Chapter 06: Corporate Debt

Question 1

When is a convertible Bond considered to be at parity

Answer 1

If a convertible bonds conversion value ( the market value of the stock received at conversion) is equal to its market price.

Question 2

Calculate a bonds conversion ratio

Answer 2

Par Value of Convertible Bond ($1,000)/ Conversion Price

Question 3

True or false. The bonds conversion price is set at the time it’s issued

Answer 3

True

Question 4

True or false. Both the conversion price and conversion ratio are established at the time the bonds are issued and will not change unless there’s a change in the underlying stock

Answer 4

True

A convertible debenture is a bond that can be turned into shares of the company’s stock. Its value is tied to the stock’s value. If the stock price goes up, the debenture’s value increases, making conversion attractive. If the stock price drops, the debenture’s value may decrease, and investors might prefer to keep the bond for its fixed-income returns.

Question 5

True or false. If the underlying stock appreciates, the bond will trade at a price based on its potential conversion value. However, if the price of the underlying stock decline to the point where the conversion feature offers no advantage, the bond will simply trade at a price that’s based on its inherent value as a bond

Answer 5

True

Question 6

Important fact is that if the conversion price is multiplied by the conversion ratio, it should always equal _____.

Answer 6

Important fact is that if the conversion price is multiplied by the conversion ratio, it should always equal $1,000

Question 7

How do you calculate the parity price of a bond

Answer 7

(Market Price of Underlying Stock × Conversion Ratio)

For example, let’s say you have a convertible bond with a conversion ratio of 20 (meaning 1 bond can be converted into 20 shares) and the market price of the underlying stock is $50 per share. To calculate the parity price of the convertible bond, you would do the following calculation:

Parity Price of Convertible Bond = ($50 per share × 20 shares) = $1,000

In this example, the parity price of the convertible bond is $1,000. This means that if the convertible bond is trading at a price equal to or near $1,000, it is trading at parity with the underlying stock.

Question 8

How do you calculate parity price of stock

Answer 8

(Market Price of Convertible Bond) / Conversion Ratio

For example, let’s say you have a convertible bond with a conversion ratio of 20 (meaning 1 bond can be converted into 20 shares) and the market price of the convertible bond is $1,000. To calculate the parity price of the stock, you would do the following calculation:

Parity Price of Stock = ($1,000 / 20 shares) = $50 per share

In this example, the parity price of the stock is $50 per share. This means that if the stock is trading at a price equal to or near $50 per share, it is trading at parity with the convertible bond.

Question 9

Define conversion ratio

Answer 9

represents the number of shares an investor will receive for each bond when it’s converted into stock.

The par value is divided by the conversion price to establish the conversion ratio

Question 10

Widget Inc issues 10% convertible subordinate debentures with a conversion price of $40. Calculate the conversion ratio.

On March 1st the stock of widget Inc is selling at $30 share.

What is the conversion value as of March 1st?

Answer 10

$1,000 (par) / $40 = 25 conversion ratio

If the bondholder decided to convert their 25 shares their conversion value would equal $750

($30 X 25 shares)

Question 11

Most bonds trade at a _______ to parity, which means that the market price of the bond is higher than the aggregated market value of the stock the investor will received if converted.

Answer 11

Most bonds trade at a premium to parity, which means that the market price of the bond is higher than the aggregated market value of the stock the investor will received if converted.

Meaning, most convertible bonds do not end up converted as they are worth more as a bond that they would be if converted for the stock’s value.

Question 12

A corporation has issued convertible bonds with a conversion price of $50 per share. If the common stock is selling at $60 per share, what price does the bond need to be trading for it to be at parity with the common stock?

Answer 12

Given the conversion price of $50 per share and the current stock price of $60 per share, we can use the following formula to find the bond price at parity:

Parity Price of Convertible Bond = (Market Price of Underlying Stock × Conversion Ratio)

First, we need to find the conversion ratio:

Conversion Ratio = Par Value of Convertible Bond / Conversion Price

Assuming a standard par value of $1,000:

Conversion Ratio = $1,000 / $50 = 20 shares

Now, we can calculate the parity price of the convertible bond:

Parity Price of Convertible Bond = ($60 per share × 20 shares) = $1,200

Question 13

Corporate bonds are divided into two major categories ____ and _______.

