Chapter 7

Question 1

Bond

Answer 1

Bond = contract of corporation/government borrowing money from public on LT-basis by issuing or selling debt securities

Coupon = stated interest payment made on bond. (Coupon Rate = ratio of the payments and par value)

Face/Par Value/Stated Value = principal amount repaid at end of term

Maturity =date when principal amount must be paid, length of time that debt remains outstanding with unpaid balance

Yield-to-Maturity = rate required in market on bond

Question 2

4 key items of Bond

Answer 2

1) Par value of final payment
2) Length of time before then
3) Frequency of coupon payment
4) Coupon interest rate

Question 3

Debt vs. Equity

Answer 3

Debt: Not an ownership interest, Creditors do not have voting rights, Interest is considered a cost of doing business and is tax deductible, Creditors have legal recourse if interest or principal payments are missed, Excess debt can lead to financial distress and bankruptcy

Equity Ownership interest, Common stockholders vote for BOD, Dividends are not considered a cost of doing business and are not tax deductible, Dividends are not a liability of the firm, and stockholders have no legal recourse if dividends are not paid, An all equity firm can not go bankrupt merely due to debt since it has no debt

Question 4

Bond Features and Characteristics

Answer 4

Indenture = written agreement between corporation and creditors, deed of trust. Trustee (bank) 1) makes sure terms are obeyed, 2) manage the sinking fund and 3) represent the bondholders

• Security
• Sinking Fund
• Call Provision
• Call Price
• Rating
• Protective Covenants

Question 5

Security Feature

Answer 5

SECURED
Collateral = securities that are pledged as security for debt payment

Mortgage Securities = are secured by real property

-Utility/Railroad bonds are secured

UNSECURED
Notes = unsecured debt, issued with maturity of 10 years or less

Debenture Bonds = unsecured debt with maturity of 10 years or more. Claim only on property not otherwise pledged.

-Industrial/Financial bonds are unsecured

Question 6

Seniority Feature

Answer 6

Seniority = preference in position over other lenders (Senior/Junior)

Subordinated = holders of this debt must give preference to other specified creditors

Question 7

Repayment Feature

Answer 7

Sinking fund = early repayment, managed by trustee, calling in bonds early, paying over the life of a bond, balloon payments

Question 8

Call Provision Feature

Answer 8

Call Provision = allows company to repurchase bond at specified price before maturity. Generally above par. (AKA Call Premium)

Deferred Call Provision = Can’t call bond before a certain date, during that time it is “call protected”

Question 9

Protective Covenants Feature

Answer 9

Protective Covenant = limiting and confirming certain actions that might be taken during term of loan. With purpose of protecting the lender’s interest.

Question 10

8 Types of Bonds

Answer 10

Government Bonds
Zero Coupon Bonds
Floating-Rate Bonds
Catastrophe (Cat) Bonds
Income Bonds
Convertible Bond
Put Bond
Sukuk

Question 11

Government Bonds

Answer 11

• Mostly ordinary coupon bonds
• Older issues are callable

2 Features of Federal Bonds:

1) No default risk
2) Exempt from state income taxes (not federal)

Municipal Notes/Bonds = State/local government borrowing, always callable. Coupons exempt from federal income tax. (Lower yield to maturity because of their lower tax rates)

Question 12

Zero Coupon Bonds

Answer 12

Zero Coupon Bonds = No coupons, must be offered at price lower than stated value