Chapter 4: Long-Term Financing Debts

Question 1

usually paid on installment

Answer 1

Debt

Question 2

are incurred to purchase capital assets such as land, buildings, and machinery equipment

Answer 2

Long-Term Debts

Question 3

advantages of issuing long-term debts

Answer 3

1. Unlike dividends declares, the interests can serve as a “tax shield”.
2. Long-term debts help increase a firm’s EPS.
3. The repayment of a long-term debt (in pesos) is cheaper during times of inflation.
4. The outstanding shares of stock are not diluted because new shares of stock are not issued.
5. The issuer of the bond enjoys financial flexibility because of the call provision in the bond indenture. A call provision permits a firm to redeem the bonds before the maturity date.

Question 4

disadvantages of issuing a long-term debt

Answer 4

1. A scheduled interest payment is required regardless of the firm’s actual earnings.
2. A firm with a considerable amount of outstanding loans does not project a “healthy” financial position.
3. Companies with high financial leverage normally pay a higher interest due to their low credit rating.
4. A covenant provision in the indenture which subjects a firm to certain constraints is very common.

Question 5

debt financing is advisale in the following situations:

Answer 5

1. The firm’s revenues and earnings are stable
2. The firm has adequate liquidity and determinable cash inflows.
3. The firm has a low debt-to-equity ratio.
4. Inflation is expected.
5. The indentures on the debt contract are not burdensome.

Question 6

two major forms of long-term debts

Answer 6

1. Publicly Issued Obligations
2. Direct or Private Placement

Question 7

obligations which are issued publicly

Answer 7

Publicly Issued Obligations

Question 8

obligations placed by individuals directly to a company for the purpose of lending money

Answer 8

Direct or Private Placement

Question 9

obligations granted by banks or other financial institutions to the borrower that uses real estate or movable assets as collateral

Answer 9

Mortgages

Question 10

borrower

Answer 10

Mortgagor

Question 11

lender

Answer 11

Mortgagee

Question 12

advantages of using a mortgage

Answer 12

1. Lower interest rate
2. Less covenants on financing
3. Extended maturity dates on the payment of the principal and interest

Question 13

examples of negative covenants

Answer 13

1. Acceleration clause
2. Prohibition on making additional loans
3. Disallowing the collateral to be used in obtaining additional loans
4. Limitation on the amount of dividends
5. Restriction on investing
6. Restriction on merging with another company

Question 14

provides the issuer of the bonds with the right to redeem the bonds previously issued before the maturity date, thus enabling the corporation to pay-off the bonds due

Answer 14

Call Provision

Question 15

greater than the par value of the bond

Answer 15

Call Price

Question 16

difference between the call price and the par value

Answer 16

Call Premium

Question 17

calls that are not operative during the early years of the callable bonds

Answer 17

Deferred Call

Question 18

bonds that are not operative during the early years of the callable bonds

Answer 18

Conversion Provision

Question 19

issued at a premium or discount are amortized from the time they were issued until the date of maturity instead of the date of conversion

Answer 19

Convertible Bonds

Question 20

retirement of bonds may be done in several ways

Answer 20

1. Payment of the maturity date
2. Conversion, if the bonds issued are convertible
3. Call, if the bonds have call feature
4. Periodic payment, if the bond issued are sinking-fund issues

Question 21

it is a provision which requires the issuing corporation to set aside an amount to pay-off the bond issuances

Answer 21

Sinking-Fund Provision

Question 22

two forms of sinking-fund provision

Answer 22

1. The trustee requires cash payment from the corporation that issued the bonds. From the payment received, the trustee then calls the bonds the sinking-fund call price.
2. The bonds are purchased in the open market.

