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Chapter+14+solutions - CHAPTER 14 Long-Term Liabilities...

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CHAPTER 14 - Long-Term Liabilities ANSWERS TO QUESTIONS 1. (a) Funds might be obtained through long-term debt from the issuance of bonds, and from the signing of long-term notes and mortgages. (b) A bond indenture is a contractual agreement (signed by the issuer of bonds) between the bond issuer and the bondholders. The bond indenture contains covenants or restrictions for the protection of the bondholders. (c) A mortgage is a document which describes the security for a loan, indicates the conditions under which the mortgage becomes effective (that is, conditions of default), and describes the rights of the mortgagee under default relative to the security. The mortgage accompanies a formal promissory note and becomes effective only upon default of the note. 2. If the entire bond matures on a single date, the bonds are referred to as term bonds. Mortgage bonds are secured by real estate. Collateral trust bonds are secured by the securities of other corporations. Debenture bonds are unsecured. The interest payments for income bonds depend on the existence of operating income in the issuing company. Callable bonds may be called and retired by the issuer prior to maturity. Registered bonds are issued in the name of the owner and require surrender of the certificate and issuance of a new certificate to complete the sale. A bearer or coupon bond is not recorded in the name of the owner and may be transferred from one investor to another by mere delivery. Convertible bonds can be converted into other securities of the issuing corporation for a specified time after issuance. Commodity-backed bonds (also called asset-linked bonds) are redeemable in measures of a commodity. Deep-discount bonds (also called zero-interest bonds) are sold at a discount which provides the buyer’s total interest payoff at maturity. 3. (a) Yield rate—the rate of interest actually earned by the bondholders; it is synonymous with the effective and market rates. (b) Nominal rate—the rate set by the party issuing the bonds and expressed as a percentage of the par value; it is synonymous with the stated rate. (c) Stated rate—synonymous with nominal rate. (d) Market rate—synonymous with yield rate and effective rate. (e) Effective rate—synonymous with market rate and yield rate. 4. (a) Maturity value—the face value of the bonds; the amount which is payable upon maturity. (b) Face value—synonymous with par value and maturity value. (c) Market value—the amount realizable upon sale. (d) Par value—synonymous with maturity and face value. 5. A discount on bonds payable results when investors demand a rate of interest higher than the rate stated on the bonds. The investors are not satisfied with the nominal interest rate because they can earn a greater rate on alternative investments of equal risk. They refuse to pay par for the bonds and cannot change the nominal rate. However, by lowering the amount paid for the bonds, investors can alter the effective rate of interest.
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