s06

s06 - Chapter 6: Fixed Income Securities: Characteristics...

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Chapter 6: Fixed Income Securities: Characteristics and Valuation 6-1 Chapter 6 FIXED INCOME SECURITIES: CHARACTERISTICS AND VALUATION ANSWERS TO QUESTIONS: 1. a. Indenture - the contract between the issuing firm and the lenders in a debt obligation, specifying the nature of the debt issue, the manner in which the principal must be paid, and the restrictions (covenants) placed on the firm by the lenders. b. Trustee - the bondholders representative in a public debt offering. The trustee is responsible for monitoring the borrower's compliance with the terms of the indenture. c. Call feature - a provision that permits the bond issuer to retire the obligation prior to its maturity. d. Sinking fund - a method of providing for the gradual retirement of a bond issue. The sinking fund requirement can be met by depositing a certain amount of money annually in a sinking fund account. Alternatively, the firm can either purchase a portion of the debt each year in the open market or, if the debt is callable, use a lottery technique to determine which actual bonds will be called and retired each year. e. Conversion feature - a provision that allows the holder to exchange the bond for shares of the company's common stock at the option of the holder. f. Coupon rate - the annual rate of interest paid to bondholders. It is expressed as a percentage of par value. 2.a. Mortgage bond - a debt issue that is secured by specific physical assets of the issuing company. b. Debenture - an unsecured debt issue. The quality of the debt issue depends on the general credit-worthiness of the issuing company. c. Subordinated debenture - an unsecured debt issue that is “junior” to other types of debt. In the event of liquidation or reorganization of the company, claims of subordinated debenture holders are considered only after the claims of unsubordinated debt holders. d. Equipment trust certificate - used largely by railroad and trucking companies to purchase specific assets, such as rolling stock. The certificate holders own the equipment and lease it to the company.
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Chapter 6: Fixed Income Securities: Characteristics and Valuation 6-2 e. Collateral trust bond - a bond that is backed by stocks or bonds of other corporations. This type of bond is used primarily by holding companies. f. Income bond - a bond that promises to pay interest only if the issuing firm earns sufficient income, otherwise no interest obligation exists. This type of bond often is created in reorganizations following bankruptcy and normally is issued in exchange for junior or subordinated issues. 3. Investors would have a potential tradeoff between the 9 1/8% senior issue (which promises less return and is less risky than the subordinated issue) and the 9 3/8% senior subordinated issue (which promises more return and is more risky than the 9 1/8% senior issue). 4. a.
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s06 - Chapter 6: Fixed Income Securities: Characteristics...

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