Question 6: Which of the following statements is CORRECT?
A One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the debt until the bonds mature.
B Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.
C Once a firm declares bankruptcy, it must then be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and lawyer fees.
D Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds.
E A firm with a sinking fund that gave it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.
Question 7: A 25-year, $1,000 par value bond has an 8.5% annual coupon. The bond currently sells for $875. If the yield to maturity remains at its current rate, what will the price be 5 years from now?
Question 8: Which of the following statements is CORRECT?
A The proper goal of the financial manager should be to attempt to maximize the firm's expected cash flows, because this will add the most to the wealth of the individual shareholders.
B The financial manager should seek that combination of assets, liabilities, and capital that will generate the largest expected projected after-tax income over the relevant time horizon, generally the coming year.
C The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, and thus on the firm's assets. However, EPS is not affected by the manner in which those assets are financed.
D Potential agency problems can arise between stockholders and managers, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders.
E Large, publicly-owned firms like AT&T and GM are controlled by their management teams. Ownership is generally widely dispersed, hence managers have great freedom in how they manage the firm. Managers may operate in stockholders' best interests, but they may also operate in their own personal best interests. As long as managers stay within the law, there is no way to either force or motivate them to act in the stockholders' best interests.
Question 9: A company is planning to raise $1,000,000 to finance a new plant. Which of the following statements is CORRECT?
A The company would be especially eager to have a call provision included in the indenture if its management thinks that interest rates are almost certain to rise in the foreseeable future.
B If debt is used to raise the million dollars, but $500,000 is raised as first mortgage bonds on the new plant and $500,000 as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds.
C If two tiers of debt are used (with one senior and one subordinated debt class), the subordinated debt will carry a lower interest rate.
D If debt is used to raise the million dollars, the cost of the debt would be lower if the debt were in the form of a fixed-rate bond rather than a floating-rate bond.
E If debt is used to raise the million dollars, the cost of the debt would be higher if the debt were in the form of a mortgage bond rather than an unsecured term loan.
Question 10: What's the present value of $1,525 discounted back 5 years if the appropriate interest rate is 6%, compounded monthly?
This solution answers questions regarding bonds, price, financial managers, debt and present value.