Corporate Debt Flashcards
All of the following statements are true regarding a bond that is “registered to principal only” EXCEPT:
A. the bond is negotiable
B. interest coupons are detached from the corpus of the bond
C. interest payments can be redeemed by anyone
D. at maturity, the registered owner receives the face amount of the bond
The best answer is B.
A registered to principal only bond has a physical certificate with the bond’s face amount registered in the owner’s name, but interest coupons are attached which are payable to the “bearer.” Bearer coupons can be redeemed by anyone. The bonds are negotiable. No new issues have been sold in the U.S. since 1983 - after this point only fully registered or book entry bonds have been issued. However, these bonds still trade in the market (at least until 2023, if the bond had 40 years to maturity).
A customer has bought a “book entry” bond which pays interest semi-annually. The customer will receive interest payments:
A. from the paying agent once a year
B. from the paying agent twice a year
C. by clipping coupons once a year
D. by clipping coupons twice a year
The best answer is B.
A “book entry” bond is a fully registered bond where no paper certificate is issued. Instead, the owner simply receives that confirmation that he or she bought the bond. On such bonds, the paying agent mails the semi-annual interest payments to the registered owner. All new issues of U.S. Government bonds, municipal bonds and corporate bonds are book entry.
Note that there are still many issues of long term corporate bonds still outstanding that have paper certificates. These bonds have not yet matured. Book entry bonds did not really come to dominate bond issuance until the 1990s, so 30-year bond certificates issued, say in 1995, do not mature until 2025. Also note that no bearer bonds have been sold since 1983, but 40-year bearer bonds still exist (at least until 2023!).
The term “Funded Debt” refers to:
A. Short term U.S. Government debt
B. Long term U.S. Government debt
C. Long term corporate debt
D. Short term corporate debt
The best answer is C.
Funded debt is a somewhat archaic term that refers to corporate debt that is long term. This is considered to be part of a corporation’s long term (permanent) funding.
Promises made by corporate issuers to bondholders, as well as any restrictions placed on the issuer are found in the:
A. indenture
B. legal opinion
C. prospectus
D. underwriting agreement
The best answer is A.
The trust indenture of a bond spells out all of the protective and restrictive covenants made to the bondholders. The trustee ensures that the corporation adheres to the covenants.
Which statement is TRUE when comparing bonds and preferred stock?
A. Both bonds and preferred stock have a fixed payout rate and some may be convertible into common stock
B. Bonds have a fixed payout rate; preferred stock does not
C. Both bonds and preferred stock pay dividends
D. Bonds can be convertible; preferred stock cannot
The best answer is A.
Both bonds and preferred stock can be convertible and both have a fixed payout rate. Bonds pay interest, preferred stock pays dividends Think of preferred stock as a “bond” designed for corporate investment, so that a corporate investor can take advantage of the dividend exclusion from taxation (this tax benefit is not available to individual investors).
A company that has issued first mortgage bonds is declared in default by the trustee. Which statement is TRUE?
A. The bondholders have legal claim to the property backing the bond and may sell that property to satisfy the unpaid obligation
B. The bondholders have legal claim to all property of the failed company and may attach and sell any, or all, of that property
C. The bondholders have first claim to all assets of the failed company that have not been pledged
D. The bondholders are general creditors of the failed company
The best answer is A.
First mortgage bondholders have been granted a “first mortgage lien” on any “real” properties (real estate - land and buildings) that are pledged by the issuer as backing for the bond issue. If a default occurs, the bondholders have the legal right to sell the pledged property, and to use the proceeds to satisfy the outstanding debt. The value of the pledged property is always well in excess of the outstanding loan amount, so if the property is sold for less than book value, there should still be enough proceeds to satisfy the debt.
Mortgage bondholders do not have claim to all property of the failed company (such as cash in bank accounts; accounts receivable; inventory; etc.). They only have claim to the real property pledged. If the bondholders’ claims are not satisfied from the sale of the real property, then they become general creditors for the balance due.
All of the following statements are true regarding mortgage bonds EXCEPT:
A. Mortgage bonds are issued in term maturities
B. Default of mortgage bonds is common during recessionary periods
C. Mortgage bonds are commonly issued by utilities
D. Mortgage bonds are secured by real property
The best answer is B.
Mortgage bonds are term issues; all of the bonds are issued at the same date and mature on the same date. A serial structure is not required since real property is not a depreciating asset (as is the case with rolling stock pledged as collateral for equipment trust certificates). At maturity, it is common for mortgage bond issuers to sell a “refunding” bond issue. A new mortgage bond issue is floated, with the proceeds used to retire the maturing debt. In essence, the issuer is rolling over the debt. Mortgage bonds originated in the 1890s as a means of financing the growth of utility companies. As a means of lowering the interest cost to the issuer, bondholders were given a lien on all real property of the utility. In theory, if the issuer defaulted, the bondholders could sell that real property to repay the outstanding debt balance. Historically, mortgage bond defaults have been very low, because we need to keep our lights on!
All of the following are likely to purchase dealer commercial paper EXCEPT:
A. Institutions
B. Trust Companies
C. Individuals
D. Open-end Investment Companies
The best answer is C.
