Corporate Finance, 3e (Berk/DeMarzo)
Chapter 24 Debt Financing
24.1 Corporate Debt
1) What kind of corporate debt must be secured by real property?
A) Mortgage bonds
B) Notes
C) Asset-backed bonds
D) Debentures
2) What kind of corporate debt can be secured by any specified assets?
A) Mortgage bonds
B) Notes
C) Asset-backed bonds
D) Debentures
3) What kind of corporate debt has a maturity of less than 10 years?
A) Asset-backed bonds
B) Debentures
C) Notes
D) Mortgage bonds
4) What kind of unsecured corporate debt has a maturity of less than 10 years?
A) Mortgage bonds
B) Asset-backed bonds
C) Debentures
D) Notes
5) Bonds issued by a local entity, denominated in the local currency, traded in a local market, but
purchased by foreigners are called:
A) domestic bonds.
B) Yankee bonds.
C) Eurobonds.
D) foreign bonds.
6) Bonds issued by a foreign company in a local market, intended for local investors, and
denominated in the local currency are known as:
A) domestic bonds.
B) Yankee bonds.
C) Eurobonds.
D) foreign bonds.
7) Which of the following statements is FALSE?
A) Global bonds combine the features of domestic, foreign, and Eurobonds, and are offered for
sale in several different markets simultaneously.
B) In a leveraged buyout (LBO), a group of private investors purchases all the equity of a public
corporation.
C) A term loan is a bank loan that lasts for a specific term.
D) Eurobonds are international bonds that are denominated in the local European currency of the
country in which they are issued.
8) Which of the following statements is FALSE?
A) With registered bonds, on each coupon payment date, the bond issuer consults its list of
registered owners and mails each owner a check (or directly deposits the coupon payment into
the owner’s brokerage account).
B) If a coupon bond is issued at a discount, it is called an original issue discount bond.
C) The face value or principal amount of the bond is denominated in standard increments, most
often $10,000.
D) In a public offering, the indenture lays out the terms of the bond issue.
9) Which of the following statements is FALSE?
A) In the event of default, the assets not pledged as collateral for outstanding bonds cannot be
used to pay off the holders of subordinated debentures until all more senior debt has been paid
off.
B) Because more than one debenture might be outstanding, the bondholder’s priority in claiming
assets in the event of default, known as the bond’s seniority, is important.
C) When a firm conducts a subsequent debenture issue that has lower priority than its
outstanding debt, the new debt is known as a subordinated debenture.
D) Most debenture issues contain clauses restricting the company from issuing new debt with
equal or lower priority than existing debt.
10) Which of the following statements regarding the private debt market is FALSE?
A) Private debt has the advantage that it avoids the cost of registration.
B) Bank loans are an example of private debt, debt that is not publicly traded.
C) Private debt has the disadvantage of being illiquid.
D) The public debt market is larger than the private debt market.
11) Which of the following statements is FALSE?
A) Almost all bonds that are issued today are registered bonds.
B) The trust company represents the bondholders and makes sure that the terms of the indenture
are enforced.
C) For private placements, the prospectus must include an indenture, a formal contract between
the bond issuer and a trust company.
D) In the case of default, the trust company represents the bondholders’ interests.
12) Which of the following statements is FALSE?
A) The registered bond system also facilitates tax collection because the government can easily
keep track of all interest payments made.
B) Asset backed bonds and mortgage bonds are secured debt: Specific assets are pledged as
collateral that bondholders have a direct claim to in the event of bankruptcy.
C) Notes typically have longer maturities (more than ten years) than debentures.
D) Although the word “bond” is commonly used to mean any kind of debt security, technically a
corporate bond must be secured.
13) Which of the following statements regarding private placements is FALSE?
A) A private placement is a bond issue that does not trade on a public market but rather is sold to
a small group of investors.
B) Privately placed debt need not conform to the same standards as public debt; as a
consequence, it can be tailored to the particular situation.
C) In 1990, the U.S. Securities and Exchange Commission (SEC) issued Rule 144A, which
significantly decreased the liquidity of certain privately placed debt.
D) Because a private placement does not need to be registered, it is less costly to issue.
