The Many Different Kinds Of Debt Chapter 24 Exam Prep

Principles of Corporate Finance, 13e (Brealey)

Chapter 24 The Many Different Kinds of Debt

1) A "foreign" bond is a bond

A) sold in the United States by a U.S. company.

B) sold to investors in the local market but issued by a company from some other country.

C) sold in Europe by a U.S. company.

D) sold in Europe by a European company.

2) The largest market for foreign bonds is

A) U.S.

B) Japan.

C) Switzerland.

D) Russia.

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 United States.

B) sold in the United States by a foreign firm.

C) sold in the United States by a local company.

D) sold in Japan by a company from some other country.

5) A Yankee bond will be denominated in

A) U.S. dollars.

B) British pounds.

C) Japanese yen.

D) Euros.

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 United States.

D) bonds issued through private placements can be bought and sold by institutional investors and SEC registration is not needed for privately placed bonds.

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

A) indenture.

B) collateral maintenance agreement.

C) prospectus.

D) debenture.

9) The trust company for a bond issue represents the

A) managers of the firm.

B) firm's shareholders.

C) firm's board of directors.

D) firm's bondholders.

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 options are correct.

11) In general, which of the following statements 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 normally issued in a major currency, e.g., $US, euro, or yen.

IV) Eurobonds are normally issued in the local currency.

A) I and III only

B) II only

C) III only

D) II and IV only

12) A type of bond that has the advantage of secrecy of ownership, but has the disadvantage of ownership not recorded by the firm's registrar, is a

A) registered bond.

B) premium bond.

C) par bond.

D) bearer bond.

13) Which of the following are 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) a pure discount bond.

B) a zero-coupon bond.

C) an original issue discount bond.

D) a premium bond.

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 semiannually.

C) Bonds issued in the United States and other countries pay interest annually.

D) Bonds issued in the United States pay interest semiannually, while bonds issued in other countries pay interest annually.

16) The Alfa Co. has a 6 percent coupon bond outstanding that pays semiannual interest. Calculate the semiannual interest payment on a $1,000 face value bond.

A) $60

B) $30

C) $10

D) $6

17) The Alfa Co. has a 6 percent coupon bond outstanding that pays annual interest. Calculate the annual interest payment on a $1,000 face value bond.

A) $60

B) $30

C) $10

D) $120

18) The Alfa Co. has a 12 percent bond outstanding on a $1,000 face value bond 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

19) A zero-coupon bond is also called a(n)

A) income bond.

B) original issue discount bond.

C) pure discount bond.

D) premium bond.

20) LIBOR means

A) London Interbank Offered Rate.

B) London International Bank Offered Rate.

C) Long-term International Bank Offered Rate.

D) Liberty of Repayment.

21) Which of the following bonds is secured by assets?

A) A mortgage bond

B) A floating rate bond

C) A debenture

D) An indenture

22) Which of the following bonds is typically secured?

A) Sinking fund debenture

B) Mortgage bond

C) Floating rate note

D) Eurobond

23) Long-term bonds that are unsecured obligations of a company are called

A) indentures.

B) debentures.

C) mortgage bonds.

D) bearer bonds.

24) The following are secured bonds except

A) mortgage bonds.

B) debentures.

C) collateral trust bonds.

D) equipment trust certificates.

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 that sets the minimum.

C) a cap rate that sets the maximum.

D) a floor rate that sets the minimum and a cap rate that sets the maximum.

27) Which of the following bonds is typically not secured?

A) Collateral trust bond

B) Mortgage bond

C) Debenture

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.

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 first-mortgage 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) mortgage bonds.

32) A sinking fund may be useful to a corporation because

A) the corporation does not have to worry about paying the bondholders.

B) it may provide the corporation with the option to acquire the bonds 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 often 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.

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 a bond because of a nonrefunding 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 percent debenture (face value = $1,000) pays interest on June 30 and December 31. It is callable at a price of 105 percent together with accrued interest. Suppose the company decides to call the bonds on September 30. What amount must it pay for each bond?

