Chapter 6 - Terms

Question 1

Debt

Answer 1

A loan to a firm, a government, or an individual.

Question 2

Examples of debt

Answer 2

• home mortgages
• bonds
• commercial paper
• unsecured notes

Question 3

Identifying debt

Answer 3

debt can be identified by describing three of its features:

• the principal amount that must be repaid
• the interest payments
• the time to maturity

Question 4

Principal value

Answer 4

the amount owed to the lender which must be repaid.

Also referred to as:

• face value
• maturity value
• par value

Question 5

Maturity date

Answer 5

the maturity date represents the date on which the principal amount of a debt is due

Question 6

Types of debt:

Answer 6

• short term

- long term

Question 7

Short term

Answer 7

mature in one year or less

Question 8

Treasury bills:

Answer 8

discounted securities issued by U.S. government to finance operations.

Question 9

Repurchase agreement:

Answer 9

one firm sells financial assets to another firm with the promise to repurchase the securities later at a higher price

Question 10

Federal funds:

Answer 10

overnight loans from one bank to another

Question 11

Banker’s acceptance

Answer 11

a postdated check

Question 12

Commercial paper

Answer 12

a type of promissory note issued by large, financially sound firms

Question 13

Certificate of Deposit

Answer 13

represents a time deposit at a bank or other financial intermediary

Question 14

Eurodollar deposit

Answer 14

a deposit in a bank outside the US that is not converted to the currency of the foreign country

Question 15

Money market mutual funds

Answer 15

pooled funds that are invested in money markets and managed by investment companies

Question 16

Long term debt:

Answer 16

Term loans
-loans obtained from a financial institution, on which the borrower agrees to make a series of payments, consisting of interest and principal, on specific dates.

Bonds
-a long-term contract where a borrower agrees to make payments of interest during the life of the loan and then repay the principal amount borrowed at the end of the life of the bond.

Question 17

Government bond

Answer 17

• municipal bonds are issued by state and local governments

- Treasury bonds are issued by the U.S. treasury

Question 18

Corporate Bond

Answer 18

bonds issued by corporations

Question 19

Mortgage bond

Answer 19

a bond backed by fixed assets

Question 20

Debenture

Answer 20

an unsecured bond (no lien, no claim)

Question 21

Subordinated debenture

Answer 21

a bond that has a claim on assets only after the senior debt has been paid off in the event of liquidation (inferior)

Question 22

Types of corporate bonds

Answer 22

(next few flashcards)

Question 23

Income bond

Answer 23

a bond that pays interest only if the firm earns enough income to cover the interest payments.

Question 24

Putable bond

Answer 24

a bond that can be redeemed at the bondholder’s option if the firm takes a particular action (acquired by a weaker company or O/S debt increases substantially)

Question 25

Indexed (purchasing power) Bond

Answer 25

a bond with interest payments that are based on an inflation index; helps protect the bondholder from inflation.

THE INFLATION RATE RISES… INTEREST PAID RISES.

Question 26

Floating-rate bonds

Answer 26

the bond’s rate “floats” with market interest rates rather than with the inflation rate.

Question 27

Zero (or very low) coupon bonds

Answer 27

bonds that pay no annual interest; sold at a discount below par

Question 28

Junk bonds

Answer 28

high-yield, high-risk bond, generally used to finance mergers, leveraged buyouts.

Question 29

Indenture

Answer 29

a formal agreement (contract) between the issuer of a bond and the bondholders.

Question 30

Trustee

Answer 30

an official who ensures that the bondholders’ interests are protected and the terms of the indenture are carried out.

Question 31

Restrictive covenant

Answer 31

a provision in a debt contract that constrains te actions of the borrower

Question 32

Call provision

Answer 32

a provision in a bond contract that gives the issuer the right to redeem the bonds under specified terms prior to the normal maturity date

Question 33

Refunding

Answer 33

retiring an existing bond issue using the proceeding newly issued bond

Question 34

Sinking Fund

Answer 34

a required annual payment designed to pay off a bond or preferred stock issue

Question 35

Firms handle a singing fund in one of two ways:

Answer 35

• call in for redemption a certain percentage of the bonds each year
• buy the required amount of bonds in the open market

Question 36

Convertible feature

Answer 36

permits the bondholder to convert the bond into shares of common stock at a fixed price

Question 37

One-way conversion

Answer 37

investors cannot convert the stock to bonds

Question 38

Bond-rating

Answer 38

bonds are often assigned quality ratings that reflect the probability of default

Question 39

Rating agencies

Answer 39

research the financial health of each bond issuer (including issuers of municipal bonds) and assign ratings to the bonds being offered.

Question 40

Understanding bond ratings

Answer 40

triple-a and double-a bonds are extremely safe

Question 41

Why are bond ratings important?

Answer 41

• serve as an indicator of default risk
• direct measurable influence on bond’s interest rate and the firm’s cost of using such debt
• institutional bonds purchasers may be prohibited from purchasing a bond falling below a BBB rating

Question 42

Bond valuation

Answer 42

an equation used to calculate the value of a bond

–the value of a bond is determined by calculating the present value of all expected cash flows.

Question 43

Bond value

Answer 43

calculate the present value of the bond’s two sources of cash flow

• interest payments
• principal payment