Corporate Debt
All new corporate bonds are issued in: A book entry form B fully registered form C registered to principal only form D bearer form
The best answer is A. 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 or registered to principal only bonds (a bond with bearer coupons, but the principal repayment is registered in the owner's name) have been sold since 1983. However, 40-year bearer coupon bonds still exist (at least until 2023!). Bearer bondholders receive interest payments by clipping coupons and submitting them to the paying agent.
Which statement is TRUE? A A debenture is 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
The best answer is A. 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).
Who will be paid first in a corporate liquidation under Chapter 11? A Secured bondholders B Administrative claim holders C Unpaid wages and taxes D Preferred stockholder
The best answer is A. In a Chapter 11 bankruptcy, the company will attempt to make a settlement with existing claim holders, restructure, and emerge as a "new" company. In contrast, in a Chapter 7 bankruptcy. the company is simply being liquidated. In any bankruptcy, the secured creditors who have a line on pledged assets get those assets first. That is why they are "secured." Then unpaid wages and taxes are paid, as well as the claims of other general creditors that occurred before the date of bankruptcy. Because the company is still operating in bankruptcy as it restructures, the bankruptcy trustee allows the company to pay ongoing expenses - these are the administrative claim holders. After this, the unsecured creditors would be paid, followed by the preferred stockholders, and finally, the common stockholders.
A corporate bond which is backed solely by the full faith and credit of the issuer is a: A debenture B collateral trust certificate C mortgage bond D general obligation bond
The best answer is A. 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.
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 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.
A corporation has issued $10,000,000 of 7 1/4%, 20 year, $1,000 par, convertible debentures, convertible at a ratio of 40:1. The bond is currently trading at 96, while the company's common stock is at 24. The parity price per share is: A $20 B $24 C $25 D $40
The best answer is B. The bond is currently priced at $960. For the common stock to be trading at "parity," 40 shares (the conversion amount per bond) must be worth the same $960. $960 divided by 40 shares per bond equals $24 per share parity price. Since the current market price is $24, this bond is trading at parity. The parity price formula is: $96040 = $24
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.
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 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 $40 B $44 C $46 D $48
The best answer is B. Since the bond is now trading at 110 ($1,100 per bond) and each bond is convertible into 25 common shares, the parity price of the common is $1,100 / 25 = $44. Since the common is currently trading at 42, it is below parity and it does not make sense to convert. It only makes sense to convert if the common is trading above parity.
All of the following are likely to purchase dealer commercial paper EXCEPT: A Institutions B Trust Companies C Individuals D Open-end Investment Companies
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.
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
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.
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
The best answer is C. The bond is convertible into common at a 12.5:1 ratio, based on the par value of the bond. The conversion price formula is: $1,000 par12.5 = $80 conversion price
Which industry is most susceptible to swings in market interest rates? A Consumer Goods B Auto Manufacturer C Public Utility D Technology
The best answer is C. 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.
All of the following corporate bonds are secured EXCEPT? A Collateral trust certificate B Second mortgage bond C Subordinated debenture D Equipment trust certificate
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.
A corporation has posted a large financial loss for this year. It has a legal obligation to pay interest on all of the following bonds EXCEPT: A debentures B subordinated debentures C adjustment bonds D equipment trust certificates
The best answer is C. Adjustment (also known as "income") 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.
All of the following statements are true about both bonds and preferred stock EXCEPT: A Both bonds and preferred stock are "Senior" securities over common stock in a dissolution B Both bonds and preferred stock can be convertible C Payments to both bondholders and preferred stockholders are subject to approval of the Board of Directors D Both bonds and preferred stock have a stated fixed payment rate
The best answer is C. Both bonds and preferred stock are "Senior" securities over common; both bonds and preferred stock can be convertible; and both have a fixed payout rate. 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.
Equipment trust certificates would most likely be issued by a(n): A manufacturer B utility C airline D bank
The best answer is C. 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.
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 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. Review
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 bond with at least 5 years to maturity
The best answer is C. 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.
The trust indenture of a bond would include all of the following information EXCEPT: A Interest rate B Maturity and call covenants C Collateral backing the issue D Dividend payout policy
The best answer is D. 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. Dividend payouts refer to equity issues, not debt.
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 principal at maturity is assured C Semi-annual payment of interest is not assured and repayment of principal at maturity is assured D Semi-annual payment of interest is not assured and repayment of principal at maturity is not assured
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. Review
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
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.
A short term corporate debt which is backed solely by the full faith and credit of the issuer is: A commercial paper B an income bond C a mortgage bond D a general obligation bond
The best answer is A. 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 bond which is guaranteed by another corporation is known as a: A guaranteed corporate bond B general obligation bond C adjustment bond D subordinated bond
The best answer is A. A guaranteed corporate bond is one guaranteed by another corporation. Review
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
The best answer is A. 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.
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
The best answer is A. 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).
When comparing convertible to non-convertible corporate bonds, convertible bonds have: A lower yields and price appreciation potential based on the market price of the common stock B lower yields and no price appreciation potential based on the market price of the common stock C higher yields and price appreciation potential based on the market price of the common stock D higher yields and no price appreciation potential based upon the market price of the common stock
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).
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 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
The best answer is A. 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.
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. 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.
An investor purchases a $1,000 par convertible bond at $80 per share. 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
The best answer is B. 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.
Which statement is TRUE about adjustment (income) bonds? A Timing of interest payments made is not predictable and any interest payment made is not predictable in amount B Timing of interest payments made is not predictable and any interest payment made is predictable in amount C Timing of interest payments made is predictable and any interest payment made is predictable in amount D Timing of interest payments made is predictable and any interest payment made is not predictable in amount
The best answer is B. Income bonds only pay interest if the corporation earns enough "income" to make that interest payment. So, timing of payments is not predictable. However, if a payment is made, the amount received is the stated rate of interest on the bond - so the payment amount (if the payment is made) is predictable.
In a corporate liquidation, the first to get paid is: A unpaid wages and taxes B secured bondholders C preferred stockholders D unsecured bondholders
The best answer is B. 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.
A corporate security with at least 5 years to maturity is a: A Money market instrument B Non-callable funded debt C Treasury bill D Treasury note
The best answer is B. 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.
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
The best answer is C. 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
A guaranteed corporate bond is one which is: A insured by a private agency such as FGIC B guaranteed by the Federal Government C guaranteed by another corporation D funded through mandatory sinking fund payments
The best answer is C. 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. Review
A corporation has issued 10% convertible debentures, convertible into 40 shares of common stock. The current market price of the common stock is $25.25. If the bonds are trading at 5 points above parity, they are priced at: A 100 B 101 C 106 D 107
The best answer is C. The bonds are convertible into 40 shares of stock. The current market value of the stock is $25.25, so the parity price of the bonds is 40 x $25.25 = $1,010. Since the bonds are trading at 5 points ($50) above parity, they are priced at $1,010 + $50 = $1,060 per bond = 106.
