Which one of the following statements is true when comparing bond financing alternatives?
Answer(s): C
A callable bond can be recalled by the issuer prior to maturity. A call provision is detrimental to the investor because the issuer can recall the bond when market interest rates decline. It is usually exercised only when a company wishes to refinance high- interest debt.
All of the following may reduce the coupon rate on a bond issued at par except a
Answer(s): B
A bond issued at par may carry a lower coupon rate than other similar bonds in the market if it has some feature that makes it more attractive to investors. For example, a sinking fund reduces default risk. Hence, investors may require a lower risk premium and be willing to accept a lower coupon rate. Other features attractive to investors include covenants in the bond indenture that restrict risky undertakings by the issuer and an option to convert the debt instruments to equity securities. The opportunity to profit from appreciation of the firm's stock justifies a lower coupon rate. An improvement in a bond's rating from Aa to Aaa (the highest possible) also justifies reduction in the risk premium and a lower coupon rate. However, a call provision is usually undesirable to investors. The issuer may take advantage of a decline in interest rates to recall the bond and stop paying interest before maturity.
A firm has $3 million in total assets and $1.65 million in equity. How much of its $500,000 capital budget should be debt- financed to retain the same debt-equity ratio?
The firm's total assets are $3 million and total equity is $1.65 million. Thus, liabilities are $1.35 million ($3 million - $1.65 million). The current debt-equity ratio is 1.35 to 1.65, or 45% ($1.35 million ÷ $3 million) to 55% ($1.65 million ÷ $3 million). Thus, to maintain this ratio, 45% of all new investment should come from debt financing. Multiplying 45% times the $500,000 capital budget results in a need for $225,000 in debt financing.
Randolf Castell opened a small general store in 1964. A cousin, Alfred Bedford, served as bookkeeper and office manager while Castell concentrated on operations. The business prospered and each of Castell's three sons joined their father in the business. In fact, aseach son finished school, Castell opened a new store and put the son in charge. In time, each son began to specialize: one in hardware; another in dry goods, and the third in furniture. Further expansion took place, and the business was incorporated as Four Castles Inc. with all of the stock being held by the family. Castell closed his original store to serve as president and concentrate on administration. As Four Castles prospered and more stores opened, the company needed additional capital Bedford suggested "going public" but pointed out that this required accounting and reporting procedures with which he was unfamiliar. Therefore, a trained and qualified accountant was hired as controller. The new controller has had to provide explanations to Castell and Bedford on the accounting and reporting requirements of public companies. From the viewpoint of the investor, which of the following securities provides the least risk?
Answer(s): A
A mortgage bond is secured with specific fixed assets, usually real property. Thus, under the rights enumerated in the bond indenture, creditors will be able to receive payments from liquidation of the property in case of default. In a bankruptcy proceeding, these amounts are paid before any transfers are made to other creditors, including those preferences. Hence, mortgage bonds are less risky than the others listed.
If a bond sells at a premium, the
Answer(s): D
If the stated, or coupon, rate of a bond is higher (lower) than the effective; or market; rate on the date of issue, the bonds sell at a premium (discount).
Post your Comments and Discuss Financial CMA exam prep with other Community members:
Our website is free, but we have to fight against AI bots and content theft. We're sorry for the inconvenience caused by these security measures. You can access the rest of the CMA content, but please register or login to continue.