Ch 18: Gov. Bonds

Question 1

Corporate Bond

Answer 1

is issued by a corporation, represents a promise to pay bondholders the principle at a future maturity date, along with periodic payments of interest

Trade on NYSE, mostly owned by pension funds and life insurance companies

Question 2

Bond Trading

Answer 2

An active secondary market exists with a substantial volume of bond trading, satisfying most of the liquidity needs of investors

Question 3

Plain Vanilla Bonds (or “bullet” bonds)

Answer 3

these bonds are issued with a standard, relatively simple set of features on maturity, coupon and indenture provisions

Question 4

Debentures

Answer 4

are unsecured bonds issued by a large firm

Question 5

Mortgage bonds :

Answer 5

are debt secured with a property lien

Question 6

Collateral trust bonds, commonly issued by holding companies,

Answer 6

are debt secured with financial collateral such as stocks and bonds.

Question 7

Equipment trust certificates

Answer 7

are debt issued by a trust with income from a lease contract for heavy industrial equipment (commonly used by rail roads, airlines and other transportation firms).

Question 8

Bond indenture

Answer 8

a formal written agreement between the corporation and the bondholders

Question 9

Term bonds:

Serial Bonds:

Answer 9

are issued with a single maturity date

are issued with a regular sequence of maturity dates.

Question 10

Senior Debentures

Subordinated Debentures

Answer 10

are the bonds paid first in case of default.

are paid after senior debentures.

Bond seniority may be protected by a negative pledge clause, prohibiting a new debt issue that would have seniority over existing bonds.

Question 11

Most corporate bonds are callable bonds

Answer 11

A call provision gives the issuer the option to buy back the bond at a specified call price, which is often equal to par value (callable at par) although it may be higher.

Question 12

Common restrictions to call privilege:

Answer 12

1. a deferred call provision provides a call protection period, usually 5 years after its issue date
2. a call premium, included in the call price, usually equals to one year coupon payment

Question 13

Bond refunding

Answer 13

When interest rates fall, bond prices increase. The corporation can “call-in” the existing bonds, then issue new bonds with a lower coupon

Question 14

Which bond sells at a higher price: callable or non-callable bond, other things equal?

Answer 14

Non Callable bonds sell at higher prices below 20% Yield to Maturity

Question 15

Retractable bond:

Extendible bond:

Answer 15

a retractable bond gives bondholder the option to redeem the bond early, when the bond’s coupon rate is below current market yields

an extendible bond gives bondholder the option to retain the bond for additional period beyond maturity, when coupon exceeds current rates.

Question 16

A bond with a put provision

Answer 16

can be sold back to the issuer at a pre-specified price (normally set at par value) on any of a sequence of pre-specified ‘put’ dates. Putable bonds can be retractable or extendible.

Question 17

Convertible bonds can be exchanged for

Answer 17

common stocks according to a pre-specified conversion ratio

Question 18

A convertible bond consists of which two assets:

Answer 18

1. a bond

2. a warrant (which is a call option issued by the firm)

Question 19

Valuing a convertible requires assumptions:

Answer 19

1) the underlying stock volatility, and
2) the credit spread for the fixed income portion that takes into account the firm’s credit profile and the ranking of the convertible within the capital structure.

Question 20

A convertible bond is:

out-of - money if:

in-the-money:

Answer 20

out-of-money if conversion value < straight bond value (when the convertible is issued),

in-the money if conversion value > straight bond value.

Question 21

Convertible bonds allow debt financing with lower borrowing costs.

Answer 21

(BLANK PAGE) This is a true statement

Question 22

Sinking Fund Provision

Answer 22

requires the firm to make periodic payments into a trustee-managed account, to ensure the repayment of principle.

provides security to bondholders for the repayment of principle.

Question 23

Protective Covenants Are:

Answer 23

are restrictions designed to protect bondholders.

Question 24

Negative covenants:

Answer 24

• The firm cannot pay dividends in excess of what is allowed by some formula based on the firm’s earnings.
  
  • The firm cannot pledge any assets to other lenders
  • The firm cannot merge with other firms
  • The firm cannot issue additional long term debt

Question 25

Positive Covenants

Answer 25

• The firm must maintain collateral in good condition
  
  • Working capital must be above some specified level
  • The firm must provide financial statements to lenders

Question 26

______ bonds are secured by financial assets of the issuing company.

Answer 26

Collateral trust

Question 27

Names two negative protective covenants that can be found in a bond indenture?

Answer 27

I) Bonds with senior status cannot be issued while this bond issue is outstanding

II)The issuer is prohibited from guaranteeing debt of another firm