in the event of bankruptcy. IV) To common stock holders. A. I, II, III and IV B. I and II only C. I, II, and III only D. II and III only

58. Two major differences between a warrant and a call option are: I) Warrant are contracts outside of the firm while options are within the firm. II) Warrants have long maturities while options are usually short maturities. III) Warrant exercise dilutes the value of equity while option exercise does not. A. II and III only B. I only C. II only D. III only

59. A bond-warrant package: A. Always increases the risk of the common equity. B. Always decreases the risk of the common equity. C. Could either increase or decrease the risk of the common equity. D. All of the above.

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Chapter 24 - The Many Different Kinds of Debt

60. The exercise of warrants creates new shares which: A. Increases the total number of shares but does not affect share value. B. Increases the total number of shares that reduces the individual share value. C. Does not change the number of shares outstanding similar to options. D. Increases share value because cash is paid into the firm at the time of warrant exercise.

61. Privately placed loans are advantageous because: A. There are usually fewer restrictive covenants B. There is direct contact with the lender and renegotiations can be handled more easily C. SEC registration is necessary D. Both B and C

62. Project finance is generally provided by: A. US Government B. Foreign governments C. International banks D. World bank

63. Project finance is extensively used in developing countries to finance: A. Power projects B. Telecommunications projects C. Transportation projects D. All of the above

64. LYONs are bonds that are: I) Callable II) Puttable III) Convertible IV) Zero-coupon A. I and II only B. I, II and III C. I, II, III and IV D. II, III and IV

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Chapter 24 - The Many Different Kinds of Debt

65. PIKs are: A. Pay-In-Kind bonds B. Pay Interest Kicker bonds C. Paid Interest in Krugerand D. None of the above

66. A loan guarantee provided by the government on a corporate bond acts like what kind of derivative security for the investor? A. Long put B. Short put C. Long call D. Short call

67. What happens to the value of a convertible bond as the total value of the firm increases? A. Goes up B. Goes down C. Stays the same D. May go up or down

True / False Questions

68. The term "Yankee bond" refers to any bond sold in the United States. True False

69. Bonds issued in the United States are usually registered. True False

70. Sinking funds reduce the average life of a bond and thereby reduce the risk of a default. True False

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Chapter 24 - The Many Different Kinds of Debt

71. The difference between the price of callable and non-callable bonds is greatest when bond prices are lowest. True False

72. A negative pledge clause states that the company may grant an exclusive lien or claim on any of its assets. True False

73. Affirmative covenants impose certain duties on the company. True False

74. The owner of a convertible bond owns both a straight bond and a call option. True False

75. Convertible bonds can also have a call feature. True False

76. Issuing convertible debt makes sense whenever investors have difficulty estimating the risk of the company's bond. True False

77. A warrant holder is not entitled to vote but receives dividends. True False

78. Bond-warrant package has different effects on the firm's cash flow and capital structure than the convertible bond. True False

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Chapter 24 - The Many Different Kinds of Debt

79. Many times warrants may be issued on their own and do not have to be issued in conjunction with other securities. True False

80. Project finance requires a capital investment that can be clearly separated from the parent that offers tangible security to lenders. True False

81. Floating price convertibles are convertible debt where bond holders can convert into a fixed value of shares. True False

82. Reverse floaters are floating rate bonds that pay a higher rate of interest when other interest rates fall and a lower rate when other rates rise. True False

83. Loan guarantees are valuable methods for propping up the value of debt without up front cash. True False

84. Government loan guarantees are risk free and costless means for helping struggling firms. True False

Short Answer Questions

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Chapter 24 - The Many Different Kinds of Debt

85. Explain the differences between a bond issued only in the United States and Eurobond issues.

86. Briefly explain the provisions of a typical bond indenture.

87. Briefly explain the restrictive covenants in a bond indenture.

88. Briefly explain the term "conversion ratio."

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Chapter 24 - The Many Different Kinds of Debt

89. Briefly explain the term "Conversion premium."

90. Discuss the valuation of a convertible bond.

91. What are the three elements of convertible bond value?

92. Briefly explain what is meant by "force conversion?"

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Chapter 24 - The Many Different Kinds of Debt

93. Explain why firms issue convertible debt.

94. Explain the differences between warrants and convertibles.

95. Discuss the differences between publicly issued bonds and private placements.

96. Briefly explain project financing.

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Chapter 24 - The Many Different Kinds of Debt

97. What are LYONs?

98. What are reverse floaters?

99. What are PIK bonds?

100. Explain why the following phrase is true or false. "Government loan guarantees are costless methods for the government to help troubled firms."

