Debt Financing in Capital Structure

Question 1

There are two types of debts:

Private debt and ___ debt.

Answer 1

public debt

Question 2

Public debt
Most corporate bonds in the United States pay coupons

1) annually
2) quarterly
3) semiannually

Answer 2

3)semiannually

However, some companies issue zero-coupon bonds.

Question 3

Public debt

Most corporate bonds have maturities of

1) 20 years or less
2) 25 years or less
2) 30 years or less

Answer 3

2) 30 years or less

Maturities of corporate bonds have a wide range. Some have been issued with a 999-year maturity.

Question 4

Public debt

What are the four common types of corporate debt?

Answer 4

1) notes
2) debentures
3) mortgage bonds
4) asset-backed bonds.

Question 5

Public debt

Which ones are secured debts, meaning that in case of bankruptcy, bondholders can claim specific assets which have been designated as collateral?

1) notes
2) debentures
3) mortgage bonds
4) asset-backed bonds.

Answer 5

3) mortgage bonds

4) asset-backed bonds.

Question 6

Public debt

Which has shorter maturities between notes and debentures?

Answer 6

notes

Question 7

Public debt

Which has higher seniority secured debt or unsecured debt?

Answer 7

Secured debt has a higher seniority than unsecured debt. The bond having the highest seniority will always have the first claim.

Question 8

Public debt

What are domestic bonds?

Answer 8

These bonds are 
- issued by a local body
- available in a local market 
- priced in the local currency
However, these bonds are bought by foreign investors.

Question 9

Public debt

What are foreign bonds?

Answer 9

These bonds are

• issued by a foreign entity
• traded in a local market
• priced in the local currency

These bonds are intended for local investors. Foreign bonds in the U.S. are known as Yankee bonds.

In Japan, they are called Samurai bonds; in the United Kingdom, they are known as Bulldogs.

Question 10

Public debt

What are Eurobonds?

Answer 10

These bonds are

• not priced in the country of origin’s currency
• traded anywhere, and the entity which issues them may be local or foreign.

Question 11

Public debt

What are global bonds?

Answer 11

These bonds are simultaneously sold on one or more markets.

Question 12

What is the advantage and disadvantage of private debt?

Answer 12

advantage: avoid the cost of registration
disadvantage: illiquidity

Question 13

What are Sovereign debt ?

Answer 13

Sovereign debt is issued by the
-National Government.
In the US, sovereign debt is issued as bonds called “Treasury securities.”

Question 14

What are the four types of Treasury securities?

Answer 14

• Treasury bills
• Treasury notes
• Treasury bonds
• Treasury inflation-protected securities TIPS

Question 15

What has ZCB and maturity under 1 year? 
A)Treasury bills
B)Treasury notes
C)Treasury bonds
D)Treasury inflation-protected securities  TIPS

Answer 15

A)Treasury bills

Question 16

What is the difference between treasury bonds and notes?

Answer 16

Both have semiannual coupon bonds, but notes have maturity from 1-10 years and bonds have maturity of 10 years or more

Question 17

Are income from Treasury securities taxable?

Answer 17

Yes on the federal level but not on the local, state level.

Question 18

Sovereign debt is issued by national government and municipal bonds are issued by?

Answer 18

state and local governments

Question 19

Are income from municipal bonds taxable?

Answer 19

Income from municipal bonds is not taxable at the federal level. Some issues are also exempt from state and local taxes.

Question 20

What are the two types of municipal bonds?

Answer 20

1) Revenue bonds.

2) General obligation bonds

Question 21

What are Revenue bonds?

Answer 21

Revenue bonds. Revenue bonds are backed by the revenues that the projects will earn as a result of the debt issued.

Question 22

What are General obligation bonds?

Answer 22

General obligation bonds. These bonds are backed by the full faith and credit of a local government. If local governments strengthen the commitment further by tying the promise to a particular revenue source, this commitment is over and above the usual commitment, and the bonds are called double-barreled.

Question 23

Which is more secured, municipal bonds or sovereign debt?

Answer 23

sovereign debt. Since 1970, about 4% of municipal bonds have defaulted.

Question 24

What is the biggest sector of the ABS market ?

Answer 24

The mortgage-backed security (MBS) sector. It has its cash flows backed by home mortgages

Question 25

Sallie Mae is another government agency that issues asset-backed securities, but instead of being backed by home loans, these are backed by _____?

Answer 25

Student loans

Question 26

TRUE OR FALSE ?

A private ABS can be backed by another ABS.

Answer 26

TRUE

This new ABS is known as collateralized debt obligation (CDO). The cash flows for a CDO are often divided into various tranches, each being assigned different priorities.

Tranches with lower priority will not receive any cash flows until higher priority tranches are fulfilled.

Question 27

What are two main types of private debt?

Answer 27

Term loan

Private placement

Question 28

Which is cheaper to issue: private debt or public debt?

Answer 28

Private debt is negotiated directly with a bank or a small group of investors. It is cheaper to issue because there is no registration cost.

Question 29

Private debt

What are the two main types of private debt?

Answer 29

1) Term loan

2) Private Placement

Question 30

Determine which of the following statements regarding asset-backed securities (ABS) is TRUE.

A
An ABS is a security that is made up of home mortgages.

B
The largest sector of the ABS market is the mortgage-backed security market.

C
Fannie Mae is explicitly backed by the full faith and credit of the U.S. government.

D
Freddie Mac is the largest issuer of mortgage-backed securities in the U.S.

E
When banks re-securitize asset-backed and other fixed income securities, the new asset-backed security is known as asset securitization.

Answer 30

Statement B is true.

Statement A is false.

An ABS is a security that is made up of other financial securities. The “other financial securities” can be many things such as home mortgages and student loans. Thus, an ABS is not restricted to just home mortgages.

A mortgage-backed security (MBS) is an asset-backed security backed by home mortgages. Note that an MBS is a subset of an ABS.

Statement B is true.

By far, the largest sector of the ABS market is the mortgage-backed security market.

Statements C and D are false.

Ginnie Mae is the largest issuer of MBS in the U.S. and is explicitly backed by the full faith and credit of the U.S. government. The U.S. government provides an explicit guarantee to investors against default risk.

Other government-sponsored enterprises issuing MBS include Fannie Mae and Freddie Mac. Unlike Ginnie Mae, these enterprises are not explicitly backed by the full faith and credit of the U.S. government. However, most investors doubt that the government would allow any of its agencies to default and so believe these issues contain an implicit guarantee.

Statements E is false.

When banks re-securitize asset-backed and other fixed income securities, the new asset-backed security is known as collateralized debt obligation (CDO).

Question 31

What is Ginnie Mae?

Answer 31

The Government National Mortgage Association (GNMA), or Ginnie Mae is explicitly backed by the full faith and credit of the U.S. government. The U.S. government provides an explicit guarantee to investors against default risk.

Question 32

What is Fannie Mae?

Answer 32

The Federal National Mortgage Association (FNMA), commonly known as Fannie Mae.
Unlike Ginnie Mae, this enterprise is not explicitly backed by the full faith and credit of the U.S. government.

Question 33

What is Freddie Mac?

Answer 33

The Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac. Unlike Ginnie Mae, this enterprise is not explicitly backed by the full faith and credit of the U.S. government.