Question 1

Which one of the following does not explain why banks enjoy lower asymmetry of information?

Accepted Answer

While the three other choices explain how banks have access to information about the companies they work with, choice C suggests that companies are required by law to give banks access to privileged information. This is not necessarily true, and some information may remain private and only shared on a need-to-know basis. Therefore, choice C does not explain why banks enjoy a lower asymmetry of information.

Question 2

Short-term debt securities that are unsecured obligations issued by corporations are called:

Accepted Answer

Treasury bills are short-term debt securities that are issued by the government, not corporations. Debentures are also a type of corporate debt security, but they are typically long-term and can be secured by the issuer's assets. Therefore, the correct answer is commercial paper, which refers specifically to unsecured short-term debt securities issued by corporations.

Question 3

The Winnipeg Curling Company currently has one issue of debt outstanding.Winnipeg Curling has decided to borrow more money by issuing new debt with a higher priority in the event of bankruptcy.This could result in a violation of which type of covenant on the original debt?

Accepted Answer

A negative pledge covenant prevents the borrower from issuing more debt that has a higher claim on the company's assets in the event of bankruptcy, which would be violated if Winnipeg Curling issues new debt with a higher priority.

Question 4

When specific assets such as land, plant, or equipment are pledged as collateral, what is the term for the debt issue?

Accepted Answer

When specific assets such as land, plant, or equipment are pledged as collateral, the term for the debt issue is a mortgage bond. Debentures are unsecured debt, meaning there is no collateral backing the debt issue. Bonds can be either secured or unsecured, so it is too general of a term to be the correct answer.

Question 5

In general, a line of credit has a ______ maturity while a term loan has a ______ maturity.

Accepted Answer

A line of credit usually has a floating maturity, meaning that it can be used and repaid repeatedly during a certain period without a set repayment schedule. On the other hand, a term loan has a fixed maturity, meaning that it has a set repayment schedule over a certain period and cannot be accessed again once it has been fully repaid.

Question 6

Junk bonds are:

Accepted Answer

Junk bonds are bonds with ratings below investment grade, which means they are considered speculative and carry a higher risk of default than investment grade bonds. Despite the higher risk, they may offer investors higher yields than other bonds.

Question 7

Rank the following in order of priority in the event of bankruptcy:
I.Subordinated, secured debt
II.Subordinated, unsecured debt
III.Unsubordinated, secured debt
IV.Unsubordinated, unsecured debt

Accepted Answer

In the event of bankruptcy, debts are prioritized based on their security and subordination status. Unsubordinated, secured debt (III) is paid first because it has the highest claim on assets. Subordinated, secured debt (I) comes next as it is secured but has a lower priority due to its subordination. Unsubordinated, unsecured debt (IV) follows, having a higher priority than subordinated debts due to its unsubordinated status, despite being unsecured. Finally, subordinated, unsecured debt (II) is paid last, being the lowest in priority due to both its unsecured and subordinated status.

Question 8

Evaluate the following statement:
Private debt financing is generally cheaper than public financing.

Accepted Answer

Private debt financing typically has lower interest rates and fees than public financing, as it is not subject to the same regulations and oversight.

Question 9

In general a "floating rate" on a debt issue refers to:
I.Variable payment times for the interest payments
II.Variable interest payments
III.Yield on the debt equals the average dividend yield on the Toronto Stock Exchange

Accepted Answer

A floating rate on a debt issue typically refers to variable interest payments, which is option II. Option I refers to variable payment times, which is not typically associated with a floating rate on a debt issue. Option III is not accurate, as the yield on the debt would not necessarily be tied to the average dividend yield on a stock exchange.

Question 10

Investment-grade debt rating refers to which of the following?

Accepted Answer

Investment-grade debt rating indicates that the issuer is likely to meet debt payment obligations. It implies a low credit risk for the investors. Option A is incorrect because investment-grade rating indicates low credit risk and that the issuer is likely to meet its debt obligations. Option B is incorrect because increased dividend payments do not necessarily impact the issuer's creditworthiness or ability to meet its debt obligations.

Question 11

Private financing is advantageous because:

Accepted Answer

None of the options listed are advantages of private financing. In fact, private financing typically has less restrictive covenants and does not require a detailed prospectus like public financing. Private financing is not typically filed with provincial securities commissions either.

Question 12

A typical five-year revolving line of credit is characterized by:

Accepted Answer

A typical five-year revolving line of credit usually has a floating interest rate that is adjusted periodically based on market conditions.

Question 13

Which of the following is the least important for assessing the company's profile for purposes of a line of credit?

Accepted Answer

The price to earnings ratio is typically more relevant for investors looking at potential returns, as opposed to creditors primarily focused on a company's ability to repay its debts. The other three ratios listed are more commonly used in credit analysis.

Question 14

Use the following statements to answer this question:
I.The major implication of backing money market funds with risky assets is an increase in money market spreads.
II.Bankers' acceptance yields are always lower than commercial paper yields.

Accepted Answer

The answer of Use the following statements to answer this...

Question 15

Which of the following is an example of a covenant?

Accepted Answer

A covenant is a condition in a financial contract, such as maintaining a minimum level of current ratio, which is a common financial covenant.

Question 16

A junk bond is also known as:

Accepted Answer

A junk bond is a high yield bond, meaning it has a higher interest rate than investment grade bonds due to its higher risk of default. It is not a second mortgage, line of credit, or subordinated unsecured bond.

Question 17

Which of the following is secured by the assets of a firm?

Accepted Answer

Asset-backed commercial paper (ABCP) is secured by the assets of a firm, unlike debentures and fixed interest rate loans, which may not necessarily be asset-backed.

Question 18

Which of the following statements is correct?

Accepted Answer

Mortgages are secured by claims on specific real assets, typically a property or piece of real estate. Debentures, on the other hand, are unsecured debt and are not backed by any specific asset. Therefore, option C is the correct statement. Option A is incorrect because while both mortgage bonds and debentures are types of debt, they differ in terms of the assets used as collateral. Option B is incorrect because in the event of bankruptcy, debenture holders are typically paid before preferred shareholders. Option D is also incorrect for the same reason as option A.

Question 19

North American Bat Experts Company (NABE)has just sold a batting machine to a Jamaican cricket team.The team will pay for the machine by borrowing the money from NABE and securing the loan using the machine.This type of debt is called:

Accepted Answer

A purchase-money mortgage is a loan used to purchase an asset, with the asset itself serving as collateral for the loan. In this case, the Jamaican cricket team is borrowing money from NABE to buy the batting machine and securing the loan using the machine. Therefore, C is the most appropriate choice. A debenture is a type of bond that is not backed by collateral, an acceptance is a financial instrument used in international trade transactions, and a line of credit is a flexible loan that can be used for a variety of purposes. None of these options accurately describe the debt arrangement between NABE and the Jamaican cricket team.

Question 20

The purpose of a covenant is:

Accepted Answer

A covenant is a contractual obligation imposed on a borrower by a lender to protect the lender's interests. It is designed to minimize the risk of default by the borrower by setting certain conditions or restrictions on the borrower's behavior. Covenants can be financial or non-financial and are often used in loan agreements, bond indentures, and other debt instruments. The purpose of these covenants is to ensure that the borrower will be able to repay the loan and that the lender will be protected in the event of default by the borrower. Therefore, option A is the best choice as it correctly explains the purpose of a covenant.

Quiz 18: Debt Instruments