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Chapter 24 - The Many Different Kinds of Debt

Chapter 24 The Many Different Kinds of Debt Answer Key

Multiple Choice Questions

1. A "foreign" bond is a bond: A. Sold in the United States by a company in the USA B. Sold to investors in the local market issued by a company from some other country C. Sold in Europe by a company from the United States D. None of the above

Type: Easy

2. The largest market for foreign bonds is A. U.S.A B. Japan C. Switzerland D. none of the above

Type: Easy

3. A "samurai bond" is a bond: A. Sold by a company from Japan B. Sold in the United States by a company from Japan C. Sold in Japan by a local company D. Sold in Japan by a company from some other country

Type: Easy

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Chapter 24 - The Many Different Kinds of Debt

4. A "yankee bond" is a bond A. Sold by a company from the U.S.A. B. Sold in the United States by a foreign firm C. Sold in the U.S.A. by a local company D. Sold in Japan by a company from some other country

Type: Easy

5. Recently a high proportion of international bond issues are denominated in A. U.S. dollars B. British pounds C. Yens D. Euros

Type: Easy

6. The bonds that are sold to local investors issued by a firm from another country are called: A. Private placement B. Foreign bonds C. Junk bonds D. Investment grade bonds

Type: Easy

7. According to SEC Rule 144A: A. Bonds issued through private placements can be bought and sold by institutional investors B. SEC registration is not needed for privately placed bonds C. SEC registration is required of all securities issued in the U.S.A. D. (A) and (B) only

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

8. The written agreement between a corporation and the bondholder's representative is called: A. The indenture B. The collateral maintenance agreement C. The prospectus D. The debenture

Type: Easy

9. In case of Eurobond issues, the entity that carries out similar functions of a bond trustee is called: A. a bond trustee B. an international bank C. underwriter D. a fiscal agent

Type: Medium

10. Very large bond issues that are marketed both internationally as well as in individual domestic markets are called: A. Eurobonds B. Foreign bonds C. Global bonds D. none of the above

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

11. In general which of the following statement(s) is (are) true: I) Bonds issued in the United States are registered II) Bonds issued in the United States are bearer bonds III) Eurobonds are registered IV) Eurobonds are bearer bonds A. I and IV only B. II only C. III only D. II and III only

Type: Easy

12. A type of bond that has the advantage of secrecy of ownership, but has the disadvantage of ownership not recorded by the registrar is: A. A registered bond B. A premium bond C. A par bond D. A bearer bond

Type: Easy

13. Which of the following would not generally be included in the typical bond indenture? I) The basic terms of the bond II) Details of the protective covenants III) Sinking fund arrangements IV) Call provisions A. I only B. II only C. II and III only D. I, II, III, and IV

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

14. Any bond that is issued at a discount is known as: A. Pure discount bond B. Zero-coupon bond C. Original issue discount bond D. Premium bond

Type: Easy

15. In general which of the following statements is true? A. Bonds issued in the United States pay interest annually, while bonds issued in other countries pay interest semiannually B. Bonds issued in the United States and other countries pay interest semi-annually C. Bonds issued in the United States and other countries pay interest annually D. Bonds issued in the United States pay interest semi-annually, while bonds issued in other countries pay interest annually

Type: Medium

16. The Alfa Co. has a 6% coupon bond outstanding that pays semiannual interest. Calculate the semi-annual interest payment: A. $60 B. $30 C. $10 D. None of the above 6% of $1000 = $60; Semiannual interest = 60/2 = $30

Type: Easy

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Chapter 24 - The Many Different Kinds of Debt

17. The Alfa Co. has a 6% coupon bond outstanding that pays annual interest. Calculate the annual interest payment: A. $60 B. $30 C. $10 D. None of the above 6% of $1000 = $60

Type: Easy

18. The Alfa Co. has a 12% bond outstanding that pays interest on February 1st and July 1st. Today is March 1st and you are planning to purchase one of these bonds. How much will you pay in accrued interest? A. $10 B. $20 C. $30 D. $60 (60/180) * 30 = $10

Type: Easy

19. A zero-coupon bond is also called: A. an Income bond B. original issue discount bond C. pure discount bond D. none of the above

Type: Easy

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Chapter 24 - The Many Different Kinds of Debt