Answer 13

Corporate bonds are divided into two major categories secured and unsecured.

Question 14

_________ are secured by a first or second mortgage on real property; therefore, bondholders are given a lien on the property.

• normally, are issued serially or a number of years. In other words, as one group of bonds are paid off, the company will issue a new group to be secured by a mortgage on the same piece of property.

Answer 14

Mortgage bonds are secured by a first or second mortgage on real property; therefore, bondholders are given a lien on the property.

• normally, are issued serially or a number of years. In other words, as one group of bonds are paid off, the company will issue a new group to be secured by a mortgage on the same piece of property.

Question 15

These bonds are usually issued by transportation companies and the collateral that’s used by these companies is often referred to as rolling stock (i.e., assets that move) and includes railroad cars, airplanes, and trucks.

Answer 15

Equipment Trust Certificates

Question 16

Are secured by third party securities that are owned by the issuer.

• the securities are placed in escrow as collateral for the bonds.

Answer 16

Collateral Trust Bond’s Are secured by third party securities that are owned by the issuer.

Question 17

When corporate bonds are backed by only the corporation’s full faith and credit, these forms of unsecured debt are referred to as ______ and _____.

Answer 17

When corporate bonds are backed by only the corporation’s full faith and credit, these forms of unsecured debt are referred to as notes and debentures.

Question 18

Occasionally, companies issue unsecured bonds that have a junior claim on their assets compared to its outstanding unsecured bonds. These bonds are referred to as __________.

Answer 18

Occasionally, companies issue unsecured bonds that have a junior claim on their assets compared to its outstanding unsecured bonds. These bonds are referred to as subordinated debentures.

Question 19

What are the two types of bankruptcy for corporations?

Answer 19

Chapter 7 - liquidation of all assets.

Chapter 11 - Reorganization of debt
- corporations will negotiate new terms with its existing bondholders to avoid going out of business

Question 20

Chapter __ bankruptcy allows individuals to negotiate with their creditors

Answer 20

Chapter 13 bankruptcy allows individuals to negotiate with their creditors

Question 21

Bankruptcies involving foreign issuers, foreign assets, or foreign investors can file bankruptcy under chapter __

Answer 21

Bankruptcies involving foreign issuers, foreign assets, or foreign investors can file bankruptcy under chapter 15

Question 22

What does the term Fallen Angels refer to?

Answer 22

Bonds that started out as investment-grade ratings, but are later downgraded to below investment grade (lower than

Question 23

______ are normally issued by companies in reorganization (bankruptcy).

The issuer promises to repay the principal amount at maturity, but does NOT promise to pay interest unless it has sufficient earnings.

Answer 23

income bonds are normally issued by companies in reorganization (bankruptcy).

The issuer promises to repay the principal amount at maturity, but does NOT promise to pay interest unless it has sufficient earnings.

Question 24

Despite their name, _______ (also referred to as adjustment bonds) are not suitable for the typical income-seeking bond investor.

This due to a few factors:

• trade flat (without accrued interest)
• sell at a deep discount
• are considered speculative investments

Answer 24

Despite their name, income bonds (also referred to as adjustment bonds) are not suitable for the typical income-seeking bond investor.

Question 25

The __________ bond is issued with a low coupon that increases at regular intervals. The issue are generally reserves the right to call the bond on the dates that the coupon is reset.

Also referred to as dual coupon or step-up coupons

Answer 25

The stepped coupon bond is issued with a low coupon that increases at regular intervals. The issue are generally reserves the right to call the bond on the dates that the coupon is reset.

Also referred to as dual coupon or step-up coupons

Question 26

Although a zero-coupon bond doesn’t provide the purchaser with semi-annual interest payments, the basis (value) of the bond must be upwardly adjusted each year over its life.

The adjusted dollar value of the bond is referred to as its _______ (or accumulated value to date)

The increase in the bonds value is considered __________ and, for tax purposes, considered taxable interest income.