24.2 Other Types of Debt
1) In January 2010, the U.S. Treasury issued a $1000 par, ten-year, inflation-indexed note with a
coupon of 4%. On the date of issue, the consumer price index (CPI) was 200. By January 2020,
the CPI had increased to 300. The coupon payment that was made in January 2020 is closest to:
A) $20
B) $30
C) $40
D) $50
2) In January 2010, the U.S. Treasury issued a $1000 par, ten-year, inflation-indexed note with a
coupon of 4%. On the date of issue, the consumer price index (CPI) was 200. By January 2020,
the CPI had increased to 300. The principal payment that was made in January 2020 is closest
to:
A) $1000
B) $1020
C) $1030
D) $1500
3) In January 2010, the U.S. Treasury issued a $1000 par, five-year, inflation-indexed note with a
coupon of 5%. On the date of issue, the consumer price index (CPI) was 250. By January 2015,
the CPI had decreased to 200. The coupon payment that was made in January 2015 is closest to:
A) $20
B) $25
C) $30
D) $40
4) In January 2010, the U.S. Treasury issued a $1000 par, five-year, inflation-indexed note with a
coupon of 5%. On the date of issue, the consumer price index (CPI) was 250. By January 2015,
the CPI had decreased to 200. The principal payment that was made in January 2015 is closest
to:
A) $800
B) $1000
C) $1250
D) $1500
5) Treasury securities that are pure discount bonds with original maturities ranging from a few
days to 26 weeks are called:
A) TIPS.
B) Treasury bonds.
C) Treasury notes.
D) Treasury bills.
6) Treasury securities that are semiannual coupon bonds with original maturities of between 1
and 10 years are called:
A) Treasury bonds.
B) Treasury bills.
C) Treasury notes.
D) TIPS.
7) Treasury securities that are semiannual-paying coupon bonds with maturities longer than 10
years are called:
A) Treasury bonds.
B) TIPS.
C) Treasury bills.
D) Treasury notes.
8) Treasury securities that are standard coupon bonds where the outstanding principal is adjusted
for inflation are called:
A) Treasury notes.
B) Treasury bonds.
C) TIPS.
D) Treasury bills.
9) Which of the following statements is FALSE?
A) Zero-coupon Treasury securities with maturities longer than one year also trade in the bond
market.
B) Treasury securities are initially sold to the public through dealers.
C) Municipal bonds (“munis”) are issued by state and local governments.
D) Municipal bonds’ distinguishing characteristic is that the income on municipal bonds is not
taxable at the federal level.
10) Which of the following statements is FALSE?
A) In the case of a Treasury note or Treasury bond offering, the stop-out yield determines the
coupon of the bond and then all bidders pay the discounted value for the bond or note.
B) All competitive bidders submit sealed bids in terms of yields and the amount of bonds they
are willing to purchase.
C) In the past, the Treasury has issued bonds with maturities of 30 years (often called long
bonds) and 20 years.
D) Noncompetitive bidders (usually individuals) just submit the amount of bonds they wish to
purchase and are guaranteed to have their orders filled at the auction.
11) Which of the following statements regarding municipal bonds is FALSE?
A) A single municipal bond issue will often contain a number of different maturity dates. Such
issues are often called multi-muni bonds because the bonds are scheduled to mature over a
multiple number of years.
B) Revenue bonds are where the local government pledges specific revenues generated by
projects that were initially financed by the bond issue.
C) Municipal bonds are sometimes also referred to as tax-exempt bonds.
D) Bonds backed by the full faith and credit of a local government are known as general
obligation bonds and are not as secure as bonds backed by the full faith and credit of the federal
government.
12) Which of the following statements is FALSE?
A) Mortgage-backed securities, such as GNMAs, are pass-through securities. That is, each
security is backed by an underlying portfolio or pool of mortgages.
B) The Government National Mortgage Association (GNMA, or “Ginnie Mae”) is an example of
an enterprise; the Student Loan Marketing Association (“Sallie Mae”) is an example of a
government-sponsored agency.
C) Sovereign debt is debt issued by national governments.
D) Agency securities are issued by agencies of the U.S. government or by U.S. government
sponsored enterprises.
13) Packaging a portfolio of financial securities and issuing an asset-backed security backed by
this portfolio is known as:
A) asset securitization.
B) revenue securitization.
C) backup securitization.
D) payment securitization.
14) Asset securitization is the process of creating a(n):
A) collateralized security.
B) asset-backed security.
C) municipal security.
D) payment security.