A) $1,000.00

B) $1,037.50

C) $1,062.50

D) $1,050.00

37) An 8 percent debenture has five years of call protection and is thereafter callable at 100 percent, except that it is nonrefundable below interest cost. Which of the following statements is correct?

A) The debenture may be called any time during the next five years.

B) The debenture may not be called during the next five years.

C) The lender has the option to demand early repayment.

D) The bond should be called when the yield on similar noncallable bonds falls to 8 percent.

38) A puttable provision in a bond allows the

A) issuer to call the bond at par on the coupon payment date.

B) holder to redeem the bond at par before maturity.

C) issuer to extend the maturity of the bond.

D) 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) nonrecourse covenant.

B) recourse covenant.

C) positive covenant.

D) negative covenant.

42) If a corporate security can be exchanged for a fixed number of shares of stock, the security is said to be

A) callable.

B) convertible.

C) protected.

D) None of the options are correct.

43) The holder of a $1,000 face value bond has the right to exchange the bond any time 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) 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) $975.

46) The holders of ZZZ Corporation's bonds with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $25. What is the conversion price?

A) $35

B) $7.70

C) $28.57

D) $975

47) The holders of ZZZ Corporation's bonds with a face value of $1,000 can exchange that bond for 35 shares of stock. The stock is selling for $25. What is the conversion value of the bond?

A) $1,000

B) $875

C) $1,200

D) $965

48) A convertible bond is selling for $993. It has 15 years to maturity, $1,000 face value, and pays 8 percent coupon interest payments annually. Similar straight bonds (nonconvertible) are priced to yield 8.5 percent. 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) $58.48

49) Which of the following statements about convertible bonds is true?

A) A convertible bond cannot have a sinking fund.

B) A callable bond cannot have a convertible feature.

C) A convertible bond can also have a call feature.

D) A convertible bond must have a sinking fund.

50) A convertible bond issue can be thought of as the

A) sale of a straight bond.

B) sale of a straight bond and a call option.

C) sale of a put option.

D) sale of common stock.

51) All else equal, which of the following features will increase the value of a convertible bond?

A) The risk-free interest rate is higher.

B) The conversion ratio is higher.

C) The conversion price is lower.

D) All of the features increase the value.

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) the U.S. government.

54) A firm may prefer to issue a convertible bond, as opposed to issuing equity, 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 the stock price;

III) a convertible issue shows the management's willingness to take a chance that the stock price will rise enough to lead to conversion and 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 is the most 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 undervalued.

56) Which of the following situations increase the difficulty of valuing convertible bonds?

A) Dividends

B) Dilution caused by conversion

C) Changing bond price

D) All of the options are correct.

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 stockholders

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) warrants 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 options exercise usually 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) does not affect the risk of common equity.

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 and 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) there are usually fewer restrictive covenants and SEC registration is necessary.

62) Project finance is generally provided by

A) the U.S. government.

B) foreign governments.

C) international banks.

63) Project finance is extensively used in developing countries to finance

A) power projects.

B) telecommunications projects.

C) transportation projects.

D) All of the options are correct.

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

65) PIKs are

A) pay-in-kind bonds.

B) pay interest kicker bonds.

C) pay interest in Krugerrands.

D) pay interest in kroner.

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) The term bearer bond refers to bonds that bear little interest via coupon payments.

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

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

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

71) The difference between the price of callable and noncallable bonds is greatest when bond prices are lowest.

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

73) Affirmative covenants impose certain duties on the company.

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

75) Convertible bonds can also have a call feature.

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

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

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

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

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

81) Floating price convertibles are convertible debt where bondholders can convert into a fixed value of shares.

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.

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

84) Government loan guarantees are a risk-free and costless means for helping struggling firms.

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.

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.

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.

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 a costless method for the government to help troubled firms."