20. LIBOR means: A. London Interbank Offered Rate B. London International Bank Offered Rate C. Long-term International Bank Offered Rate D. None of the above

Type: Medium

21. Which of the following bonds is secured by assets? A. A mortgage bond B. A floating rate bond C. A debenture D. All of the above

Type: Medium

22. Which of the following bonds is typically secured? A. Sinking fund debenture B. Mortgage bond C. Floating rate note D. Eurobond E. None of the above

Type: Easy

23. Long-term Bonds that are unsecured obligations of a company are called: A. Indentures B. Debentures C. Mortgage bonds D. Bearer bonds

Type: Easy

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Chapter 24 - The Many Different Kinds of Debt

24. The following are secured bonds except: A. Mortgage bonds B. Debentures C. Collateral trust bonds D. Equipment trust certificate

Type: Easy

25. The following are various types of secured debt: I) Mortgage bonds II) Collateral trust bonds III) Equipment trust certificate IV) Debentures A. I only B. I and II only C. I, II and III only D. I, II, III and IV

Type: Medium

26. Floating-rate bonds have adjustable rates to protect real rates of return against inflation. The rates paid are limited by: A. The put provisions of the issues B. A floor rate which sets the minimum C. A cap rate which sets the maximum D. B and C

Type: Medium

27. Which of the following bonds is typically not secured? A. Collateral trust bond B. Mortgage bond C. Debentures D. Equipment trust certificate

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

28. The recovery rate on defaulting debt is the highest for the following type of debt: A. Bank debt B. Senior secured bonds C. Senior subordinated bonds D. Junior subordinated bonds

Type: Medium

29. The recovery rate on defaulting debt is the least for the following type of debt: A. Bank debt B. Senior secured bonds C. Senior subordinated bonds D. Junior subordinated bonds

Type: Medium

30. Which of the following provisions would often be included in the indenture for a firstmortgage bond? A. A limit on officer salaries B. A negative pledge clause C. A limit on new issues of subordinated debt D. A limit on the amount of senior debt that can be issued

Type: Medium

31. Firms often bundle up a group of assets and then sell the cash flows from these assets in the form of securities. They are called: A. Debentures B. Subordinated issues C. Asset-backed securities D. All of the above

Type: Easy

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Chapter 24 - The Many Different Kinds of Debt

32. 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

Type: Difficult

33. Corporations typically have the right to repurchase a debt issue prior to maturity at a fixed price. Such debt issues are said to be: A. Indentured B. Protected C. Convertible D. Callable

Type: Easy

34. Even though many bonds have deferred sinking funds, the sinking fund has the following effects on bondholders: I) Provides extra protection to bondholders as both an early warning system and perhaps some collateral cash II) Provides an option to the firm to buy bonds at the lower of market or face value III) Puts the bondholders at added risk due to potential inability to meet sinking fund payments A. I and II only B. III only C. II only D. II and III only

Type: Difficult

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Chapter 24 - The Many Different Kinds of Debt

35. The following are some of the complications associated with call provisions of bonds: I) the firm may be prevented from calling bond because of non-refunding clause from issuing new debt. II) the call premium is a tax-deductible expense for the firm but is taxed as capital gains to bondholders. III) there may be other tax consequences to both the firm and the bondholders from replacing a low-coupon bond with a higher-coupon bond. IV) there are costs and delays associated with calling and reissuing debt. A. I only B. I and II only C. I, II and III only D. I, II, III and IV

Type: Difficult

36. A 5% debenture (face value = $1000) pays interest on June 30 and December 31. It is callable at a price of 105% together with accrued interest. Suppose the company decides to call the bonds on September 30. What price must it pay for each bond? A. $1000.00 B. $1037.50 C. $1062.50 D. $1050.00 1050 + ((25)(90)/180) = $1062.50

Type: Medium

37. An 8% debenture has 5 years of call protection and is thereafter callable at 100%, except that it is non-refundable below interest cost. Which of the following statements is correct? A. The debenture may be called any time during the next 5 years B. The debenture may not be called during the next 5 years C. The lender has the option to demand early repayment D. The bond should be called when the yield on similar non-callable bonds falls to 8%

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

38. Puttable provision in bonds allows: A. The issuer to call the bond at par on the coupon payment date B. The holder to redeem the bond at par before maturity C. The issuer to extend the maturity of the bond D. The holder to extend the maturity of the bond

