Debt - Corporate Debt
The best answer is A. 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 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 B. The bondholders have legal claim to all property of the failed company; and may attach and sell any, or all, of that property C. The bondholders have first claim to all assets of the failed company that have not been pledged D. The bondholders are general creditors of the failed company
The best answer is C. The conversion price is found by taking $1,000 par and dividing this by the conversion ratio. $1,000 / 32 = $31.25 conversion price.
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? A. $30.00 B. $30.63 C. $31.25 D. $32.67
The best answer is B. Bonds are convertible based on their par value - not the current market price. $1,000 par divided by 25 shares per bond equals a conversion price of $40 per common share.
A corporation has issued $10,000,000 of 8%, 20 year, $1,000 par, convertible debentures, convertible at a ratio of 25:1. The bond is currently trading at 120, while the company's common stock is at 46. The conversion price per share is: A. $25 B. $40 C. $46 D. $48
The best answer is A. The bonds are convertible at $100, based on $1,000 par value. Therefore each bond converts into 10 shares ($1,000 par / $100 conversion price). If the common is trading at $90, the bond must be trading at 10 times this to be at parity. $90 x 10 = $900 parity price of one bond. The parity price of "5M" ($5,000 face amount, "M" is Latin for $1,000) is $900 x 5 = $4,500.
A corporation has issued 10%, $1,000 par convertible debentures, convertible at $100. The common stock is currently trading at $90. If the bond and the common are trading at parity, a customer purchasing 5M of the bonds will pay: A. $4,500 B. $5,000 C. $5,225 D. $5,500
The best answer is D. The bonds are convertible at $31.25, based on $1,000 par value. Therefore each bond converts into 32 shares ($1,000 par / $31.25 conversion price). If the common is trading at $35, the bond must be trading at 32 times this to be at parity. $35 x 32 = $1,120 parity price of one bond. The parity price of "5M" ($5,000 face amount, "M" is Latin for $1,000) is $1,120 x 5 = $5,600.
A corporation has issued 10%, $1,000 par convertible debentures, convertible at $31.25. The common stock is currently trading at $35. If the bond and the common are trading at parity, a customer purchasing 5M of the bonds will pay: A. $3,500 B. $4,800 C. $5,000 D. $5,600
The best answer is B. 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.
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: A. 31.25:1 B. 32.00:1 C. 37.50:1 D. 38.40:1
The best answer is B. Regular way trades of corporate bonds and stocks settle 2 business days after trade date.
A customer buys 10 ABC Corporation 10% debentures, M '45, at 93 on Tuesday, May 10th in a regular way trade. The interest payment dates are March 1st and September 1st. The trade settles on: A. Wednesday, May 11th B. Thursday, May 12th C. Friday, May 13th D. Monday, May 16th
The best answer is B. Regular way trades of corporate bonds and stocks settle 2 business days after trade date.
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 15th B. Tuesday, June 16th C. Wednesday, June 17th D. Friday, June 19th
The best answer is B. 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. Note 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. Also note that no bearer bonds have been sold since 1983, but 40-year bearer bonds still exist (at least until 2023!).
A customer has bought a "book entry" bond which pays interest semi-annually. 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
The best answer is C. 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.
All of the following are likely to purchase dealer commercial paper EXCEPT: A. Insurance Companies B. Trust Companies C. Individuals D. Open-end Investment Companies
The best answer is B. 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."
All of the following are true statements 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. the yield on 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
The best answer is B. A registered to principal only bond has a physical certificate with the bond's face amount registered in the owner's name, but interest coupons are attached which are payable to the "bearer." Bearer coupons can be redeemed by anyone. The bonds are negotiable. No new issues have been sold in the U.S. since 1983 - after this point only fully registered or book entry bonds have been issued. However, these bonds still trade in the market (at least until 2023, if the bond had 40 years to maturity).
