Corporate Debt
Interest earned on corporate bonds is:
A 100% taxable at the Federal level
A customer buys a new issue corporate bond with a dated date of January 1st, settling on January 21st. The first interest payment is due March 1st. How many days of accrued interest must the customer pay to the underwriter?
A 20 The issue is dated Jan 1st, with the first interest payment due Mar 1st (short first interest payment, also called an odd first interest payment). Since the customer bought the bonds from the underwriter, settling on Jan 21st, he or she must pay 20 days of accrued interest to the underwriter. Remember, interest accrues up to, but not including, settlement date.
A corporate bond which is backed solely by the full faith and credit of the issuer is a:
A debenture A debenture is corporate debt which is backed solely by the full faith and credit of the issuing corporation. Collateral trust certificates are backed by marketable securities held in trust; mortgage bonds are backed by real property owned by the issuing corporation. General obligation bonds are issued by municipalities; they are not issued by corporations.
A customer purchases a convertible bond at 90, convertible into the common stock at $40. The common stock is currently trading at $36. The company declares a 25% stock dividend. The bond trust indenture includes an anti-dilution clause. After the ex date for the stock dividend, the conversion price for this bond issue will be:
B $32 $40/1.25= $32 per share
A customer buys 10 Allied Corporation 8% debentures, M '29, at 90 on Friday, August 21st in a regular way trade. The interest payment dates are March 1st and September 1st. How many days of accrued interest will the buyer pay to the seller?
B 174
In a period of steep increases in interest rates, which issuer is most likely to be negatively affected?
B Utility company
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 conversion price?
C $31.25 The conversion price is found by taking $1,000 par and dividing this by the conversion ratio. $1,000 / 32 = $31.25 conversion price.
TRACE reports trades of all of the following EXCEPT:
TRACE is FINRA's Trade Reporting and Compliance Engine. It reports trades of corporate, government, and agency bonds. Municipal bond trades are reported via RTRS - the Real Time Reporting System - operated by the MSRB. Trades must be reported to TRACE "as soon as practicable," but no later than 15 minutes after execution. TRACE disseminates the trade report immediately.
All of the following corporate bonds are secured EXCEPT:
C sinking fund debentures 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.
Ford Motor Company has issued 8% convertible debentures, convertible at a 10:1 ratio. Currently the debenture is trading at 94. The stock is trading at $80. What is the conversion price of the stock?
The bond is convertible into common at a 10:1 ratio, based on the par value of the bond. The conversion price formula is: $1,000/10= $100
The Standard and Poor's Bond Guide includes information on:
A Corporate Bonds Standard and Poor's Bond Guide is published on the web, and gives capsule summaries of every outstanding corporate issue, including recent price, rating, and yield.
A short term corporate debt which is backed solely by the full faith and credit of the issuer is:
A commercial paper Commercial paper is simply backed by the issuer's full faith and credit (the promise to pay). The maturities are short, most typically 30 days or less, though legally the maturity can extend to 270 days maximum (9 months). All of the other debts listed are long term (over 1 year) obligations. Income bonds are long term corporate obligations that require the issuer to pay interest only if it has sufficient income. Mortgage bonds are backed by real property owned by the issuing corporation. General obligation bonds are issued by municipalities; they are not issued by corporations.
A new issue corporate bond has a dated date of September 1st. The bond is assigned by the issuer to the underwriter on August 31st. Accrued interest on the bond will be calculated based on how many days in a year?
B 360
A customer has bought a "book entry" bond which pays interest semi-annually. The customer will receive interest payments:
B from the paying agent twice a year 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. All new issues of U.S. Government bonds, municipal bonds and corporate bonds are book entry.
Which of the following statements are TRUE when comparing bonds and preferred stock? I Both bonds and preferred stock have a fixed payout rate II Bonds have a fixed payout rate; preferred stock does not III Both bonds and preferred stock can be convertible into shares of common stock IV Bonds can be convertible; preferred stock cannot
A I and III Both bonds and preferred stock can be convertible and both have a fixed payout rate. 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).
When comparing convertible to non-convertible corporate bonds, convertible bonds have: I lower yields II higher yields III price appreciation potential based on the market price of the common stock IV no price appreciation potential based upon the market price of the common stock
A I and III Convertible bonds are issued at lower interest rates than non-convertible issues; which bondholders accept in return for price appreciation potential based upon the market value of the common stock (since the bond is convertible into a fixed number of shares of common).
A company that has issued first mortgage bonds is declared in default by the trustee. Which statement is TRUE?
A The bondholders have legal claim to the property backing the bond; and may sell that property to satisfy the unpaid obligation First mortgage bondholders have been granted a "first mortgage lien" on any "real" properties (real estate - land and buildings) that are 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. The value of the pledged property is always well in excess of the outstanding loan amount; so if the property is sold for less than book value, there should still be enough proceeds to satisfy the debt. Mortgage bondholders do not have claim to all property of the failed company (such as cash in bank accounts; accounts receivable; inventory; etc.); they only have claim to the real property pledged. If the bondholders' claims are not satisfied from the sale of the real property, then they become general creditors for the balance due.
