boken kap 16 del 2

Question 1

Q13: What is a sinking fund?

Answer 1

A: An account managed by the bond trustee to repay the bonds over time.

Question 2

Q14: What are the two opposing effects of sinking funds on bondholders?

Answer 2

A: 1. Extra protection because missing contributions signal potential default.
2. Attractive to the firm as it offers flexibility in debt repayment.

Question 3

Q15: What is a call provision in a bond?

Answer 3

A: It allows the company to repurchase (call) the bond issue at a predetermined price over a specific period.

Question 4

Q16: What is a call premium?

Answer 4

A: Call price is generally above FV and the difference between them is then called a call premium.

Question 5

Q17: What is a deferred call?

Answer 5

A: A period during which the bond cannot be called back.

Question 6

Q18: What is a make-whole call?

Answer 6

A: A provision ensuring bondholders receive approximately the bond’s worth if it is called.

Question 7

Q1: What is bond refunding?

Answer 7

A: Replacing all or part of a bond issue with a new one.

Question 8

Q2: Why do bondholders demand higher interest rates on callable bonds?

Answer 8

A: Because callable bonds include a call provision, which allows the issuer to repurchase the bond, creating additional risk for bondholders.

Question 9

Q3: What are the four reasons firms issue callable bonds?

Answer 9

1. Superior interest rate predictions.
2. Tax advantages.
3. Financial flexibility for future investment opportunities.
4. Less interest rate risk.

Question 10

Q4: How can superior interest rate predictions benefit the issuer of callable bonds?

Answer 10

A: Company insiders may have better knowledge of future interest rate changes and use this information to call bonds strategically.

Question 11

Q5: How can taxes make callable bonds advantageous for companies?

Answer 11

A: If bondholders are taxed at a lower rate than the company, call provisions may provide tax advantages.

Question 12

Q6: Why do callable bonds provide flexibility for future investment opportunities?

Answer 12

A: The company can repurchase bonds at the call price to free up capital for better investment opportunities.

Question 13

Q7: How does a call provision reduce interest rate risk?

Answer 13

A: Callable bonds have higher coupon rates, so their value falls less than non-callable bonds when interest rates rise.