Corporate Debt
Ford Motor Company has issued 8% convertible debentures, convertible at a 50:1 ratio. Currently the debenture is trading at 110. The stock is trading at 21. What is the conversion price of the stock? A. $20 B. $21 C. $22 D. $50
A. $20 par value of bond / conversion ratio = conversion price 1000/50 = 20
The conversion price of a convertible debenture is set at issuance at $25 per share. The common stock is now trading at $27.50 while the bond is trading at 110. If the bond falls 20% from its current market value, the new parity price of the common stock will be: A. $22.00 B. $25.00 C. $27.50 D. $31.25
A. $22.00 If the bond falls 20% from its current price of $1,100, the new price will be 80% x $1,100 = $880 per bond. Since each bond is convertible based upon a conversion price of $25 per share, the conversion ratio is $1,000 par / $25 conversion price = 40:1. The new parity price is $880 / 40 = $22 per share
Ford Motor Company has issued 8% convertible debentures, convertible at a 12.5:1 ratio. Currently the debenture is trading at 90. The stock is trading at $72. Which statement is TRUE? A. The bond is trading at parity with the stock B. the stock is trading above the bond's parity price C. the stock is trading below the bond's parity price D. the parity price is based on the market price of the stock
A. The bond is trading at parity with the stock The bond is convertible into 12.5 shares of stock, now trading at $72, for a conversion value of $900 ($72 x 12.5 = $900). Since the bond is trading at 90 ($900), the stock and the bond are trading at parity to each other.
Which statement is TRUE? A. a debenture issued under an indenture B. an indenture is issued under a debenture C. all bonds are commonly known as debentures D. all bonds are issued under an indenture
A. a debenture issued under an indenture Debentures are corporate bonds backed solely by the issuer's "full faith and credit." The Trust Indenture Act of 1939 requires that all corporate bonds be issued under a "trust indenture." The indenture is the written contract between the issuer and the bondholder. An independent trustee is appointed (a large commercial bank or trust company) to monitor the issuer's compliance with all of the covenants included in the bond contract. The trustee gives an annual report of compliance to the bondholders. A trust indenture is required for all corporate bond issues of more than $50,000,000. Treasury issues, agency issues and municipal issues are exempt from this requirement (though municipal revenue bonds typically have a trust indenture because the market demands this additional protection).
Which statement is TRUE when comparing bonds and preferred stock? A. both bonds and preferred stock have a fixed payout rate and some may be convertible into common stock B. bonds have a fixed payout rate; preferred stock does not C. both bonds and preferred stock pay dividends D. bonds can be convertible; preferred stock cannot
A. both bonds and preferred stock have a fixed payout rate and some may be convertible into common stock Both bonds and preferred stock can be convertible and both have a fixed payout rate. Bonds pay interest, preferred stock pays dividends Think of preferred stock as a "bond" designed for corporate investment, so that a corporate investor can take advantage of the dividend exclusion from taxation (this tax benefit is not available to individual investors)
A customer has bought a fully registered Exxon-Mobile debenture. The customer will receive interest payments: A. from the paying agent once a year B. from the paying agent twice a year C. by clipping coupons once a year D. by clipping coupons twice a year
A. from the paying agent twice a year All new issues of U.S. Government bonds, municipal bonds and corporate bonds are book entry. A "book entry" bond is a fully registered bond where no paper certificate is issued. Instead, the owner simply receives that confirmation that he or she bought the bond. On such bonds, the paying agent mails the semi-annual interest payments to the registered owner. Note, however, that there are still many issues of long term corporate bonds still outstanding that have paper certificates. These bonds have not yet matured. Book entry bonds did not really come to dominate bond issuance until the 1990s, so 30-year bond certificates issued, say in 1995, do not mature until 2025. A fully registered bond is one issued with a physical certificate. The paying agent has the record of the owner's name and mails the interest payments semi-annually to the registered owner. Also note that no bearer bonds have been sold since 1983, but 40-year bearer bonds still exist (at least until 2023!). Bearer bondholders receive interest payments by clipping coupons and submitting them to the paying agent.
