Unit 5

Question 1

types of bonds issued by corporations

Answer 1

• mortgage bonds
• equipment trust certificates
• collateral trust bonds
• debentures
• guaranteed bonds
• Senior
• Subordinated
• income bonds

Question 2

secured debt securities

Answer 2

backed by various forms of assets of the issuing corporation

Question 3

unsecured debt securities

Answer 3

backed only by the reputation. credit record and financial stability of the corporation

Question 4

mortgage bonds

Answer 4

corporation will borrow money back by real estate of the corporation. Value of real estate must be in excess of the amt borrowed. If corporation can’t pay loan back the real estate is sold off to pay the bondholders. If sale of the property results in an outstanding balance, the mortgage holder becomes a general creditor for the unsatisfied balance

Question 5

equipment trust certificates

Answer 5

• often used by railroads, airlines
• typically pay 20% of the cost and finances the balance with equipment trust certificates
• when the company pays off the loan it gets clear title to the equipment from the trustee
• if the company doesn’t pay off the loan, the lender repossess it and sells it

Question 6

collateral trust bonds

Answer 6

• company deposits securities it owns into a trust to serve as collateral for lenders
• can be any securities as long as they are marketable
• AKA collateral trust certificates

Question 7

debentures

Answer 7

a debt obligation of the corporation backed only by its word and general creditworthiness. quality depends on overall assets and earnings of the corporation

Question 8

guaranteed bonds

Answer 8

a bond that is guaranteed as to payment of interest, or both principal and interest but a corporate entity other than the issuer.
- popular with railroad industry

Question 9

Senior

Answer 9

describes relative priority of claim of a security.

every debt security has senior claim over preferred stock.

Question 10

Subordinated

Answer 10

usually describing a debenture

still senior to any stockholder

Question 11

income bonds/adjustment bonds

Answer 11

are used when a company is reorganizing and coming out of bankruptcy.

pay interest only if the corporation has enough income to meet the payment and BOD declares a payment.

Not suitable for investors looking for stable income

Question 12

income bonds

Question 13

zero coupon bond

Answer 13

• debt obligations that make no interest payments
• trade at deep discount
• return is difference between discounted price and face value (1000) - accretion
• current market price for zero income bonds reflects the current interest rates for similar maturities
• allows investors to lock in yield/ROR for predetermined, investor selected time with no reinvestment risk
• often used to fund edu or retirement accounts
• price volatility

Question 14

liquidation priority

Answer 14

1a. secured creditors (mortgage bonds, equipment trusts, collateral trust bonds)
1b. wages
1c. taxes
2. unsecured creditors (general creditors, debenture holders)
3. subordinated debt holders
4. preferred stockholders
5. common stockholders

Question 15

convertible debt securities

Answer 15

investors may exchange debt into shares of the company’s common stock.

issued by company.

excised at the discretion of the investor

Conversion ratio varies

typically debentures

Question 16

conversion price

Answer 16

is the stock price at which a convertible bond can be exchanged for shares of common stock

Question 17

conversion ratio

Answer 17

• expresses the number of shares of stock a bond may be converted into
• bond always represents 1000, so compute the number of shares by dividing by 1000. Ex - convertible at $20. 1000/20 = 50 shares

Question 18

benefits of convertible debt to issuer

Answer 18

sweetener for issuer: sold with lower coupon; can eliminate a fixed interest charge at conversion thus reducing debt; b/c it occurs over time, shouldn’t impact stock price; at issuance conversion price is higher than common stock

Question 19

disadvantage of convertible debt to issuer

Answer 19

• when bonds are converted, shareholder equity is diluted
• common stockholders can vote - shift of control
• loss of leverage
• raises corporation’s taxable income

Question 20

benefits of convertible debt to investor

Answer 20

• offer the safety of fixed income with potential appreciation
• pays fixed interest and is redeemable at face value at maturity. interest income is higher and surer than dividend income on common stock
• have priority over common stockholders
• tends to be more stable during market declines
• possible inflation protection
• no tax liability on the conversion transaction

Question 21

disadvantage of convertible debt to investor

Answer 21

• lower interest rate
• not suitable for investors looking for income
• lower priority than other debt
• potentially callable

Question 22

1/8

Answer 22

$1.25

Question 23

1/4

Answer 23

$2.50

Question 24

3/8

Answer 24

$3.75

Question 25

1/2

Answer 25

$5

Question 26

5/8

Answer 26

$6.25

Question 27

3/4

Answer 27

$7.50

Question 28

7/8

Answer 28

$8.75

Question 29

taxation of corporate debt

Answer 29

• interest paid by corporations is taxed as ordinary income
• taxed at federal, state and local levels
• income tax is due regardless of market price

Question 30

capital gain

Answer 30

bond is sold for a higher price than it costs

Question 31

capital loss

Answer 31

bond is sold for a lower price than it costs

Question 32

anti-dilutive provision

Answer 32

means that a stock dividend or stock split will not cause the investor’s conversion privilege to be diminished.