Type: Easy
65. PIKs are:
A. Pay-In-Kind bonds B. Pay Interest Kicker bonds C. Paid Interest in Krugerand D. None of the above
Type: Easy
66. A loan guarantee provided by the government on a corporate bond acts like what kind of derivative security for the investor?
A. Long put B. Short put C. Long call D. Short call
Type: Difficult
67. What happens to the value of a convertible bond as the total value of the firm increases?
A. Goes up B. Goes down C. Stays the same D. May go up or down
True / False Questions
68. The term "Yankee bond" refers to any bond sold in the United States.
FALSE
Type: Easy
69. Bonds issued in the United States are usually registered.
TRUE
Type: Easy
70. Sinking funds reduce the average life of a bond and thereby reduce the risk of a default.
TRUE
Type: Easy
71. The difference between the price of callable and non-callable bonds is greatest when bond prices are lowest.
FALSE
Type: Medium
72. A negative pledge clause states that the company may grant an exclusive lien or claim on any of its assets.
FALSE
Type: Medium
73. Affirmative covenants impose certain duties on the company.
TRUE
Type: Medium
74. The owner of a convertible bond owns both a straight bond and a call option.
TRUE
Type: Medium
75. Convertible bonds can also have a call feature.
TRUE
Type: Medium
76. Issuing convertible debt makes sense whenever investors have difficulty estimating the risk of the company's bond.
TRUE
Type: Medium
77. A warrant holder is not entitled to vote but receives dividends.
FALSE
Type: Easy
78. Bond-warrant package has different effects on the firm's cash flow and capital structure than the convertible bond.
TRUE
79. Many times warrants may be issued on their own and do not have to be issued in conjunction with other securities.
TRUE
Type: Medium
80. Project finance requires a capital investment that can be clearly separated from the parent that offers tangible security to lenders.
TRUE
Type: Medium
81. Floating price convertibles are convertible debt where bond holders can convert into a fixed value of shares.
TRUE
Type: Medium
82. Reverse floaters are floating rate bonds that pay a higher rate of interest when other interest rates fall and a lower rate when other rates rise.
TRUE
Type: Medium
83. Loan guarantees are valuable methods for propping up the value of debt without up front cash.
TRUE
Type: Medium
84. Government loan guarantees are risk free and costless means for helping struggling firms.
FALSE
Type: Medium
Short Answer Questions
85. Explain the differences between a bond issued only in the United States and Eurobond issues.
There are two basic differences. First, a bond issued in the United States will generally have a fixed interest rate, while a Eurobond will usually have a floating interest rate tied to LIBOR.
Second, bonds sold in the United States are almost always registered, which means that the company's registrar records the owner's name; most Eurobonds are sold in bearer form.
Type: Easy
86. Briefly explain the provisions of a typical bond indenture.
An indenture is a written agreement between the corporation and a trust company which represents the bondholders. The trust company ensures that the provisions of the indenture are observed and generally look after the interest of the bondholders. Indenture normally includes the following provisions: The basic terms of the bond; a description of property used as a security; details of the restrictive covenants; other provisions like call provisions, bond ratings, sinking fund arrangements etc.
Type: Difficult
87. Briefly explain the restrictive covenants in a bond indenture.
The restrictive covenants, also called protective covenants, are placed in the bond indenture to protect the bondholders' interests. There are two types of covenants, negative and positive (affirmative). Negative covenants limit or prohibit the company from taking certain actions like paying huge dividends to stockholders. Affirmative covenants specify certain duties on the company. These have to be exhaustive, as courts have held that only written covenants count.
Type: Medium
88. Briefly explain the term "conversion ratio."
The number of shares received for each bond is called the conversion ratio. This is fixed for the life of the bond.
Type: Easy
89. Briefly explain the term "Conversion premium."
Conversion premium is the difference between the conversion price and stock price expressed as a percent of stock price. Suppose the stock price is $25 and the conversion price is $45.
Then the conversion premium is (45 - 25)/25 = 80%. This shows that the conversion price is 80% higher than the stock price.
Type: Easy
90. Discuss the valuation of a convertible bond.
The value of a convertible bond will be the higher of the bond value or the conversion value.
The bond value is what each bond would sell for if it could not be converted. The conversion value is what the bond would sell for assuming immediate conversion.
Type: Medium
91. What are the three elements of convertible bond value?
The value of a convertible bond is determined by straight bond value, conversion value and the option value. Value of a convertible bond = Higher of [Straight bond value, conversion value] + Option value. The straight bond value and the conversion values provide the floor for the convertible bond value.
Type: Medium
92. Briefly explain what is meant by "force conversion?"
If the conversion value is greater than the call price and bond is called, then the call is said to force conversion. Obviously, bondholders would convert the bonds to realize the higher conversion value.
Type: Medium
93. Explain why firms issue convertible debt.
Smaller and more risky firms generally issue convertibles. Convertibles are useful when investors have difficulty in assessing the risk of a company's debt. They also diminish the possible conflicts of interest between bondholder and stockholder.
Type: Medium
94. Explain the differences between warrants and convertibles.
The main differences are: warrants are usually issued as a part of a private placement;
warrants can be detached and sold separately; warrants may be issued on their own; warrants are exercised for cash; warrants and convertibles are subject to different tax rules.
Type: Medium
95. Discuss the differences between publicly issued bonds and private placements.
Mainly, there are three differences. First, publicly issued bonds must be registered with the SEC, while private placements need not. Second, publicly issued bonds are highly
standardized, while private placements are tailor-made for the firms involved. Third, the restrictions placed on the issuer are much more stringent with private placements.
Type: Medium
96. Briefly explain project financing.
Project financing refers to debt financing that is largely a claim against the cash flow from a particular project rather than against the firm as a whole. Project financing is used for power, communication and transportation projects. This is also used extensively in developing countries.
Type: Medium
97. What are LYONs?
LYONs (Liquid yield option notes) are an innovation in bond design. They are puttable, callable, convertible and carry zero-coupon interest rate.
Type: Medium
98. What are reverse floaters?
Reverse floaters are floating-rate bonds that pay a higher rate of interest when other rates of interests fall and a lower rate when other rates rise.
Type: Easy
99. What are PIK bonds?
PIK (pay-in-kind) bonds carry high coupon payments. They can be paid in cash or with bonds of equivalent face value.
Type: Medium
100. Explain why the following phrase is true or false. "Government loan guarantees are costless methods for the government to help troubled firms."
This phrase is false for many reasons. While the issuance of a guarantee does not involve an upfront cost, it does transfer value and risk. A loan guarantee adds value to the recipients. By providing a guarantee the firm will assume more risk than the capital markets would
otherwise allow it to take. The transfer of risk to the government and the subsequent reduced risk aversion of the firm, may increase the chance of a payout by the government. The intervention of the government prevents capital markets from assigning proper risk adjusted prices to firm assets.
Type: Difficult