Answer 26

Although a zero-coupon bond doesn’t provide the purchaser with semi-annual interest payments, the basis (value) of the bond must be upwardly adjusted each year over its life.

The adjusted dollar value of the bond is referred to as its accredited value (or accumulated value to date)

The increase in the bonds value is considered phantom income and, for tax purposes, considered taxable interest income.

Question 27

A Bond’s accreted value may be ____ or _____ than the market value of the bond.

Answer 27

A Bond’s accreted value may be higher or lower than the market value of the bond.

Question 28

This type of bond is similar to a zero-coupon bond in that they don’t pay periodic interest and are unsuitable for investors seeking current income.

Their cost basis equates to the compound accreted value (CAV), which is calculated by adding the initial principal to the accreted value to date.

Answer 28

Capital appreciation bond (CAB)

Question 29

True or false. A Eurodollar is a dollar-denominated deposit that’s made outside the United States.

They pay their principal and interest in U.S. dollars, but are issued outside of the U.S. (primarily in europe)

Answer 29

True

Question 30

These bonds are not registered with the SEC and, consequently, may not be sold in the U.S. until 40 days have elapsed from the date of issuance.

Primarily bought by foreign investors.

Greatly affected by movement in U.S. interest rates.

Answer 30

Eurodollars

Question 31

Allow foreign entities to borrow money in the U.S. marketplace.

These bonds are registered with the SEC and sold primarily in the United States.

Answer 31

Yankee bond.

Question 32

As opposed to a Eurodollar bond, a ______ is one that’s sold in one country, but denominated in the currency of another country.

In fact the issuer, currency, and primary market may all be different.

Also referred to as a foreign pay bond, can be greatly affected by interest-rate movementd in the country in which its denominated.

Answer 32

Eurobond

Question 33

Represent debt that’s issued by foreign national governments.

• credit rating is based on the current standing of the issuing government.

Ultimately, the issuer’s ability to repay the principal and interest is reflected in the Bond’s yield.

Answer 33

Sovereign bond

Question 34

Examples of money-market securities and related instruments include

Answer 34

• commercial paper
• bankers acceptances
• negotiable certificates of deposit
• Federal funds
• Money-market funds
• Repurchase agreements (Repos)

Question 35

_________ instruments are classified as a separate asset class and are referred to as cash equivalents

Answer 35

Money-market instruments

Question 36

When corporations need short-term financing, they issue _______. A short-term, unsecured corporate debt which typically matures in 270 days or less.

Answer 36

When corporations need short-term financing, they issue commercial paper. A short-term, unsecured corporate debt which typically matures in 270 days or less.

Question 37

There are two methods by which commerical paper may be sold

What are they?

Answer 37

Directly placed commercial paper &

Dealer-placed commercial paper.

Question 38

In ____ ______ commercial paper, the issuer of commercial paper sells its issues directly to the public using its own sales force.

Answer 38

Directly placed commercial paper

Question 39

______ ________ commercial paper, the issuer sells to large commercial paper dealers that then resell the issue to the public.

Answer 39

Dealer-placed Commercial Paper.

Question 40

A ________, ______ CD will offer an investor an interest rate that’s initially higher than current market rates. Subsequent interest rates that are paid to investors will be lower and may be adjusted more than once.

An RR should disclose to the client that he will not receive the higher interest rate for the life of the CD.

Answer 40

A step-up, long-term CD will offer an investor an interest rate that’s initially higher than current market rates. Subsequent interest rates that are paid to investors will be lower and may be adjusted more than once.

An RR should disclose to the client that he will not receive the higher interest rate for the life of the CD.

Question 41

The funds that are borrowed overnight on a bank-to-bank basis are referred to as fed funds.

This interbank borrow is usually done to allow a bank to meet the reserve requirement that’s set by the federal reserve.

The rate charged on these overnight loans is referred to as the _______

Answer 41

The funds that are borrowed overnight on a bank-to-bank basis as re referred to as fed funds.

This interbank borrow is usually done to allow a bank to meet the reserve requirement that’s set by the federal reserve.