Dealer commercial paper is sold for corporations by dealer firms such as Goldman Sachs. The minimum purchase amount is generally $100,000. This eliminates most individuals from the market. The dealer commercial paper market is primarily an institutional market, with purchasers including insurance companies, trust companies and money market mutual funds.
As compared to “dealer” paper, many corporations sell their commercial paper directly to the investing public. “Direct” paper is sold directly to the investing public, usually via the web. It also sells in $100,000 and $500,000 minimum amounts, so the individual investor is pretty much cut out.
Corporate debentures are backed by:
A. real estate
B. equipment
C. portfolio of marketable securities
D. full faith and credit
The best answer is D.
Debentures are backed solely by the full faith and credit of the issuer. Debentures are usually issued by “Blue Chip” organizations with high credit ratings or lower credit rated companies in the form of high yield or “junk” bonds.
Which statement is TRUE about adjustment (income) bonds?
A. Semi-annual payment of interest is assured and repayment of principal at maturity is not assured
B. Semi-annual payment of interest is assured and repayment of principal at maturity is assured
C. Semi-annual payment of interest is not assured and repayment of principal at maturity is assured
D. Semi-annual payment of interest is not assured and repayment of principal at maturity is not assured
The best answer is D.
Income bonds only pay interest if the corporation earns enough “income” to make that interest payment. So payment of interest is not assured. In addition, if the issuer defaults (which could happen), then the principal will not be repaid either.
The credit rating of a guaranteed corporate bond is based on the credit quality of the:
A. corporate issuer
B. corporate guarantor
C. FDIC
D. SIPC
The best answer is B.
Guaranteed corporate bonds are guaranteed by another corporation (typically a parent company guaranteeing the debt of a wholly owned subsidiary). The guarantor will have the higher credit rating, so the bonds will be able to be issued at a lower interest cost. Such bonds take on the credit rating of the corporate guarantor, who is liable for payment if the issuer defaults.
Agencies, such as Federal Deposit Insurance Corp. and Securities Investor Protection Corp. do not guarantee corporate bonds. They protect customer accounts if banks, or securities firms fail, respectively.
All of the following corporate bonds are secured EXCEPT?
A. Collateral trust certificate
B. Second mortgage bond
C. Subordinated debenture
D. Equipment trust certificate
The best answer is C.
A secured bondholder has a lien on a specific asset of the company - such as equipment (an equipment trust certificate), real property (a mortgage bond) or securities given as collateral (a collateral trust certificate). A debenture is a promise to pay without any liens on corporate assets.
All of the following are true statements regarding convertible bond issues EXCEPT:
A. at the time of issuance, the conversion price is set at a premium to the stock’s current market price
B. the yield on convertible issues is higher than the yield for similar non-convertible issues
C. when the stock price is at a premium to the conversion price, bond price movements are usually caused by those of the stock
D. when the stock price is at a discount to the conversion price, bond price movements are usually caused by interest rate changes
The best answer is B.
When convertible bonds are issued, it is normal for the conversion price to be at a premium to the current market price. Thus, for the conversion feature to be worth something, the stock’s price must move up in the market. Due to the value of the conversion feature (or rather, the potential value if the stock price goes up), convertible bonds are saleable at lower yields than bonds without the conversion feature.
When the stock price is at a discount to the conversion price, the conversion feature is worthless. The bond is valued based on interest rate movements. On the other hand, when the stock price is at a premium to the conversion price, the conversion feature now has intrinsic value. For every dollar that the stock now moves, the bond will move as well, since the securities are “equivalent.”
When comparing convertible to non-convertible corporate bonds, convertible bonds have:
A. lower yields and price appreciation potential based on the market price of the common stock
B. lower yields and no price appreciation potential based on the market price of the common stock
C. higher yields and price appreciation potential based on the market price of the common stock
D. higher yields and no price appreciation potential based upon the market price of the common stock
The best answer is A.
Convertible bonds are issued at lower interest rates than non-convertible issues, which bondholders accept in return for price appreciation potential based upon the market value of the common stock (since the bond is convertible into a fixed number of shares of common).
All of the following statements are true regarding convertible bond issues EXCEPT:
A. At the time of issuance, the conversion price is set at a premium to the stock’s current market price
B. When the stock price is at a premium to the conversion price, the conversion feature has intrinsic value.
C. For the conversion feature to have value, the stock’s price must move up in the market after issuance
D. Convertible bonds usually have higher yields than bonds without the conversion feature
The best answer is D.
When convertible bonds are issued, it is normal for the conversion price to be set at a premium to the current market price.
Assume that a convertible bond is issued with a conversion price of $40 when the market price of the common is $30. Thus, the market price must rise to the conversion price before the conversion feature has any value. If the market price rises above the conversion price, then the conversion feature has “intrinsic value.”
For example, if the conversion price is set at $40 and the market price rises to $50 per share, there is $10 per share of “intrinsic value.” Once the stock’s market price moves above the conversion price, for every dollar that the stock price now moves, the bond will move by an equivalent amount as well. The securities are termed “equivalent.”
For the conversion feature to be worth something, the stock’s price must move up in the market after issuance.
Due to the value of the conversion feature (or rather, the potential value if the stock price goes up), convertible bonds are saleable at lower yields than bonds without the conversion feature.