Type: Medium

39. The call policy that maximizes shareholder wealth is to call a bond issue when: A. The bond's price is above par B. The bond's price is above par, but below the call price C. The bond's price exceeds the call premium D. The bond's price equals or exceeds the call price

Type: Medium

40. Which of the following is not an example of an affirmative (positive) covenant? A. Requirement to maintain a minimum level of working capital B. Requirement to furnish bondholders with a copy of the firm's annual accounts C. Requirement to limit dividends to net income D. Requirement to maintain a minimum level of net worth

Type: Medium

41. 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 non-recourse covenant B. A recourse covenant C. A positive covenant D. A negative covenant

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

42. If a corporate security can be exchange for a fixed number of shares of stock, the security is said to be: A. Callable B. Convertible C. Protected D. None of the above

Type: Medium

43. The holder of a $1,000 face value bond has the right to exchange the bond anytime before maturity for shares of stock priced at $50 per share. The $50 is called the: A. Conversion price. B. Stated price. C. Exercise price. D. Striking price.

Type: Medium

44. The holder of a $1,000 face value bond can exchange the bond any time for 25 shares of stock. Then the conversion ratio: A. is $40 B. is $25 C. is $100 D. depends on the current market price of the bond.

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

45. The holder of a $1,000 face value bond can be exchanged any time for 25 shares of stock. Then the conversion price is: A. $40 B. $25 C. $100 D. None of the above. Conversion price = 1000/25 = $40

Type: Medium

46. The holders of ZZZ Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $25.00. What is the conversion price? A. $35 B. $7.70 C. $28.57 D. None of the above

Type: Medium

47. The holders of ZZZ Corporation's bond with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $25.00. What is the conversion value of the bond? A. $1,000 B. $875 C. $1,200 D. None of the above Conversion value = 35 * 25 = $875

Type: Easy

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Chapter 24 - The Many Different Kinds of Debt

48. A convertible bond is selling for $993. It has 15 years to maturity, $1,000 face value, and pays 8% coupon interest payments annually. Similar straight bonds (non-convertible) are priced to yield 8.5%. The conversion ratio is 20. The stock is currently selling for $45. Calculate the convertible bond's option value. A. $34.52 B. $93.00 C. $7.00 D. None of the above Straight bond value at 8.5% yield to maturity = $958.48 Conversion value = (20) * (45) = $900; Convertible bond value = $993; Option value = [Convertible bond value - Straight bond value] = 993 - 958.48 = $34.52

Type: Difficult

49. Which of the following statements about convertible bonds is (are) true? A. A convertible bond cannot have call feature. B. A callable bond cannot have a convertible feature. C. A convertible bond can also have call feature. D. all of the above statements about convertible bonds are false

Type: Medium

50. A convertible bond issue by a firm can be thought of as: A. selling straight bonds B. selling straight bond and a call option C. selling put options D. selling common stock

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

51. A convertible bond issue by a firm can be thought of as: A. selling straight bonds B. selling a call options C. selling the common stock plus a put option D. selling common stock

Type: Difficult

52. Issuing convertible bonds or bonds with warrants is useful for a company of unknown risk because A. The effects of risk are opposite on the two value components and tend to cancel each other out. B. If the firm is high risk, the option premium will be higher while the straight bond value is fixed. C. Only risky companies issued these instruments. D. The equity value is dependent on current risks only, not the future risk at conversion.

Type: Difficult

53. Generally, convertible bonds are issued by: A. smaller and more speculative firms B. mature and profitable firms C. very large firms D. none of the above

Type: Easy

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Chapter 24 - The Many Different Kinds of Debt

54. Issuing convertible bond is better than issuing equity by a firm because: I) a convertible issue sends a better signal to investors than an issue of common stock. II) an announcement of a stock issue generates worries of overvaluation and usually depresses stock price. III) a convertible issue shows the management's willingness to take chance that the stock price will rise enough to lead to conversion also signals management's confidence in the future. A. I only B. III only C. I and II only D. I, II and III

Type: Difficult

55. Which of the following could be a sensible reason for issuing convertibles? A. Convertibles are convenient and flexible - they're usually unsecured and subordinated, and cash requirements for debt service are relatively low B. Interest rates on convertible issues are significantly less than on straight debt C. Firms that need equity capital use convertibles as a roundabout way of issuing stock D. Firms prefer to issue convertibles when their shares are under-valued

