[SOURCE] Prefinals Flashcards
Bonds that are subject to retirement at a stated dollar amount prior to maturity at the option of the issuer are called
a. debentures
b. callable bonds
c. early retirement bonds
d. options
ANS: b. callable bonds.
BASIS: **Callable bonds allow issuers to repurchase and retire them before maturity at a predetermined price. (Investopedia)
The written agreement between a corporation and its bondholders might contain a prohibition against paying dividends in excess of current earnings. This prohibition is an example of a(n):
a. maintenance of security provision
b. collateral restriction
c. affirmative indenture
d. restrictive covenant
ANS: d. restrictive covenant.
BASIS: **Restrictive covenants limit corporate actions to protect bondholders’ interests. (Corporate Finance Institute)
A legal document that indicates the name of the issuer, the face value of the bond, and such other data is called
a. trading on the equity
b. convertible bond
c. a bond debenture
d. a bond certificate
ANS: c. a bond debenture.
BASIS: A bond debenture is an unsecured bond backed only by the issuer’s credit. (Investopedia)
When the market rate of interest on bonds is higher than the contract rate, the bonds will sell at
a. a premium
b. their face value
c. their maturity value
d. a discount
ANS: d. a discount.
BASIS:* When market rates exceed the bond’s contract rate, the bond price decreases to attract buyers. (Corporate Finance Institute)*
When a corporation issues bonds, the price that buyers are willing to pay for the bonds does NOT depend on which of the following below
a. face value of the bonds
b. market rate of interest
c. periodic interest to be paid on the bonds
d. denominations the bonds are sold
ANS: d. denominations the bonds are sold.
BASIS: The market price of a bond depends on interest rates, face value, and periodic interest payments, not the denominations in which they are issued.
If a debenture is subordinated, it:
a. has a higher priority status than specified creditors.
b. is secondary to equity.
c. must give preference to the specified creditor in the event of default.
d. has been issued because the company is in default.
ANS: c. must give preference to the specified creditor in the event of default.
BASIS: Subordinated debentures rank below other debts and are repaid only after higher-priority obligations are settled.
[TRUE or FALSE] Call premium is the amount by which the call price exceeds the market price of the bond.
Ans: False. Call premium is the amount by which the call price exceeds the face value of the bond, not the market price.
When the corporation issuing the bonds has the right to repurchase the bonds prior to the maturity date for a specific price, the bonds are
a. convertible bonds
b. unsecured bonds
c. debenture bonds
d. callable bonds
ANS: d. callable bonds.
BASIS: Callable bonds allow the issuer to repurchase them before maturity at a predetermined price.
[TRUE or FALSE] Putable bonds give the bondholders an option to sell the bond at a price higher than par value by the amount of one-year interest payment when the firm takes specified actions such as being acquired, acquiring another company, or issuing a large amount of additional debt.
Ans: True.
[TRUE or FALSE] Trustee is a paid party representing the bond issuer in the bond indenture.
Ans: True.
An unsecured bond is the same as a
a. debenture bond
b. zero coupon bond
c. term bond
d. bond indenture
ANS: a. debenture bond.
BASIS: Debenture bonds are unsecured bonds that rely on the issuer’s creditworthiness rather than collateral.
[TRUE or FALSE] To carry out the sinking fund requirement, the corporation makes semi-annual or annual payments to a trustee, who uses these funds to retire bonds by purchasing them in the marketplace.
Ans: True.
[TRUE or FALSE] Standard debt provisions specify certain criteria of satisfactory record keeping and reporting, tax payment, and general business maintenance on the part of the lending firm.
Ans: True.
[TRUE or FALSE] Because a rise in interest rates, and therefore the required return, results in an increase in bond value, bondholders are typically more concerned with dropping interest rates.
Ans: False. A rise in interest rates decreases bond prices. Bondholders are more concerned with rising interest rates, which lower bond values.
[TRUE or FALSE] To sell a callable bond, the issuer must pay a higher interest rate than on noncallable bonds of equal risk.
Ans: True.
[TRUE or FALSE] Bondholders will convert their convertible bonds into shares of stock only when the conversion price is greater than the market price of the stock.
Ans: False. Bondholders will only convert when the market price is greater than the conversion price, ensuring a financial gain.
A bond indenture is
a. a contract between the corporation issuing the bonds and the underwriters selling the bonds.
b. the amount due at the maturity date of the bonds.
c. a contract between the corporation issuing the bonds and the bond trustee, who is acting on behalf of the bondholders.
d. the amount for which the corporation can buy back the bonds prior to the maturity date.
ANS: c. a contract between the corporation issuing the bonds and the bond trustee, who is acting on behalf of the bondholders.
BASIS: A bond indenture is a legal agreement outlining the rights and responsibilities of the issuer and bondholders.
[TRUE or FALSE] A bond is said to sell at a premium when the required return and the bond value fall below the coupon interest rate and the par, respectively.
Ans: False.
*The statement is FALSE because a bond sells at a premium when its coupon rate exceeds the required return (also known as the yield to maturity). In such cases, the bond’s market value rises above its par value. Conversely, if the coupon rate is lower than the required return, the bond would trade at a discount, meaning its market value would be below par. *
[TRUE or FALSE] Yield to maturity (YTM) is the rate investors earn if they buy the bond at a specific price and hold it until maturity.
Ans: True.
The written agreement between a corporation and its bondholders is called the:
a. collateral agreement.
b. deed.
c. indenture.
d. deed of conveyance.
ANS: c. indenture.
BASIS: A bond indenture is the formal contract between the issuer and bondholders that outlines the terms of the bond.
A corporation would NOT be successfully trading on equity if it gathered funds by
a. issuing common stock.
b. issuing preferred stock.
c. issuing notes.
d. issuing bonds.
ANS: a. issuing common stock.
BASIS: Trading on equity refers to financing with debt rather than equity, meaning issuing common stock would not contribute to this strategy.
Debt that may be extinguished before maturity is referred to as:
a. sinking-fund debt.
b. debentures.
c. callable debt.
d. indenture debt.
ANS: c. callable debt.
BASIS: Callable debt allows the issuer to repay the bond before its maturity date, often when interest rates decline.
[TRUE or FALSE] The purpose of the restrictive debt covenant that imposes fixed assets restrictions is to limit the amount of fixed-payment obligations.
Ans: True.
A standard arrangement for the orderly retirement of long-term debt calls for the corporation to make regular payments into a(n):
a. custodial account
b. sinking fund
c. retirement fund
d. irrevocable trustee fund
ANS: b. sinking fund.
A sinking fund is a dedicated fund established by a corporation to set aside money at regular intervals for the purpose of retiring its long-term debt. This arrangement ensures that the company systematically reduces its debt over time, thereby lowering default risk and reassuring investors.
