Chapter 9 Debt Valuation

Question 1

Firms can raise money by selling debt securities either indirectly to investors through a public offering that involves the sale o the securities to an investment bank, which acts as an intermediary and resells the securities to investors, or directly to investors through :

Answer 1

private placement.

Question 2

Advantages of Private placements

Answer 2

1.Speed
2.Reduced Costs
3.Financing Flexibility

Question 3

disadvantages of private placements

Answer 3

1.Interest Cost
2.Restrictive Covenants
3.The possibility of Future SEC Registration

Question 4

2 types of bank loans classified by intended use

Answer 4

1. Working capital loans
2. Transaction loans

Question 5

These loans set up a line of credit based on an open ended credit agreement whereby the firm has prior approval to borrow up to a set limit

Answer 5

Working capital loan

Question 6

Firms use this type of loan to finance a specific asset. These loans typically call for installment payments designed to repay the principal amount of the loan, plus interest, with fixed monthly or annual payments

Answer 6

Transaction loan

Question 7

2 types of bank loan classified by collateral used to secure the loan

Answer 7

1. Secured debt
2. Unsecured debt

Question 8

This type pf debt act as a promise to pay that is backed by granting the lender an interest in a specific piece of property known as collateral

Answer 8

Secured debt

Question 9

This type of debt act as a promise to pay that is not supported by collateral, so the lender relies on the creditworthiness and reputation of the borrower

Answer 9

Unsecured debt

Question 10

3 basic functions of investment banker

Answer 10

1.Underwriting
2.Distributing
3.Advising

Question 11

it is borrowed from field of insurance. It means assuming risk. The investment banker assumes the risk of selling a corporation’s securities at a satisfactory price.

Answer 11

Underwriting

Question 12

this is the distribution or selling function of investment banking. The investment banker may have branch offices across the country or it may have an informal arrangement with several security dealer who regularly buy a portion of each new offering for final sale.

Answer 12

Distributing

Question 13

The investment banker is an expert in the issuance and marketing of securities. A sound investment-banking house will be aware of prevailing market conditions and can relate those conditions to the particular type of security and the price at which it should be sold at a given time.

Answer 13

Advising

Question 14

Bonds that are issued by corporations are often referred to as :

Answer 14

Corporate Bonds

Question 15

Corporate Bond is a security
sold by a :

Answer 15

corporation that has promised future payments and a maturity date.

Question 16

If the borrowing firm is unable to repay the debt in accordance with the bond indenture, the claims of the debt holders must be honored before those of the firm’s stockholders.

Answer 16

Claims on Assets and Income

Question 17

It is the amount that must be repaid to the bondholder at maturity.

Answer 17

Par or Face Value

Question 18

refers to the price before considering any accrued interest that the current owner is owed.

Answer 18

clean price

Question 19

the quoted price, plus accrued interest is called

Answer 19

Dirty price or the invoice price

Question 20

indicates the percentage of the par value of the bond that will be paid out annually in the form of interest, and that interest rate is quoted as an annual percentage rate (APR).

Answer 20

Coupon Interest Rate

Question 21

This means that the rate adjusts up and down in response to changes in the market rate of interest.

Answer 21

Floating-rate bonds

Question 22

indicates the length of time until the bond issuer is required to repay and terminate the bond.

Answer 22

Maturity and Repayment of Principal

Question 23

most valuable when the bond is sold during a period of abnormally high rates of interest and there is a reasonable expectation that rates will fall in the future before the bond matures

Answer 23

Call Provisions and Conversion Features

Question 24

based on an evaluation of the probability that the bond issuer will make the bond’s promised payments

Answer 24

Bond Ratings and Default Risk

Question 25

This is equal to the present value of the contractually promised principal and interest payments (the cash flows) discounted back to the present using market’s required yield to maturity on bonds of similar risk.

Answer 25

The value of corporate debt

Question 26

three basic principles of finance:

Answer 26

Principle 1: Money has time value
Principle 2: There is a risk-return tradeoff
Principle 3: Cash flows are the source of value

Question 27

Valuing Bonds by Discounting Future Cash Flows Steps

Answer 27

Step 1: Determine bondholder cash flows
Step 2: Estimate the appropriate discount rate
Step 3: Calculate the present value of the bond’s interest and principal payments from step 1 using the discount rate estimated in step 2.

Question 28

Bond Valuation: Four Key Relationships

Answer 28

Relationship 1 : The value of a bond is inversely related to changes in the market’s required yield to maturity.
Relationship 2 : The market value of a bond will be less than the par value if the market’s required yield to maturity is above the coupon interest rate and will be more than the par value if the market’s required yield to maturity is below the coupon interest rate.
Relationship 3 : As the maturity date approaches, the market value of a bond approaches its par value.
Relationship 4 : Long-term bonds have greater interest-rate risk than short-term bonds.

Question 29

various types of bonds

Answer 29

1.Secured vs Unsecured
2.Priority of claims
3.Initial offering market
4.Abnormal risk
5.Coupon level
6.Amortizing or non-amortizing 7.Convertibility

Question 30

Determinants of Interest Rates

Answer 30

1.Real Risk-Free Rate of Interest
2.Inflation Premium
3.Default-Risk Premium
4.The maturity-Risk Premium
5.Term Structure of Interest Rates

Question 31

the interest rate on a fixed-income security that has no risk in an environment of zero inflation. It could also be stated as the nominal interest rate on a liquid and risk-free bond minus the inflation rate.

Answer 31

Real Risk-Free Rate of Interest

Question 32

a premium for the expected rate of increase in the prices of goods and services in the economy over the term of the bond or note.

Answer 32

Inflation Premium

Question 33

a premium to reflect the risk of default by the borrower

Answer 33

Default-Risk Premium

Question 34

It is the compensation that investors demand for bearing interest rate risk on longer-term bonds.

Answer 34

The maturity-Risk Premium

Question 35

it is a relationship between interest rates and time to maturity, with default risk held constant

Answer 35

Term Structure of Interest Rates