ch2. corporate debt - quiz

Which statement is TRUE when comparing bonds and preferred stock?

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).

The term "Funded Debt" refers to which of the following issues?

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.

Which of the following are the least likely purchasers of commercial paper?

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.

Equipment trust certificates would most likely be issued by a(n):

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.

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:

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.

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:

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.

Which corporate bonds are NOT secured?

Secured bonds are backed by a pledge of physical collateral - the lender can seize the collateral if the borrower defaults. First and second mortgage bonds are backed by a pledge of real property; equipment trust certificates are backed by a pledge of tangible property (railroad cars, trucks, airplanes, etc.). Guaranteed bonds are not backed by a pledge of collateral - they are guaranteed by a second party (usually a parent company) that typically has a better credit rating than the issuer - so the issue can be sold at a lower interest rate.

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?

The bond's parity price is found by taking the stock's market price and multiplying this number by the conversion ratio. $30 X 32 = $960.

A company that has issued first mortgage bonds is declared in default by the trustee. Which statement is TRUE?

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 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?

The conversion price is found by taking $1,000 par and dividing this by the conversion ratio. $1,000 / 32 = $31.25 conversion price.

reset bond

a debt security whose interest rate is reset periodically (e.g., weekly, monthly, semi-annually, annually) to reflect current interest rates, as determined by a formula specified in the bond's trust indenture. Unlike fixed rate debt, whose price moves inversely with market interest rate movements; the interest rate on reset bonds changes with market interest rates, hence the price stays at par.

Adjustment Bond

also known as an income bond, this debt security pays interest only if the company earns the interest or to the extent that the company earns the interest. This type of bond is usually issued by a corporation trying to reorganize its capitalization in order to avoid bankruptcy. With the existing bondholders' approval, the corporation would exchange its regular bonds for adjustment bonds, where the interest rate or par value is adjusted upwards; however the new bonds pay interest only if the corporation has sufficient earnings (thus, these are also known as "income bonds"). Adjustment bonds trade flat, that is, without accrued interest.

A customer has bought a fully registered Exxon-Mobil debenture. The customer will receive interest payments

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.

The trust indenture is a contract between the:

issuer and trustee The trust indenture is a contract between the issuer and trustee (since the trustee is paid by the issuer) where the trustee acts for the benefit of the bondholders. also called the indenture, a series of covenants or protective promises made by the issuer of a debt security to the purchasers of a debt security. Typical covenants require the issuer to make semi-annual interest payments to the bondholders and to file annual reports with the SEC (for corporate bonds). To insure that the issuer complies with all of the terms of the covenants, an independent trustee is appointed by the issuer to protect the interests of the bondholders. The trustee is usually a commercial bank, that gives a report of its findings to the bondholders annually.

All of the following are true statements regarding convertible bond issues EXCEPT:

the yield on convertible issues is higher than the yield for similar non-convertible issues