Promises made by corporate issuers to bondholders, as well as any restrictions placed on the issuer are found in the: A. indenture B. legal opinion C. prospectus D. underwriting agreement
A. indenture The trust indenture of a bond spells out all of the protective and restrictive covenants made to the bondholders. The trustee ensures that the corporation adheres to the covenants.
All of the following statements are correct when comparing bonds and preferred stock EXCEPT? A. payments to bondholders are subject to approval of the board of directors B. payments to preferred stockholders are subject to approval of the board of directors C. bonds are considered senior securities over common stock in a corporate dissolution D. preferred stock is considered to be a senior security over common stock in a corporate dissolution
A. payments to bondholders are subject to approval of the board of directors Both bonds and preferred stock are "Senior" securities over common. Payments to bondholders are a legal obligation of the issuer. They are not a discretionary decision on the part of the Board of Directors, as is the decision to pay a dividend to preferred and common shareholders.
A company that has issued first mortgage bonds is declared in default by the trustee. Which statement is TRUE? A. the bondholders have a "first mortgage lien" to the property backing the bond B. the bondholders do not have a legal claim to the property backing the bond C. the bondholders have first claim on all of the assets of the failed company to satisfy the debt D. the bondholders may not sell the pledged property to satisfy the unpaid obligation unless the lending bank approves
A. the bondholders have a "first mortgage lien" to the property backing the bond First mortgage bondholders have been granted a "first mortgage lien" on any "real" property (real estate - land and buildings) that is pledged by the issuer as backing for the bond issue. If a default occurs, the bondholders have the legal right to sell the pledged property, and to use the proceeds to satisfy the outstanding debt.
A convertible bond is convertible into common stock at a 32:1 ratio. The common stock is currently trading at $30. The bond is currently trading at $980. What is the bond's parity price? A. $940 B. $960 C. $980 D. $1000
B. $960 The bond's parity price is found by taking the stock's market price and multiplying this number by the conversion ratio. $30 * 32 = $960
An investor purchases a $1,000 convertible bond at 80. The bond is convertible into common at $20 per share. The current market price of the common is $10 per share. If the investor were to convert, he or she would receive how many shares of common stock? A. 40 B. 50 C. 80 D. 100
B. 50 Conversion is based on the par value of the bond, which is $1,000. The investor can convert at $20 per share, so upon conversion, the investor would receive $1,000 par / $20 conversion price = 50 shares.
A customer buys 10 Allied Corporation 8% debentures, M '25, at 90 on Wednesday, April 19th in a regular way trade. The interest payment dates are March 1st and September 1st. The trade settles on: A. Thursday, April 20 B. Friday, April 21 C. Saturday, April 22 D. Monday, April 24
B. Friday, April 21 Regular way trades of corporate bonds and stocks settle 2 business days after trade date.
A convertible debenture is convertible into common at $50 per share. If the market price of the bond rises to a 25 point premium over par, which statement is TRUE? A. The conversion ratio is 20:1 and the parity price of the stock is $50.00 B. The conversion ratio is 20:1 and the parity price of the stock is $62.50 C. The conversion ratio is 25:1 and the parity price of the stock is $50.00 D. The conversion ratio is 25:1 and the parity price of the stock is $62.50
B. The conversion ratio is 20:1 and the parity price of the stock is $62.50 The conversion ratio is established when the bond is issued, and is par value divided by the conversion price. In this case, the conversion price is set at $50 per share, so the conversion ratio is $1000 par / $50 conversion price = 20:1 (20 shares per bond)
A customer buys 10 PDQ Corporation 10% debentures, M '35, at 93 on Friday, June 12th in a regular way trade. The interest payment dates are March 1st and September 1st. The trade settles on: A. Monday, June 15 B. Tuesday, June 16 C. Wednesday, June 17 D. Friday, June 19
