Chapter 9 - Corporate Debt Securities and Money-Market Instruments

Question 1

What is the proper order of liqudiation for a corporation at bankruptcy?

Answer 1

1. Unpaid workers
2. IRS
3. Secured creditors
4. Unsecured creditors
5. Preferred
6. Common

Question 2

The type of bond where bondholders have a lien on real property is called a _________.

Answer 2

The type of bond where bondholders have a lien on real property is called a mortgage bond

Question 3

What are some examples of rolling stock used to back a bond offering?

Answer 3

• Airplanes
• Trucks
• Railroad Cars

Question 4

A bond backed by machinery or rolling stock is called a(n) ________.

Answer 4

A bond backed by machinery or rolling stock is called a(n) Equipment Trust Bond

Question 5

True or False: Collateral Trust Bonds are backed by the stock of the issuing corporation.

Answer 5

False.

The stock pledged must be that of a separate company.

Question 6

Are debentures considered secured or unsecured?

Answer 6

Unsecured.

They are backed only by the issuer’s full faith and credit.

Question 7

Is an income bond appropriate for a client who desires income?

Answer 7

No. Income (adjustment) bonds will only pay interest if the issuer has sufficient income.

Question 8

If a bond is referred to as trading flat, this means it trades ___________.

Answer 8

If a bond is referred to as trading flat, this means it trades without accrued interest.

Question 9

The formula for finding conversion ratio is:

______

÷

____________

Answer 9

The formula for finding conversion ratio is:

Par

÷

Conversion Price

(par for a bond is $1,000)

Question 10

What is forced conversion?

Answer 10

An issuer calls bonds at a point where the stock is worth more than the bond’s call price.

Question 11

Name some of the advantages of buying convertible bonds.

Answer 11

• Consistent interest payments
• Appreciation if stock rises
• Downside protection if stock falls (since it’s still a bond)

Question 12

A corporation that issues convertible bonds is borrowing money at a ____ rate.

Answer 12

A corporation that issues convertible bonds is borrowing money at a lower rate.

Question 13

True or False: A favorable arbitrage situation occurs when a bond is trading at a discount to parity.

Answer 13

True

Question 14

Accrued interest on corporate bonds is calculated using ____ days in the month and ____ days in the year.

Answer 14

Accrued interest on corporate bonds is calculated using 30 days in the month and 360 days in the year.

Question 15

When do corporate bond trades settle?

Answer 15

T + 3 (three business days after the trade date)

Question 16

True or False: Interest paid on corporate bonds is entirely tax-exempt

Answer 16

False.

Corporate bond interest is taxed at the federal, state, and local level.

Question 17

What are Eurodollar bonds?

Answer 17

Dollar-denominated bonds issued outside the U.S.

Question 18

May Eurodollar bonds be issued in the U.S.?

Answer 18

No, and they are not registered with the SEC.

Question 19

May Eurodollar bonds later trade in the U.S.?

Answer 19

Yes

Question 20

What bonds are dollar-denominated, U.S. registered, and issued by multinational companies and foreign governments?

Answer 20

Yankee Bonds

Question 21

An ________ indenture allows additional bonds to be issued and backed by the same collateral.

Answer 21

An open-end indenture allows additional bonds to be issued and backed by the same collateral.

Question 22

The Trust Indenture Act of 1939 regulates _______ offerings.

Answer 22

The Trust Indenture Act of 1939 regulates corporate bond offerings.

(NOT municipal or government offerings).

Question 23

Corporate bonds quotes may be found in the ______.

Answer 23

Corporate bonds quotes may be found in the Yellow Sheets

Question 24

Money-market securities have a maturity of __________.

Answer 24

Money-market securities have a maturity of one year or less.

Question 25

Name some of the different types of money-market instruments.

Answer 25

• T-Bills
• Bankers’ Acceptances (BAs)
• Commercial Paper
• Negotiable CDs

Question 26

Negotiable CDs (also called Jumbo CDs) have a minimum denomination of $_____.

Answer 26

Negotiable CDs (also called Jumbo CDs) have a minimum denomination of $100,000

Question 27

What is a step-down, long-term CD?

Answer 27

A CD that offers an interest rate that’s higher than current rates, with subsequent interest rates paid being lower

Question 28

What is a step-up, long-term CD?

Answer 28

A CD that offers an interest rate that is lower than current rates, with subsequent interest rates paid being higher

Question 29

For bondholders, is a closed-end indenture more or less protective than an open-end indenture?

Answer 29

More protective, since the asset backing the bond cannot be diluted

Question 30

How is interest on corporate bonds treated for tax purposes?

Answer 30

Fully taxable (taxed at the federal, state, and local level)

Question 31

If a bond is converted to stock, what is the investor’s basis?

Answer 31

The same as the basis of the converted security.

Question 32

Is the conversion of a bond a taxable event?

Answer 32

No, it is a tax-free exchange. The taxable event would occur when the stock is sold.

Question 33

Define parity.

Answer 33

The value of two investments being equal, even, or the same

Question 34

A bond convertible at $25 is trading at $1,150, and the stock is trading at $30. Is the bond at parity with the stock?

Answer 34

No, the bond’s parity price is $1,200. The bond can be converted to 40 shares selling at $30, which equals $1,200.

Question 35

A bond convertible at $50 is trading at $1,200. For parity, where should the stock be trading?

Answer 35

Conv. ratio = $1,000 ÷ $50 = 20 sh.

The stock needs to trade at $60 to be at parity with the bond ($1,200 ÷ 20 = $60).

Question 36

ABC = $50.

ABC’s bond is convertible at $40 and callable at 105.

Is the call or conversion and sale more profitable?

Answer 36

Conversion and sale equals $1,250 (25 shares x $50), while the call only provides $1,050.

Question 37

Will a bond’s conversion price and conversion ratio be adjusted for stock splits or stock dividends?

Answer 37

Yes, due to a bond’s non-dilutive feature.

Question 38

What happens if a bond is convertible at $20 (ratio is 50 shares) and the company issues a 10% stock dividend?

Answer 38

Conversion ratio increases to 55 shares (50 x 10% = extra 5) and the new conversion price would be $18.18 ($1,000 ÷ 55).