15) A(n) ________ cash flows come from the cash flows of underlying financial securities.
A) general obligation security’s
B) revenue bond’s
C) asset-backed security’s
D) double-barreled bond’s
16) Which of the following does NOT issue asset-backed securities?
A) Government National Mortgage Association
B) Federal National Mortgage Association
C) Student Loan Marketing Association
D) Federal Reserve
17) An asset-backed security backed by home mortgages is a:
A) mortgage-backed security.
B) primary home-backed security.
C) bond-backed security.
D) real estate-backed security.
18) The largest sector of the asset-backed security market is the ________ market.
A) collateralized debt obligation
B) mortgage-backed security
C) real property-backed security
D) double-barreled security
19) When banks resecuritize other asset-backed securities, the new asset-backed security is
known as a:
A) mortgage-backed security.
B) double-barreled security.
C) collateralized debt obligation.
D) resecuritized security.
20) The cash flows of a collateralized debt obligation are usually divided into how many
different branches?
A) 2
B) 3
C) 4
D) 6
21) Mortgages that do not meet certain credit criteria and have a high probability of default are
know as ________ mortgages.
A) prepayment
B) pooled
C) under-water
D) subprime
22) Suppose that in January 2001, the U.S. Treasury issued a ten-year inflation-indexed note
with a coupon of 3 1/2%. On the date of issue the consumer price index (CPI) was 175.1. In
January 2006, the CPI had increased to 198.3. What coupon payment was made on this bond in
January 2006?
24.3 Bond Covenants
1) Galt Industries has just issued a callable, $1000 par value, five-year, 6% coupon bond with
semiannual coupon payments. The bond can be called at par in three years or anytime thereafter
on a coupon payment date. If the bond is currently trading for $978.94, then its yield to maturity
is closest to:
A) 3.4%
B) 6.0%
C) 6.5%
D) 6.8%
2) Galt Industries has just issued a callable, $1000 par value, five-year, 6% coupon bond with
semiannual coupon payments. The bond can be called at par in three years or anytime thereafter
on a coupon payment date. If the bond is currently trading for $978.94, then its yield to call is
closest to:
A) 3.4%
B) 6.0%
C) 6.5%
D) 6.8%
3) Rearden Metal has just issued a callable, $1000 par value, twenty-year, 8% coupon bond with
semiannual coupon payments. The bond can be called at par in five years or anytime thereafter
on a coupon payment date. If the bond is currently trading for $1040.79, then its yield to
maturity is closest to:
A) 3.8%
B) 7.0%
C) 7.6%
D) 8.0%
4) Rearden Metal has just issued a callable, $1000 par value, twenty-year, 8% coupon bond with
semiannual coupon payments. The bond can be called at par in five years or anytime thereafter
on a coupon payment date. If the bond is currently trading for $1040.79, then its yield to call is
closest to:
A) 3.8%
B) 7.0%
C) 7.6%
D) 8.0%
5) Which of the following statements is FALSE?
A) If the issuer fails to live up to any covenant, the issuer goes into bankruptcy.
B) The stronger the covenants in the bond contract, the less likely the issuer will default on the
bond, and so the lower the interest rate investors will require to buy the bond.
C) Covenants are restrictive clauses in a bond contract that limit the issuer from taking actions
that may undercut its ability to repay the bonds.
D) Bond agreements often contain covenants that restrict the ability of management to pay
dividends.
6) Which of the following statements is FALSE?
A) By including more covenants, issuers increase their costs of borrowing.
B) Once bonds are issued, equity holders have an incentive to increase dividends at the expense
of debt holders.
C) Covenants may restrict the level of further indebtedness and specify that the issuer must
maintain a minimum amount of working capital.
D) If the covenants are designed to reduce agency costs by restricting management’s ability to
take negative NPV actions that exploit debt holders, then the reduction in the firm’s borrowing
cost can more than outweigh the cost of the loss of flexibility associated with covenants.
24.4 Repayment Provisions
1) You own a bond with a face value of $1,000 and a conversion ratio of 45. The conversion
price is closest to:
A) $18
B) $22
C) $45
D) $1,000
2) You own a bond with a face value of $1,000 and a conversion price of $40. The conversion
ratio is closest to:
A) 15
B) 20
C) 25
D) 40
3) Which of the following statements is FALSE regarding a call provision?