B. Tuesday, June 16 Regular way trades of corporate bonds and stocks settle 2 business days after trade date.
The credit rating of a guaranteed corporate bond is based on the credit quality of the: A. corporate issuer B. corporate guarantor C. FDIC D. SIPC
B. corporate guarantor Guaranteed corporate bonds are guaranteed by another corporation (typically a parent company guaranteeing the debt of a wholly owned subsidiary). The guarantor will have the higher credit rating, so the bonds will be able to be issued at a lower interest cost. Such bonds take on the credit rating of the corporate guarantor, who is liable for payment if the issuer defaults. Agencies, such as Federal Deposit Insurance Corp. and Securities Investor Protection Corp. do not guarantee corporate bonds. They protect customer accounts if banks, or securities firms fail, respectively.
Common carriers such as airline, railroad, or trucking companies would most likely issue: A. mortgage bonds B. equipment trust certificates C. general obligation bonds D. revenue anticipation notes
B. equipment trust certificates Equipment trust certificates are issued by common carriers such as airlines, railroads, and trucking companies. The rolling (or flying) stock is the collateral for the debt. Securing the debt in this manner allows the issuer to lower its financing cost
All of the following are true statements regarding convertible bond issued EXCEPT: A. at the time of issuance, the conversion price is set at a premium to the stock's current market price B. the yield on the convertible issues is higher than the yield for similar non-convertible issues C. when the stock price is at a premium to the conversion price, bond price movements are usually caused by those of the stock D. when the stock price is at a discount to the conversion price, bond price movements are usually caused by interest rate changes
B. the yield on the convertible issues is higher than the yield for similar non-convertible issues When convertible bonds are issued, it is normal for the conversion price to be at a premium to the current market price. Thus, for the conversion feature to be worth something, the stock's price must move up in the market. Due to the value of the conversion feature (or rather, the potential value if the stock price goes up), convertible bonds are saleable at lower yields than bonds without the conversion feature. When the stock price is at a discount to the conversion price, the conversion feature is worthless. The bond is valued based on interest rate movements. On the other hand, when the stock price is at a premium to the conversion price, the conversion feature now has intrinsic value. For every dollar that the stock now moves, the bond will move as well, since the securities are "equivalent."
The conversion price of a convertible debenture is set at issuance at $40 per share. The common stock is now trading at 42 while the bond is trading at par. If the bond rises 20% from its current market value, the new parity price of the common stock will be: A. $44 B. $46 C. $48 D. $50
C. $48 If the bond rises 20% from its current price of $1,000 (par), the new price will be 120% x $1,000 = $1,200 per bond. Since each bond is convertible based upon a conversion price of $40 per share, the conversion ratio is $1,000 par / $40 conversion price = 25:1. The new parity price is $1,200 / 25 = $48 per share.
A corporation has issued 10%, $1,000 par convertible debentures, convertible at $40. The common stock is currently trading at $45. If the bond and the common are trading at parity, a customer purchasing 5M of the bonds will pay: A. $4950 B. $5000 C. $5625 D. $6550
C. $5625 The bonds are convertible at $40, based on $1,000 par value. Therefore each bond converts into 25 shares ($1,000 par / $40 conversion price). If the common is trading at $45, the bond must be trading at 25 times this to be at parity. $45 x 25 = $1,125 parity price of one bond. The parity price of "5M" ($5,000 face amount, "M" is Latin for $1,000) is $1,125 x 5 = $5,625.