Question 23

it is a certificate of the bonds issued by evidence

Answer 23

Bond Certificate

Question 24

it is a certificate of the bonds issued by evidence

Answer 24

Bond Certificate

Question 25

it is a certificate of the bonds issued by evidence

Answer 25

Bond Certificate

Question 26

it is a bond that earns interest on a specific intervals, normally a period of six months

Answer 26

Interest-Bearing Bond

Question 27

the interest payment of the bondholder

Answer 27

Nominal Interest

Question 28

bond is sold below its face value

Answer 28

Discount

Question 29

bond sold above its face value

Answer 29

Premium

Question 30

it is a bond that bears no interest but is sold at a very big discount

Answer 30

Non-Interest-Bearing Bond

Question 31

most bonds do not have any specific security attached to them

Answer 31

Unsecured Debentures

Question 32

it is so-called because particular assets are attached to it

Answer 32

Secured Debenture

Question 33

real estate collateral is involved

Answer 33

Mortgage Bonds

Question 34

types of bonds

Answer 34

1. Term bonds 2. Serial bonds 3. Secured bonds 4. Unsecured bonds 5. Registered bond 6. Coupon or bearer bonds 7. Convertible bonds 8. Callable bonds 9. Guaranteed bonds 10. Junk bonds 11. Floating-rate bonds

Question 35

it is a bond that mature on a single date

Answer 35

Term Bonds

Question 36

it is a bond in which the principal amount matures in a series of payments rather than a single payment

Answer 36

Serial Bonds

Question 37

it is a bond issued with fixed assets pledged as collateral

Answer 37

Secured Bonds

Question 38

bonds under secured bonds

Answer 38

1. First mortgage 2. Second mortgage 3. Open-end mortgage bond 4. Collateral trust bond 5. Equipment obligation bond

Question 39

also known as a closed-end mortgage bond

Answer 39

First Mortgage

Question 40

it is a one with a less favored or mortgaged for the first time

Answer 40

Second Mortgage

Question 41

this type of bond is not commonly accepted by bondholders because it treats the claims of the second mortgagee and the first mortgages equally

Answer 41

Open-End Mortgage Bond

Question 42

the investment securities owned by a firm can be used as a collateral of the issuing firm

Answer 42

Collateral Trust Bond

Question 43

if the equipment is used as a collateral to a bond issuance

Answer 43

Equipment Obligation Bond

Question 44

it is a bonds issued without collateral

Answer 44

Unsecured Bonds

Question 45

it may include negative pledge clause or an equal and ratable security clause

Answer 45

Debenture

Question 46

bonds under unsecured bonds

Answer 46

1. Debenture Bond 2. Subordinated Bond 3. Income Bond

Question 47

the claims under this type of bond are inferior to the claims of the other creditors enumerated in the bond indenture

Answer 47

Subordinated Bond

Question 48

the bondholders of this kind of bond received interest only when the firm has a sufficient income

Answer 48

Income Bond

Question 49

it requires that the name of the bondholders be registered in the books of the corporation

Answer 49

Registered Bond

Question 50

are bonds where a sheet of coupon is attached to the bond certificate

Answer 50

Coupon or Bearer Bonds

Question 51

the holders can change the bonds for a predetermined number of shares of corporate stock

Answer 51

Convertible Bonds

Question 52

bonds which may be called for redemption prior to the maturity date

Answer 52

Callable Bonds

Question 53

are made when a company or individual (other than issuing company) accepts the obligation to pay the interest and pincipal case of default

Answer 53

Guaranteed Bonds

Question 54

are high-risk, high yield bonds issued by companies that have numerous outstanding obligations or that are in a weak financial condition

Answer 54

Junk Bonds

Question 55

are a type of bond where the interest payment changes due to the fluctuations in the interest rate

Answer 55

Floating-Rate Bonds

Question 56

it is the one who accepts the guarantee of payment

Answer 56

Guarantor

Question 57

characteristics of repayment capacity

Answer 57

1. Leading market positions in well-established industries. 2. High rates of return on funds employed. 3. Conservative capitalization structures with moderate reliance on debt and sample asset protection. 4. Broad margins in earnings coverage of fixed financial charges and high internal cash generation 5. well-established access to a range of financial markets and assured sources of alternative liquidity.

Question 58

also known as bond refinancing

Answer 58

Bond Refunding

Question 59

ways to pay-off sinking funds

Answer 59

1. It can call a given percentage of the bonds at a stipulated price per year. 2. It can buy its own bonds in the open market.