A) The issuer can repurchase a fraction of the outstanding bonds in the market or it can make a
tender offer for the entire issue.
B) A call provision allows the issuer to repurchase the bonds at a predetermined price.
C) The call price is generally set at or below, and expressed as a percentage of, the bond’s face
value.
D) A call feature allows the issuer of the bond the right (but not the obligation) to retire all
outstanding bonds on (or after) a specific date (the call date), for the call price.
4) Which of the following statements is FALSE?
A) When bond yields have increased, by exercising the call on the callable bond and then
immediately refinancing, the issuer can lower its borrowing costs.
B) To understand how call provisions affect the price of a bond, we first need to consider when
an issuer will exercise its right to call the bond.
C) If the call provision offers a cheaper way to retire the bonds the issuer will forgo the option of
purchasing the bonds in the open market and call the bonds instead.
D) An issuer can always retire one of its bonds early by repurchasing the bond in the open
market.
5) Which of the following statements is FALSE?
A) The holder of a callable bond faces reinvestment risk precisely when it hurts: when market
rates are lower than the coupon rate she is currently receiving.
B) When yields have risen, the issuer will not choose to exercise the call on the callable bond.
C) The issuer will exercise the call option only when the prevailing market rate exceeds the
coupon rate of the bond.
D) A callable bond is relatively less attractive to the bondholder than the identical non-callable
bond.
6) Which of the following statements is FALSE?
A) Before the call date, investors anticipate the optimal strategy that the issuer will follow, and
the bond price reflects this strategy.
B) The yield to maturity of a callable bond is calculated as if the bond were called at the earliest
opportunity.
C) A callable bond will trade at a lower price (and therefore a higher yield) than an otherwise
equivalent non-callable bond.
D) The price of a callable bond can be low when yields are high, but does not rise above the call
value when the yield is low.
7) Which of the following statements is FALSE?
A) The assumption that underlies the yield calculation of a callable bond—that it will not be
called—is not always realistic, so bond traders often quote the yield to call.
B) The yield to call (YTC) is the annual yield of a callable bond assuming that the bond is called
at the earliest opportunity.
C) We can think of the yield to maturity of a callable bond as the interest rate the bondholder
receives if the bond is not called and repaid in full.
D) Because the price of a callable bond is higher than the price of an otherwise identical non-
callable bond, the yield to maturity of a callable bond will be lower than the yield to maturity for
its non-callable counterpart.
8) Which of the following statements regarding sinking fund provisions is FALSE?
A) With a sinking fund, if a bond is trading at below its face value, because the bonds are
repurchased at par the decision as to which bonds to repurchase is made by lottery.
B) With a sinking fund, instead of repaying the entire principal balance on the maturity date, the
company makes regular payments into a sinking fund administered by a trustee over the life of
the bond.
C) Sinking fund provisions usually specify a minimum rate at which the issuer must contribute to
the fund.
D) Because the sinking fund allows the issuer to repurchase the bonds at par, the option to
accelerate the payments is another form of call provision.
9) Which of the following statements is FALSE?
A) A convertible bond can be thought of as a regular bond plus a special type of call option
called a warrant.
B) On the maturity date of the bond, the strike price of the embedded warrant in a convertible
bond is equal to the face value of the bond divided by the conversion ratio—that is, the
conversion price.
C) Calling a convertible bond transfers the remaining time value of the conversion option from
shareholders to bondholders.
D) If the stock price is low so that the embedded warrant is deep out-of-the-money, the
conversion provision is not worth much and the bond’s value is close to the value of a straight
bond—an otherwise identical bond without the conversion provision.
Use the information for the question(s) below.
Luther Industries has just issued a callable (at 102) ten-year, 8% coupon bond with semiannual
coupon payments. The bond can be called at 102 in three years or anytime thereafter on a
coupon payment date. It has a current price of 99.
10) What is the Yield to Maturity (YTM) on this bond?
11) What is the Yield to Call (YTC) on this bond?
Use the information for the question(s) below.
KT Enterprises has just issued a callable (at par) fifteen-year, 7% coupon bond with semiannual
coupon payments. The bond can be called at par in five years or anytime thereafter on a coupon
payment date. It has a current price of 101.
12) What is the Yield to Maturity (YTM) on this bond?
13) What is the Yield to Call (YTC) on this bond?