Ford Motor Company has issued 8% convertible debentures, convertible at a 12.5:1 ratio. Currently the debenture is trading at 90. The stock is trading at $72. What is the conversion price of the stock? A. $72 B. $75 C. $80 D. $90
C. $80 1000/12.5 = 80
A customer owns a convertible subordinated debenture, convertible into common at $25 per share. The bond is currently trading at par. If the bond's market price increases by 20%, the conversion ratio will be: A. 25:1 B. 32:1 C. 40:1 D. 48:1
C. 40:1 The conversion price (and hence the conversion ratio) is fixed when the convertible security is issued and does not change. In this case, the bond is issued with a conversion price of $25, based upon converting each bond at par. $1,000 par / $25 conversion price = 40:1 conversion ratio. Thus, for every bond that is converted, the holder receives 40 shares. The only time the conversion price (and hence the conversion ratio) changes is if there is an "anti-dilutive" covenant in the trust indenture. In such a case, if the corporation issues more common shares (diluting the market price of the outstanding common), the conversion price is reduced as well to get the "value" of the conversion feature unchanged relative to the common's market price
The term "Funded Debt" refers to which of the following issues? A. Commercial paper with under 270 days to maturity B. Revenue bond with at least 5 years to maturity C. Corporate debt with at least 5 years to maturity D. Treasury debt with at least 5 years to maturity
C. Corporate debt with at least 5 years to maturity The term "funded debt" refers to CORPORATE debt that is considered part of a company's permanent long term funding. Included is all long term corporate debt. Revenue bonds are issued by municipalities and T-Bonds are issued by the Government. Commercial paper is a short term financing and is an "unfunded" debt
In a corporate bankruptcy, of the choices offered, the LAST to be paid would be: A. Junior debentures B. Secured bonds C. Preferred stockholders D. Second mortgage bonds
C. Preferred Stockholders Secured bondholders are given the assets that are pledged as collateral for the loan before anyone else is paid in a corporate liquidation. Mortgage bondholders have a lien (a claim) on the building(s) pledged as collateral. The building can be sold by the lienholders and the proceeds used to satisfy the mortgage claim. First mortgage bonds would be paid before second mortgage bonds in such a sale. Debentures are unsecured corporate bonds. They are paid after the secured bondholders. Then preferred stockholders are paid, and finally common stockholders are paid.
Which statement is FALSE regarding equipment trust certificates ("ETC"s)? A. equipment trust certificates are issued in serial maturities B. equipment trust certificates are secured by specified corporate assets C. default of ETCs is common during recessionary periods D. equipment trust certificates are commonly issued by transportation companies
C. default of ETCs is common during recessionary periods Equipment Trust Certificates (ETCs) originated in the 1870s as a means of financing the expansion of the railroads. Today, ETCs are issued by transportation companies (railroads, airlines, truckers, etc.). The collateral for the certificates is specified "rolling stock" of the issuer. For example, United Airlines might finance the purchase of a new 787 jetliner by selling an ETC issue. That jetliner is the collateral for the certificates. The serial number of that jetliner will be printed on the ETCs to show that it is pledged as collateral to the certificate holders. ETCs are issued in serial maturities, so that a portion of the debt is repaid each year. This is the typical structure for ETC issues, since the plane is a depreciating asset. Thus, as the plane depreciates each year, part of the issue is being retired. Therefore, the outstanding debt never exceeds the collateral value. Default on ETCs has been rare. Even if there is a default, certificate holders have collateral (in this case, the plane), that they may sell to obtain the funds to repay the outstanding debt balance
Which statement regarding mortgage bonds is FALSE? A. mortgage bonds are issued in term maturities B. mortgage bonds are secured by real property C. default of mortgage bonds is common during recessionary periods D. mortgage bonds are commonly issued by utilities
C. default of mortgage bonds is common during recessionary periods Mortgage bonds originated in the 1890s as a means of financing the growth of utility companies. As a means of lowering the interest cost to the issuer, bondholders were given a lien on all real property of the utility. In theory, if the issuer defaulted, the bondholders could sell that real property to repay the outstanding debt balance. Mortgage bonds are term issues; all of the bonds are issued at the same date and mature on the same date. A serial structure is not required since real property is not a depreciating asset (as is the case with rolling stock pledged as collateral for equipment trust certificates). At maturity, it is common for mortgage bond issuers to sell a "refunding" bond issue. A new mortgage bond issue is floated, with the proceeds used to retire the maturing debt. In essence, the issuer is rolling over the debt. Historically, mortgage bond defaults have been very low.