A customer bought a $1,000 par convertible subordinated debenture at par, convertible into common at $31.25 per share. If the bond's market price increases by 20%, the conversion ratio will be:
B 32.00:1 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 $31.25, based upon converting each bond at par. $1,000 par / $31.25 conversion price = 32:1 conversion ratio. Thus, for every bond that is converted, the holder receives 32 shares.
Current dealer offerings of corporate bonds can be found in:
B Bloomberg Quote providers such as Bloomberg and Reuters give dealer to dealer prices (the "wholesale" market) for corporate bonds daily. The Bond Buyer is the municipal new issue newspaper. Moody's and Fitch's rate bonds - they are not quote providers.
A corporate security with at least 5 years to maturity is a:
B Non-callable funded debt The term "funded" debt refers to corporate debt that is considered part of a company's permanent long term financing. Included is all corporate debt with 5 years or more to maturity.
What does a bond trading "flat" mean?
B The bond is trading without accrued interest A bond trades flat (without accrued interest) when the issuer has defaulted on the interest payments, or if the issue is an income bond or a zero coupon bond. Therefore, a current bondholder receives no interest on bonds that trade flat. When such a bond is traded, no accrued interest is paid from buyer to seller - so the trade is being done at a "flat" amount without any accrued interest added to the price.
ABC Corporation has 10%, $1,000 par convertible bonds outstanding, convertible at a 40:1 ratio. The common stock is currently trading at $24.75. If the bond is currently trading at 101, at what market price of the common stock would an arbitrage possibility exist between the convertible bond and the stock into which it is convertible?
D $26.00 If the common stock were trading at $26, there would be an arbitrage opportunity. If the bond is bought and immediately converted into shares of common stock, the investor would: buy the bond for $1,010, convert the shares at a 40:1 ratio - or at $25.25 and then sell these shares in the market at $26, making $.75 per common share. If the common stock is trading at 25.25, there is a "wash" - buying the bond and selling the stock at the equivalent price - this is the current parity price ($1,010 / 40 = $25.25 per share). When the stock trades below $25.25, if investor purchased the bond, converted, and sold the stock at the current market price, there would be a loss.
All of the following are true statements regarding corporate obligations EXCEPT:
D income bonds are secured by the earnings of a corporation Income bonds are unsecured and have a high level of risk, since payment of interest is dependent on the corporation reaching a designated earnings level. Debentures are usually term issues - all bonds having the same interest rate and maturity. Equipment trust certificates are generally serial issues, where a portion of the debt is repaid each year - thus the bonds in the issue have varying maturities. The annual paydown is based upon the expected depreciation rate of the equipment pledged as collateral for the loan. Commercial paper is sold at a discount and matures at par.
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:
B Tuesday, June 16th Regular way trades of corporate bonds and stocks settle 2 business days after trade date.
A corporation is going to tender for 75% of its 10% subordinated debentures, M '25. The price of the offer will be decided by the:
B issuer In a tender offer, the issuer of the securities is offering to buy back either a portion or all of the issue at a stated price. These offers are usually conditioned upon a minimum percentage of the issue being tendered, otherwise the issuer cancels the offer. The price of the tender offer is set by the issuer, typically using the advice of a securities firm acting as "financial advisor" in the offer. Choice D is technically incorrect - an underwriter does not set the price; rather, a firm advises the issuer in setting a price, and this firm may, as part of its business, participate in underwritings.
In a corporate liquidation, the first to get paid is:
B secured bondholders The priority of claim to corporate assets in a liquidation is: Secured bondholders, unpaid wages and taxes, trade creditors, unsecured bondholders, preferred stockholders, common stockholders.
The conversion price of a convertible debenture is set at issuance at $5 per share. The common stock is now trading at $3.50 while the bond is trading at 110. In order for the common stock to be trading at parity to the current market price of the bond, the stock price would be:
C $5.50 Since the bond is now trading at 110 ($1,100 per bond) and each bond is convertible into 200 common shares ($1,000 par / $5 conversion price = 200:1 conversion ratio), the parity price of the common is $1,100 / 200 = $5.50. Since the common is currently trading at $3.50, it is below parity and it does not pay to convert. It only makes sense to convert if the common is trading above parity.
A corporation has issued 10% convertible debentures, convertible into 5 shares of common stock. The current market price of the common stock is $205. If the bonds are trading at parity, they are priced at:
C 102 1/2 The bonds are convertible into 5 shares of stock. The current market value of the stock is $205, therefore the parity price of the bonds is 5 x $205 = $1,025 = 102 1/2 per bond.
Most corporate bond trades are executed: I on exchange floors II over-the-counter III by bond dealers IV by specialists (DMMs)
C II and III Most corporate bond and municipal bond trades take place dealer-to-dealer in the OTC market. The municipal market is quite illiquid and the corporate bond market is not very active either. Such illiquid markets are better handled by dealers that will buy bonds into inventory when there are no other buyers; or sell bonds out of inventory to customers when there are no other sellers. There is no corporate bond trading on the NYSE floor (NYSE bond trading, which is very limited, is now handled by a matching computer).
