clearlycanadian

The annual Fixed Income Analysts' Forum had just ended and two attendees, James Purcell and Frederick Hanes, were discussing some of the comments made by the panelists. Purcell and Hanes were specifically concerned with the following two statements that were made:

Panelist 1: Mortgage-backed securities and asset-backed securities are both fixed income securities that are backed by pools of loans and are said to be amortizing securities. For many of the loans, no principal payments are required to be made prior to the maturity date. These securities are said to have a bullet maturity structure.
Panelist 2: If coupon Treasury bonds or corporate bonds are issued with the terms specifying that the principal be repaid over time at the option of the issuer, then these bonds are putable bonds; if the principal is to be repaid over time at the option of the bondholder, then the bonds are termed callable bonds.

With regard to the statements made by Panelist 1 and Panelist 2:

A) both are incorrect.

B) both are correct

C) only one is correct.

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Panelist 1 is incorrect. These securities do not have a bullet maturity structure. The payments are structured so that the loan is paid off when the last loan payment is made.

Panelist 2 is incorrect. If coupon Treasury bonds or corporate bonds are issued with the terms specifying that the principal be repaid over time at the option of the issuer, then these bonds are callable bonds – the call provision grants the issuer an option to retire part of the issue or the entire issue prior to the maturity date. On the other hand, if the principal is to be repaid over time at the option of the bondholder, then these bonds are putable bonds – the put provision entitles the bondholder to put (sell) the issue back to the issuer at the put price (if interest rates increase and the bond’s price declines below the put price).

clearlycanadian

Which of the following statements regarding nonrefundable bonds is most accurate? Nonrefundable bonds:

A) must be refunded from funds generated from operations, not from outside sources of capital such as new debt or equity issues.

B) may only be called if the source of funds for the redemption is other than a new bond issue with a lower coupon rate.

C) and noncallable bonds are essentially the same.

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Nonrefundable bonds may be called as long as the firm does not use less expensive debt to do so. They may be refunded with outside capital, just not cheaper debt.

clearlycanadian

Which of the following statements regarding a bond being called is CORRECT? Call prices are known as regular redemption prices when bonds are called at:

A) under the call provisions specified in the bond indenture.

B) at the par value.

C) at a premium.

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When bonds are redeemed under the call provisions specified in the bond indenture, these are known as regular redemptions and the call prices are referred to as regular redemption prices which can be either at a premium or at par.

clearlycanadian

Which of the following is the appropriate redemption price when bonds are called according to the sinking fund provision?

A) Specific redemption price.

B) Regular redemption price.

C) Special redemption price.

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Regular redemption price refers to bonds being called according to the provisions specified in the bond indenture. When bonds are redeemed to comply with a sinking fund provision or because of a property sale mandated by government authority, the redemption prices (typically par value) are referred to as "special redemption prices." There is no such thing as a specific redemption price.

clearlycanadian

Which of the following is the appropriate redemption price when redemption funds are obtained as a result of a forced sale of assets for deregulatory purposes?

A) Regular redemption price.

B) General redemption price.

C) Special redemption price.

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When redemption funds are obtained as a result of a forced sale of assets for deregulatory purposes, the funds can be used to redeem bonds at the special redemption price, which are typically par value.

clearlycanadian

On November 15, 2006, Grinell Construction Company decided to issue bonds to help finance the acquisition of new construction equipment. They issued bonds totaling $10,000,000 with a 6% coupon rate due June 15, 2026. Grinell has agreed to pay the entire amount borrowed in one lump sum payment at the maturity date. Grinell is not required to make any principal payments prior to maturity. What type of bond structure has Grinell issued?

A) Bullet maturity.

B) Serial bonds.

C) Income bonds.

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These bonds have a bullet maturity structure because the issuer has agreed to pay the entire amount borrowed in one lump-sum payment at maturity.

clearlycanadian

Which of the following statements regarding a sinking fund provision is most accurate?

A) It requires that the issuer set aside money based on a predefined schedule to accumulate the cash to retire the bonds at maturity.

B) It requires that the issuer retire a portion of the principal through a series of principal payments over the life of the bond.

C) It permits the issuer to retire more than the stipulated sinking fund amount if they choose.

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A sinking fund actually retires the bonds based on a schedule. This can be accomplished through either payment of cash or through the delivery of securities. An accelerated sinking fund provision allows the company to retire more than is stipulated in the indenture.

clearlycanadian

The refunding provision found in nonrefundable bonds allows bonds to be retired unless:

A) the funds come from the sale of new common stock.

B) market interest rates have increased substantially.

C) the funds come from a lower cost bond issue.

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Refunding from a new debt issue at a higher interest rate is not prohibited, however their purchase cannot be funded by the simultaneous issuance of lower coupon bonds.

clearlycanadian

Which of the following embedded options benefits the bond investor?

A) Call provision.

B) Prepayment option.

C) Put provision.

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A put provision allows the investor to put the bond back to the issuer.

clearlycanadian

Which of the following embedded options most likely benefits the bondholder?

A) Prepayment option on an amortizing security.

B) Interest rate cap on a floating-rate bond.

C) Put provision at par on a bond that is trading at a premium.

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A put provision is an option that is exercisable by, and therefore potentially of benefit to, the bondholder. Even though the put is out of the money, it still has value to the bondholder. Interest rate caps and prepayment options both potentially benefit the issuer of the bond.