FA Chapter 11

Question 1

Advantages of Bonds

Answer 1

• Stockholders maintain control because bonds are debt, not equity.
• Interest expense is tax deductible.
• The impact on earnings is positive because money can often be borrowed at a low interest rate and invested at a higher interest rate.

Question 2

Disadvantages of Bonds

Answer 2

• Risk of bankruptcy exists because the interest and debt must be paid back as scheduled or creditors will force legal action.
• Negative impact on cash flows exists because interest and principal must be repaid in the future.

Question 3

Two types of cash payment in the bond contract

Answer 3

1. ) Principal

2. ) Cash Interest Payments

Question 4

Critical Numbers for Bonds Issued

Answer 4

PRINCIPLE
INT. PAYMENT
BOND RATE
N=number of interest periods
I=market yield (for a year, which may need to be cut in half)

Question 5

Debenture Bonds

Answer 5

No assets are pledged as guarantee of repayment at maturity.

Question 6

Secured Bonds

Answer 6

Specific assets are pledged as guarantee of repayment at

maturity.

Question 7

Callable Bonds

Answer 7

Bond may be called for early retirement by the issuer.

Question 8

Convertible Bonds

Answer 8

Bond may be converted to other securities (usually common stock).