If a corporation reports a loss for a year, it is obligated to make interest payments on all of the following bonds EXCEPT: A. non-callable bonds B. equipment trust certificates C. income bonds D. non-convertible bonds
C. income bonds Income bonds, also known as adjustment bonds, pay interest only if the corporation hits a predetermined level of earnings. If the income level is not sufficient, there is no obligation to make the interest payment. On all other corporate bonds - whether they be equipment trust certificates, mortgage bonds, debentures, etc., interest must legally be paid. Conversion and call features have no effect on the obligation to pay.
Which of the following are the least likely purchasers of commercial paper? A. trust companies B. insurance companies C. individuals D. open-end investment companies
C. individuals Dealer commercial paper is sold for corporations by dealer firms such as Goldman Sachs. The minimum purchase amount is generally $100,000. This eliminates most individuals from the market. The dealer commercial paper market is primarily an institutional market, with purchasers including insurance companies, trust companies and money market mutual funds. As compared to "dealer" paper, many corporations sell their commercial paper directly to the investing public. "Direct" paper is sold directly to the investing public, usually via the web. It also sells in $100,000 and $500,000 minimum amounts, so the individual investor is pretty much cut out.
Which industry is most susceptible to swings in market interest rates? A. consumer goods B. auto manufacturer C. public utility D. technology
C. public utility Utilities are capital intensive - building electric generating plants is expensive! To obtain long term funds, utilities can issue either stock or bonds. Because their revenue stream is stable, utilities can issue large amounts of bonds at favorable interest rates without negatively affecting their credit rating. The vast majority of utility financing is done via the issuance of mortgage bonds. It is typical for a utility to have 90% of its capitalization come from the sale of bonds with only 10% from equity. It contrast, mature manufacturing companies can rarely have more than 30% of their capital base coming from the issuance of debt without negatively affecting their credit rating. Tech companies can only issue bonds once they have seasoned in the market, typically for 10 years or so, so that they can prove to the credit rating agencies that their business will survive for the long-term. If interest rates drop steeply, a utility can call its outstanding bonds and refund at lower current market rates. This reduces its interest cost (which is one of its largest expenses), so earnings will improve, and the price of the stock will rise in the market. Because the other industries listed cannot issue such a large amount of bonds, the positive impact of refunding at lower current market rates is not as great. If interest rates rise steeply, as its bonds mature, the utility must replace them with new bonds at steeply higher interest rates. This increases its interest cost (which is one of its largest expenses), so earnings will deteriorate, and the price of the stock will fall in the market.
Which of the following debt securities is NOT issued by a corporation? A. mortgage bonds B. collateral trust certificates C. revenue bonds D. income bonds
C. revenue bonds Corporations do not issue revenue bonds - rather, these are a type of municipal bond, backed by revenues from public projects such as toll roads, bridges, tunnels and airports. Corporations can issue mortgage bonds (backed by real property), collateral trust certificates (backed by a portfolio of marketable securities), and income or adjustment bonds (that obligate the issuer to pay only if there are sufficient earnings).