All of the following statements are true regarding a bond that is "registered to principal only" EXCEPT: A. the bond is negotiable B. interest coupons are detached from the corpus of the bond C. interest payments can be redeemed by anyone D. at maturity, the registered owner receives the face amount of the bond
The best answer is B. 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. 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. Historically, mortgage bond defaults have been very low, because we need to keep our lights on!
All of the following statements are true regarding mortgage bonds EXCEPT: A. Mortgage bonds are issued in term maturities B. Default of mortgage bonds is common during recessionary periods C. Mortgage bonds are commonly issued by utilities D. Mortgage bonds are secured by real property
The best answer is D. In a corporate liquidation, secured bondholders are paid first; then unpaid wages and taxes; then debenture holders; then subordinated bondholders; then preferred stockholders; and finally, common stockholders.
Arrange the following in priority of claim in a corporate liquidation: I Unpaid Wages II Secured Bondholders III Subordinated Bondholders IV Debenture Bondholders A. I, II, III, IV B. IV, III, II, I C. I, II, IV, III D. II, I, IV, III
The best answer is D. 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.
Corporate debentures are backed by: A. real estate B. equipment C. portfolio of marketable securities D. full faith and credit
The best answer is B. These are equipment trust certificates, which are secured. These are backed by equipment (the railroad cars owned by the issuer) that has been pledged as collateral. In legal terms, the bondholders have a "lien" (legal claim) on the equipment pledged as collateral, if the
New Issue $16,275,000 Southwest Railway Company Equipment Trust No. 1 of 2018 8 3/4 % Equipment Trust Certificates - Non-Callable To mature in 15 equal annual installments of $1,085,000 commencing October 15, 2018 MATURITIES AND YIELDS 2018 8.25% 2026 9.10% 2019 8.55% 2027 9.15% 2020 8.70% 2028 9.15% 2021 8.75% 2029 9.20% 2022 8.75% 2030 9.20% 2023 8.90% 2031 9.25% 2024 8.95% 2032 9.25% 2025 9.10% The certificates are offered, subject to prior sale, when, as, and if issued and received by us. Preston, Tucker, Inc. The certificates issued by Southwest Railroad are: I secured II unsecured III backed by a lien on real property owned by the issuer IV backed by a lien on equipment owned by the issuer A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. 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.
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
The best answer is A. Each bond is convertible into 40 common shares ($1,000 par / $25 conversion price = 40:1 conversion ratio). Since the bond is now trading at 110 ($1,100 per bond) the parity price of the common is $1,100 / 40 = $27.50. Since the common is currently trading at $27.50, it is trading at parity and it does not make sense to convert. It only makes sense to convert if the common is trading above parity.
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. In order for the common stock to be trading at parity to the current market price of the bond, the stock price would be: A. $27.50 B. $30.00 C. $32.00 D. $35.50
The best answer is B. 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.
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
The best answer is C. Funded debt is a somewhat archaic term that refers to corporate debt that is long term. This is considered to be part of a corporation's long term (permanent) funding.
The term "Funded Debt" refers to: I Short term debt II Long term debt III Corporate debt IV U.S. Government debt A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. 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).
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 B. I and IV C. II and III D. II and IV
The best answer is C. 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.
Which of the following corporate bonds are secured? I Collateral trust certificate II Subordinated debenture III Second mortgage bond IV Equipment trust certificate A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV
The best answer is D. 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.
Which of the following statements are TRUE regarding convertible bond issues? I At the time of issuance, the conversion price is set at a premium to the stock's current market price II When the stock price is at a premium to the conversion price, the conversion feature has intrinsic value. III For the conversion feature to have value, the stock's price must move up in the market after issuance IV Convertible bonds usually have lower yields than bonds without the conversion feature A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV
The best answer is A. 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).
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 B. I and IV C. II and III D. II and IV
The best answer is D. 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.
Which statements are TRUE about adjustment (income) bonds? I Semi-annual payment of interest is assured II Semi-annual payment of interest is not assured III Repayment of principal at maturity is assured IV Repayment of principal at maturity is not assured A. I and III B. I and IV C. II and III D. II and IV