Zero coupon bonds: I pay interest semi-annually II pay interest at maturity III are bought at a discount and mature at parIV are bought at a par and mature at a premium
C II and III Zero-coupon bonds are often called "capital appreciation bonds" since the bondholder does not receive annual interest payments from the issuer. Instead, the bonds are bought at a discount from par, and are redeemed at par at maturity (similar to savings bonds). The discount is earned over the life of the bond and is the "income" from this type of investment.
A guaranteed corporate bond is one which is:
C guaranteed by another corporation A guaranteed corporate bond is one guaranteed by another corporation. For example, a corporation may want to issue bonds through a subsidiary. The subsidiary may have a lower credit rating than the parent company. The parent can guarantee the issue, which then takes on the parent's higher credit rating.
A corporate bond which obligates the issuer to pay interest ONLY if the company meets a specified earnings test is a(n):
C income bond Income bonds (also known as adjustment bonds) obligate the issuer to pay interest only if the company meets a specified earnings test. If the earnings are not sufficient, no interest payment is legally required. All other bonds obligate the issuer to pay interest, regardless of events.
A corporation has issued $1,000 par, 8% convertible bonds, callable at par. The bonds are convertible into 14 shares of common stock. Currently, the bond is trading at 102 while the common stock is trading at $75.50. The corporation calls the bonds at par plus accrued interest of $20 per bond. A customer holds 100 bonds, purchased at par. The customer wishes to liquidate the position at the greatest profit. The BEST recommendation is to (ignoring commissions):
C sell short the common stock and convert the bonds for delivery to cover the short If the bonds are tendered at the call price, the owner receives $1,000 per bond. If the bonds are sold at the current market price, the owner receives $1,020 per bond. Since each bond is convertible into 14 common shares, the short sale of 14 common shares will yield 14 x $75.50 = $1,057. The bonds can then be converted to common to cover the short position. Thus, selling short the common is the best choice. Continuing to hold the bonds does not make sense since interest payments will cease.
All of the following statements are true regarding corporate zero coupon bonds EXCEPT:
C the interest income on such obligations is not taxable until maturity Zero coupon bonds do not offer a current return; instead, the holder earns the discount on the bond over its life. This "earning" of the discount is taxed annually as interest income to the bondholder even though no physical payment is made. Zero coupon bonds are usually invested in IRAs and retirement plans since these vehicles are tax deferred, thus avoiding paying tax on interest income that isn't actually received. With bonds that make interest payments, the holder is subject to "reinvestment risk" on the interest payments. Rates may fall, causing the bondholder to reinvest the interest payments at lower rates. This risk is not present in zero coupon bonds since no interest payments are made.
The trust indenture of a bond would include which of the following information? I Interest rate II Maturity III Collateral backing the issue IV Call provisions
D I, II, III, IV A corporate bond is issued under a bond contract. The contract spells out the interest rate, maturity, collateral, call or put provisions, and all other relevant features of the bonds. To ensure that these covenants are followed, a trustee is appointed to monitor the issuer's compliance with all of these promises. This document is the trust indenture.
A corporation can redeem its debt securities prior to their maturity date by which of the following methods? I Purchasing outstanding debt securities in the open market II Tendering for outstanding debt securities at a price determined by the issuer III Calling outstanding securities at pre-established dates and prices IV Forcing conversion of convertible bonds where the market price of the bond has risen above the call price
D I, II, III, IV A corporation can retire its debt prior to maturity by all of the methods listed. It can purchase outstanding debt securities in the open market, which it would do if the market price of the bonds was below the call price. It can make a formal tender offer to all bondholders to buy outstanding debt securities at a price determined by the issuer. It can call outstanding securities at pre-established dates and prices. Finally, it can force conversion of convertible bonds that have appreciated in the market by calling them. Rather than tender the bonds to the issuer at the lower call price; the convertible bondholders will convert into the more valuable equivalent number of shares of common stock.
All of the following bonds trade "flat" EXCEPT:
D Reset bonds When a bond is trading "flat," it is trading without accrued interest. Income bonds (a.k.a. adjustment bonds) and defaulted bonds trade flat since they do not pay current interest. Income bonds don't pay interest unless the corporation reaches a high enough level of earnings (that is, the interest payment is dependent upon the income level of the corporation, hence the name "income bond"). Defaulted bonds are "in default" of their interest payments, and are thus not paying interest. Reset bonds establish dates when the interest rate will be reset to a given value (depending on interest rates at the time of the "reset"). They make regular semi-annual interest payments and hence trade "and interest." They do not trade flat.
Corporate bonds are issued with an "anti-dilutive" covenant. If the corporation declares a 5% stock dividend, all of the following will be reduced EXCEPT the:
D conversion ratio When a senior convertible security is issued with an "anti-dilutive" covenant, should the company issue additional common shares, the terms of conversion are adjusted when the stock's market price is reduced for the dividend. To adjust the terms of conversion, the conversion price is reduced, and the number of common shares into which the security is convertible is therefore increased. Since the parity price of the stock is: Par / Conversion Ratio, if the conversion ratio increases, the parity price of the stock will decrease as well.