Type: Medium

56. The following are problems specific to valuation of convertible bonds: A. dividends B. dilution C. changing bond value| D. all of the above

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

57. Warrants are sometimes issued: I) With private placement bonds. II) To investment bankers as compensation. III) To creditors in the event of bankruptcy. IV) To common stock holders. A. I, II, III and IV B. I and II only C. I, II, and III only D. II and III only

Type: Easy

58. Two major differences between a warrant and a call option are: I) Warrant are contracts outside of the firm while options are within the firm. II) Warrants have long maturities while options are usually short maturities. III) Warrant exercise dilutes the value of equity while option exercise does not. A. II and III only B. I only C. II only D. III only

Type: Medium

59. A bond-warrant package: A. Always increases the risk of the common equity. B. Always decreases the risk of the common equity. C. Could either increase or decrease the risk of the common equity. D. All of the above.

Type: Difficult

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Chapter 24 - The Many Different Kinds of Debt

60. The exercise of warrants creates new shares which: A. Increases the total number of shares but does not affect share value. B. Increases the total number of shares that reduces the individual share value. C. Does not change the number of shares outstanding similar to options. D. Increases share value because cash is paid into the firm at the time of warrant exercise.

Type: Medium

61. Privately placed loans are advantageous because: A. There are usually fewer restrictive covenants B. There is direct contact with the lender and renegotiations can be handled more easily C. SEC registration is necessary D. Both B and C

Type: Easy

62. Project finance is generally provided by: A. US Government B. Foreign governments C. International banks D. World bank

Type: Medium

63. Project finance is extensively used in developing countries to finance: A. Power projects B. Telecommunications projects C. Transportation projects D. All of the above

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

64. LYONs are bonds that are: I) Callable II) Puttable III) Convertible IV) Zero-coupon A. I and II only B. I, II and III C. I, II, III and IV D. II, III and IV

Type: Easy

65. PIKs are: A. Pay-In-Kind bonds B. Pay Interest Kicker bonds C. Paid Interest in Krugerand D. None of the above

Type: Easy

66. A loan guarantee provided by the government on a corporate bond acts like what kind of derivative security for the investor? A. Long put B. Short put C. Long call D. Short call

Type: Difficult

67. What happens to the value of a convertible bond as the total value of the firm increases? A. Goes up B. Goes down C. Stays the same D. May go up or down

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

True / False Questions

68. The term "Yankee bond" refers to any bond sold in the United States. FALSE

Type: Easy

69. Bonds issued in the United States are usually registered. TRUE

Type: Easy

70. Sinking funds reduce the average life of a bond and thereby reduce the risk of a default. TRUE

Type: Easy

71. The difference between the price of callable and non-callable bonds is greatest when bond prices are lowest. FALSE

Type: Medium

72. A negative pledge clause states that the company may grant an exclusive lien or claim on any of its assets. FALSE

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

73. Affirmative covenants impose certain duties on the company. TRUE

Type: Medium

74. The owner of a convertible bond owns both a straight bond and a call option. TRUE

Type: Medium

75. Convertible bonds can also have a call feature. TRUE

Type: Medium

76. Issuing convertible debt makes sense whenever investors have difficulty estimating the risk of the company's bond. TRUE

Type: Medium

77. A warrant holder is not entitled to vote but receives dividends. FALSE

Type: Easy

78. Bond-warrant package has different effects on the firm's cash flow and capital structure than the convertible bond. TRUE

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

79. Many times warrants may be issued on their own and do not have to be issued in conjunction with other securities. TRUE

Type: Medium

80. Project finance requires a capital investment that can be clearly separated from the parent that offers tangible security to lenders. TRUE

Type: Medium

81. Floating price convertibles are convertible debt where bond holders can convert into a fixed value of shares. TRUE

Type: Medium

82. Reverse floaters are floating rate bonds that pay a higher rate of interest when other interest rates fall and a lower rate when other rates rise. TRUE

Type: Medium

83. Loan guarantees are valuable methods for propping up the value of debt without up front cash. TRUE

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

84. Government loan guarantees are risk free and costless means for helping struggling firms. FALSE

Type: Medium

Short Answer Questions

85. Explain the differences between a bond issued only in the United States and Eurobond issues. There are two basic differences. First, a bond issued in the United States will generally have a fixed interest rate, while a Eurobond will usually have a floating interest rate tied to LIBOR. Second, bonds sold in the United States are almost always registered, which means that the company's registrar records the owner's name; most Eurobonds are sold in bearer form.