The rate charged on these overnight loans is referred to as the fed funds rate

Question 42

A bank charges the _____ _____ when providing loans to a corporation that’s among the bank’s best credit-rated customers.

Answer 42

A bank charges the prime rate when providing loans to a corporation that’s among the bank’s best credit-rated customers.

Question 43

are short-term notes which are issued by banks and BDs and typically pay coupon rate that’s above prevailing market rates. In addition to receiving a higher coupon rate, the investors may be forced to purchase shares of the issuer at a fixed price. If the price of the stock stays above the specified price(referred to as the knock-in level), the investor will receive the high coupon and the full return of his principal. If the underlying asset falls below the knock-in level, the investor will be obligated to purchase shares of the underlying stock at the knock-on in price. In that case, the investor may receive substantially less than the original principle

Answer 43

Reverse convertible securities are short-term notes which are issued by Banks and broker- dealers and typically pay coupon rate that’s above prevailing market rates. In addition to receiving a higher coupon rate, the investors may be forced to purchase shares of the issuer at a fixed price. If the price of the stock stays above the specified price(referred to as the knock-in level), the investor will receive the high coupon and the full return of his principal. If the underlying asset falls below the knock-in level, the investor will be obligated to purchase shares of the underlying stock at the knock-on in price. In that case, the investor may receive substantially less than the original principle

Question 44

are securities that often combine investments, such as a bond with a derivative. _______ may be linked to equity securities, commodities, or interest rates. These products may also be structured to provide principal protection. The fact that they are not bank deposits and are not insured by the Federal Deposit Insurance Corporation (FDIC) should be disclosed by an RR when these products are offered to clients.

Answer 44

Structured securities

Question 45

what type of credit instrument is issued by a company and guaranteed by a commercial bank?

Answer 45

A short-term credit instrument called a Banker’s Acceptance (BA) is issued by a company and guaranteed by a commercial bank.

Question 46

What are Banker’s Acceptances primarily used for?

Answer 46

are primarily used for financing international trade transactions, such as importing and exporting goods.

Logic: In a trade transaction, the importer’s bank guarantees payment for the goods or services by “accepting” liability on behalf of its client (the importer). The bank stamps the document as a guarantee, creating a Banker’s Acceptance. The exporter can either hold the BA until maturity to receive payment or sell it at a discount in the secondary market for immediate liquidity.

Question 47

is a structured product that combines a short-term bond with a put option on an underlying asset, often a stock. The issuer of the _____ promises to pay periodic interest to the bondholder, and at maturity, the bondholder receives either the principal amount or a predefined number of shares of the underlying asset, depending on the asset’s price.

Answer 47

reverse convertible bond

Question 48

_______________ is a crucial part of the arrangement between the bondholder and the issuer of this type of bond.

If the price of the underlying asset falls below a specific price, the (_______), at any point during the bond’s term, the bond’s principal repayment will be converted from cash to a predetermined number of shares of the underlying asset. If the underlying asset’s price never drops below the knock-in level, the bondholder will receive their full principal repayment in cash.

Answer 48

The knock-in level

Question 49

are issued in the U.S. by foreign corporations and governments, are dollar-denominated securities, and trade in U.S. markets.

Answer 49

Yankee bonds

Question 50

are short-term notes which are issued by banks and broker-dealers and typically pay a coupon rate that’s above prevailing market rates. In addition to receiving a higher coupon rate, the investors may be forced to purchase stock (or a basket of stock) if the price falls to a certain level (referred to as the knock-in price). If the price of the underlying asset remains above the knock-in level, the investors will receive the high coupon and the principal at maturity. However, if the underlying asset falls below the knock-in level, the investors will be obligated to purchase stock and will no longer receive interest or principal. If the stock’s price falls, it’s likely that the investors are losing money when they’re forced to buy the stock.

Answer 50

Reverse convertible securities

Question 51

A corporation has issued a bond with a 5% coupon that is convertible into common stock at $40. The bond is selling currently trading at par and the stock is selling at $39.00. If the bond increased in value by 20 points, what is parity of the stock?

