This assignment is mandatory and will therefore be evaluated as part of your final grade. This assignment must be completed individually. Before attempting the assignment, you should study the module’s content.
Question 1: Yield spreads. Other things equal, would you expect the difference between the price of a Treasury bond and a corporate bond to increase or decrease with:
- The company’s business risk?
- The degree of leverage?
Question 2: Default option. Company A has issued a single zero-coupon bond maturing in 10 years. Company B has issued a coupon bond maturing in 10 years. Explain why it is more complicated to value B’s debt than A’s.
Question 3: Debt types. Select the most appropriate term from within the parentheses:
- (High-grade utility bonds / Low-grade utility bonds) generally have only light sinking-fund requirements.
- Collateral trust bonds are often issued by (utilities / industrial holding companies).
- (Utility bonds / Industrial bonds) are usually unsecured.
- Equipment trust certificates are usually issued by (railroads / financial companies).
- Mortgage pass-through certificates are an example of (an asset-backed security / project finance).
Question 4: Seniority.
- As a senior bondholder, would you like the company to issue more junior debt to finance its investment program, would you prefer it not to do so, or would you not care?
- You hold debt secured on the company’s existing property. Would you like the company to issue more unsecured debt to finance its investments, would you prefer it not to do so, or would you not care?
Question 5: Debt characteristics. True or False? Briefly explain in each case.
- It is better to hold unsecured bonds than secured bonds in the event of default.
- Many new and exotic debt securities are triggered by government policies or regulations.
- Call provisions give a valuable option to debt investors.
- Restrictive covenants have been shown to protect debt investors when takeovers are financed with large amounts of debt.
- Privately placed debt issues often include stricter covenants than public debt. However, public debt covenants are more difficult and expensive to renegotiate.
Question 6: Bond pricing. Suppose that the JCPenney bond was issued at face value and that investors continue to demand a yield of 8.25%. Sketch what you think would happen to the bond price as the first interest payment date approaches and then passes. What about the price of the bond plus accrued interest?
Question 7: Restructuring. True or false?
- One of the first tasks of an LBO’s financial manager is to pay down debt.
- Once an LBO for MBO goes private, it almost always stays private.
- Targets for LBOs in the 1980s tended to be profitable companies in mature industries.
- “Carried interest” refers to the deferral of interest payments on LBO debt.
- The announcement of a spin-off is generally followed by a sharp fall in the stock price.
- Privatizations are generally followed by massive layoffs.
- On average, privatization seems to improve efficiency and add value.
Question 8: Bankruptcy. What is the difference between Chapter 7 and Chapter 11 bankruptcy?