Type: Easy

86. Briefly explain the provisions of a typical bond indenture. An indenture is a written agreement between the corporation and a trust company which represents the bondholders. The trust company ensures that the provisions of the indenture are observed and generally look after the interest of the bondholders. Indenture normally includes the following provisions: The basic terms of the bond; a description of property used as a security; details of the restrictive covenants; other provisions like call provisions, bond ratings, sinking fund arrangements etc.

Type: Difficult

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Chapter 24 - The Many Different Kinds of Debt

87. Briefly explain the restrictive covenants in a bond indenture. The restrictive covenants, also called protective covenants, are placed in the bond indenture to protect the bondholders' interests. There are two types of covenants, negative and positive (affirmative). Negative covenants limit or prohibit the company from taking certain actions like paying huge dividends to stockholders. Affirmative covenants specify certain duties on the company. These have to be exhaustive, as courts have held that only written covenants count.

Type: Medium

88. Briefly explain the term "conversion ratio." The number of shares received for each bond is called the conversion ratio. This is fixed for the life of the bond.

Type: Easy

89. Briefly explain the term "Conversion premium." Conversion premium is the difference between the conversion price and stock price expressed as a percent of stock price. Suppose the stock price is $25 and the conversion price is $45. Then the conversion premium is (45 - 25)/25 = 80%. This shows that the conversion price is 80% higher than the stock price.

Type: Easy

90. Discuss the valuation of a convertible bond. The value of a convertible bond will be the higher of the bond value or the conversion value. The bond value is what each bond would sell for if it could not be converted. The conversion value is what the bond would sell for assuming immediate conversion.

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

91. What are the three elements of convertible bond value? The value of a convertible bond is determined by straight bond value, conversion value and the option value. Value of a convertible bond = Higher of [Straight bond value, conversion value] + Option value. The straight bond value and the conversion values provide the floor for the convertible bond value.

Type: Medium

92. Briefly explain what is meant by "force conversion?" If the conversion value is greater than the call price and bond is called, then the call is said to force conversion. Obviously, bondholders would convert the bonds to realize the higher conversion value.

Type: Medium

93. Explain why firms issue convertible debt. Smaller and more risky firms generally issue convertibles. Convertibles are useful when investors have difficulty in assessing the risk of a company's debt. They also diminish the possible conflicts of interest between bondholder and stockholder.

Type: Medium

94. Explain the differences between warrants and convertibles. The main differences are: warrants are usually issued as a part of a private placement; warrants can be detached and sold separately; warrants may be issued on their own; warrants are exercised for cash; warrants and convertibles are subject to different tax rules.

Type: Medium

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Chapter 24 - The Many Different Kinds of Debt

95. Discuss the differences between publicly issued bonds and private placements. Mainly, there are three differences. First, publicly issued bonds must be registered with the SEC, while private placements need not. Second, publicly issued bonds are highly standardized, while private placements are tailor-made for the firms involved. Third, the restrictions placed on the issuer are much more stringent with private placements.

Type: Medium

96. Briefly explain project financing. Project financing refers to debt financing that is largely a claim against the cash flow from a particular project rather than against the firm as a whole. Project financing is used for power, communication and transportation projects. This is also used extensively in developing countries.

Type: Medium

97. What are LYONs? LYONs (Liquid yield option notes) are an innovation in bond design. They are puttable, callable, convertible and carry zero-coupon interest rate.

Type: Medium

98. What are reverse floaters? Reverse floaters are floating-rate bonds that pay a higher rate of interest when other rates of interests fall and a lower rate when other rates rise.

Type: Easy

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Chapter 24 - The Many Different Kinds of Debt

99. What are PIK bonds? PIK (pay-in-kind) bonds carry high coupon payments. They can be paid in cash or with bonds of equivalent face value.

Type: Medium

100. Explain why the following phrase is true or false. "Government loan guarantees are costless methods for the government to help troubled firms." This phrase is false for many reasons. While the issuance of a guarantee does not involve an upfront cost, it does transfer value and risk. A loan guarantee adds value to the recipients. By providing a guarantee the firm will assume more risk than the capital markets would otherwise allow it to take. The transfer of risk to the government and the subsequent reduced risk aversion of the firm, may increase the chance of a payout by the government. The intervention of the government prevents capital markets from assigning proper risk adjusted prices to firm assets.

Type: Difficult

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