Answer 51

If the bond increased by 20 points over its par value of $1,000, it would be selling for $1,200. The parity price for the stock is found by dividing the market value of the bond ($1,200) by the conversion ratio of 25 ($1,000 or par value ÷ $40). This is equal to $48 ($1,200 ÷ 25 = $48).

Question 52

may be linked to individual securities, commodities, foreign currencies, or indexes. These products are underwritten by most major financial services institutions and are usually registered as securities with the SEC. Structured products are not bank deposits and are not insured by the Federal Deposit Insurance Corporation (FDIC). This fact should be disclosed by an RR when offering this product to clients.

Answer 52

structured products

Question 53

_______ bonds are issued by both U.S. and foreign companies to investors outside the U.S., but interest and principal are paid in U.S. dollars. _______ bonds can be bought and sold in the U.S., but only 40 days after original issuance (i.e., after a seasoning period). Since _______ bonds are originally issued outside of the U.S. to foreign investors, they’re exempt from SEC registration

Answer 53

Eurodollar bonds are issued by both U.S. and foreign companies to investors outside the U.S., but interest and principal are paid in U.S. dollars. Eurodollar bonds can be bought and sold in the U.S., but only 40 days after original issuance (i.e., after a seasoning period). Since Eurodollar bonds are originally issued outside of the U.S. to foreign investors, they’re exempt from SEC registration

Question 54

A bond convertible at $40 is selling in the market for 120. If the stock has a current market price of $50, the parity price for the bond is:

Answer 54

It is necessary to find the conversion ratio to solve this problem. The bond is convertible at $40. $1,000 divided by $40 equals the conversion ratio of 25 shares of stock to one bond, or 25 to 1. To find the parity price of the bond, multiply the market price of the stock of $50 by the conversion ratio of 25 ($50 x 25 = $1,250). This means that the bond must sell for $1,250 to be equal in value to the stock when the stock has a market value of $50 per share.

Question 55

A corporation with an excellent earnings record has several issues of bonds outstanding. During a period of stable interest rates, which of the following securities are expected to fluctuate the most?

A Mortgage bonds
B Commercial paper
C Debenture bonds
D Convertible bonds

Answer 55

The convertible bonds will fluctuate the most because they are convertible into common stock. The price fluctuates with the price movements of the common stock. The fact that interest rates are stable is another reason why convertible bonds is the best answer. If the question had stated that interest rates were moving sharply upward or downward, then all other bonds would fluctuate sharply in price to bring yields in line with interest rates. However, the question asks what will happen in a period of stable interest rates. Given that statement, the best answer is that convertible bonds will fluctuate the most.

Question 56

_______ are defined as U.S. dollars on deposit in foreign banks, not just in Europe.

Answer 56

Eurodollars

Question 57

_____________ are securities that often combine investments, such as a bond with a derivative. may be linked to equity securities, commodities, or interest rates. These products may also be structured to provide principal protection. The fact that __________ are not bank deposits and are not insured by the Federal Deposit Insurance Corporation (FDIC) should be disclosed by an RR when these products are offered to clients.

Answer 57

Structured products are securities that often combine investments, such as a bond with a derivative. Structured securities may be linked to equity securities, commodities, or interest rates. These products may also be structured to provide principal protection. The fact that structured products are not bank deposits and are not insured by the Federal Deposit Insurance Corporation (FDIC) should be disclosed by an RR when these products are offered to clients.

Question 58

A ________ product is a financial instrument whose value is derived from the value of an underlying asset, index, or other financial instruments.

Answer 58

A derivative product, often simply called a “derivative,” is a financial instrument whose value is derived from the value of an underlying asset, index, or other financial instruments.

Question 59

An ___________ is a type of unsecured debt security, but differs from other types of fixed-income securities since _____ returns are often linked to the performance of an index.

• Don’t usually pay an annual coupon (they’re zero-coupon-like) or specified dividend.
• All gains are paid at maturity.
• Traded on an exchange, such as the NYSE, and
• may be purchased on margin and sold short.

Answer 59

Exchange-Traded Notes (ETNs)