Mortgage bonds are a(n): A. unsecured debt and pay interest monthly B. unsecured debt and pay interest semi-annually C. secured debt and pay interest semi-annually D. secured debt and pay interest monthly
C. secured debt and pay interest semi-annually Mortgage bonds are corporate obligations that pay interest semi-annually and are backed by a mortgage on real property - so these bonds are secured. The vast majority of mortgage bond issues are sold by utilities, that pledge their property, plant and equipment as collateral for the bond issue. This gets the utility a lower interest rate. Do not confuse mortgage bonds with mortgage-backed pass through certificates. Mortgage-backed pass through certificates represent ownership in a pool of home mortgages and the monthly mortgage payments are passed-through to the certificate holders
All of the following corporate bonds are secured EXCEPT: A. equipment trust certificates B. second mortgage bonds C. sinking fund debentures D. collateral trust certificates
C. sinking fund debenture A secured bondholder has a lien on a specific asset of the company - such as equipment (an equipment trust certificate), real property (a mortgage bond) or securities given as collateral (a collateral trust certificate). A debenture is a promise to pay without any liens on corporate assets.
All of the following corporate bonds are secured EXCEPT: A. collateral trust certificate B. seconds mortgage bond C. subordinated debenture D. equipment trust certificate
C. subordinated debenture A secured bondholder has a lien on a specific asset of the company - such as equipment (an equipment trust certificate), real property (a mortgage bond) or securities given as collateral (a collateral trust certificate). A debenture is a promise to pay without any liens on corporate assets.
In a corporate liquidation, the priority of claim to corporate assets is: A. Unpaid wages and taxes, debenture holders, mortgage bond holders, preferred stockholders B. Unpaid wages and taxes, preferred stockholders, debenture holders, mortgage bondholders C. Mortgage bond holders, debenture holders, unpaid wages and taxes, preferred stockholders D. Mortgage bond holders, unpaid wages and taxes, debenture holders, preferred stockholders
D. Mortgage bond holders, unpaid wages and taxes, debenture holders, preferred stockholders The priority of claim to corporate assets in a liquidation is: Secured creditors, unpaid wages and taxes, trade creditors, unsecured bondholders, preferred stockholders, common stockholders.
All of the following statements are true regarding convertible bond issues EXCEPT: A. at the time of issuance, the conversion price is set at a premium to the stock's current market price B. when the stock price is at a premium to the conversion price, the conversion feature has intrinsic value C. for the conversion feature to have value, the stock's price must move up in the market after issuance D. convertible bonds usually have higher yields than bonds without the conversion feature
D. convertible bonds usually have higher yields than bonds without the conversion feature When convertible bonds are issued, it is normal for the conversion price to be set at a premium to the current market price. Assume that a convertible bond is issued with a conversion price of $40 when the market price of the common is $30. Thus, the market price must rise to the conversion price before the conversion feature has any value. If the market price rises above the conversion price, then the conversion feature has "intrinsic value." For example, if the conversion price is set at $40 and the market price rises to $50 per share, there is $10 per share of "intrinsic value." Once the stock's market price moves above the conversion price, for every dollar that the stock price now moves, the bond will move by an equivalent amount as well. The securities are termed "equivalent." For the conversion feature to be worth something, the stock's price must move up in the market after issuance. Due to the value of the conversion feature (or rather, the potential value if the stock price goes up), convertible bonds are saleable at lower yields than bonds without the conversion feature
Corporate debentures are backed by: A. real estate B. equipment C. portfolio of marketable securities D. full faith and credit
D. full faith and credit Debentures are backed solely by the full faith and credit of the issuer. Debentures are usually issued by "Blue Chip" organizations with high credit ratings or lower credit rated companies in the form of high yield or "junk" bonds.
Which statement is TRUE about adjustment (income) bonds? A. semi-annual payment of interest is assured and repayment of principal at maturity is not assured B. semi-annual payment of interest is assured and repayment of principle at maturity is assured C. semi-annual payment of interest is not assured and repayment of principle at maturity is assured D. semi-annual payment of interest is not assured and repayment of principal at maturity is not assured
D. semi-annual payment of interest is not assured and repayment of principal at maturity is not assured Income bonds only pay interest if the corporation earns enough "income" to make that interest payment. So payment of interest is not assured. In addition, if the issuer defaults (which could happen), then the principal will not be repaid either. Review
