IMANET IMANET Certifications IMANET-CMA Questions & Answers

• Question 671:

  All of the following may reduce the coupon rate on a bond issued at par except a

  A. Sinking fund

  B. Call provision.

  C. Change in rating from Aa to Aaa.

  D. Conversion option.

  Correct Answer: B

  A bond issued at par may carry a lower coupon rate than other similar bonds in the market if it has some feature that makes it more attractive to investors. For example, a sinking fund reduces default risk. Hence, investors may require a lower risk premium and be willing to accept a lower coupon rate. Other features attractive to investors include covenants in the bond indenture that restrict risky undertakings by the issuer and an option to convert the debt instruments to equity securities. The opportunity to profit from appreciation of the firm's stock justifies a lower coupon rate. An improvement in a bond's rating from Aa to Aaa (the highest possible) also justifies reduction in the risk premium and a lower coupon rate. However, a call provision is usually undesirable to investors. The issuer may take advantage of a decline in interest rates to recall the bond and stop paying interest before maturity.

• Question 672:

  Which one of the following statements is true when comparing bond financing alternatives?

  A. A bond with a call provision typically has a lower yield to maturity than a similar bond without a call provision.

  B. A convertible bond must be converted to common stock prior to its maturity.

  C. A call provision is generally considered detrimental to the investor.

  D. A call premium requires the investor to pay an amount greater than par at the time of purchase.

  Correct Answer: C

  A callable bond can be recalled by the issuer prior to maturity. A call provision is detrimental to the investor because the issuer can recall the bond when market interest rates decline. It is usually exercised only when a company wishes to refinance high- interest debt.

• Question 673:

  The best reason corporation issue Eurobonds rather than domestic bonds is that

  A. These bonds are denominated in the currency of the country in which they are issued.

  B. These bonds are normally a less expensive form of financing because of the absence of government regulation

  C. Foreign buyers more readily accept the issues of both large and small U.S corporations than do domestic investors

  D. Eurobonds carry no foreign exchange risk

  Correct Answer: B

  International bonds are of two types: foreign bonds and Eurobonds. Foreign bonds are denominated in the currency of the nation in which they are sold. Eurobonds are denominated in a currency other than that of the nation where they are sold. Foreign bonds issued in the United States and denominated in dollars must be registered with the SEC, but such extensive disclosure is not required in most European nations. Thus, an American company may elect to issue Eurobonds denominated in dollars in a foreign nation because of the convenience of not having to comply with governmental registration requirements.

• Question 674:

  Junk bonds are

  A. Securities rated at less than investment grade.

  B. Worthless securities.

  C. Securities that are highly risky but offer only low yields.

  D. Considered illegal since the collapse of the Drexel Burnham Lambert firm

  Correct Answer: A

  Junk bonds are high-risk and therefore high-yield securities that are normally issued when the debt ratio is very high. Thus, the bondholders have as much risk as the holders of equity securities. Such bonds are not highly rated by credit evaluation companies. Junk bonds have become accepted because of the tax deductibility of the interest paid.

• Question 675:

  The best advantage of a zero-coupon bond to the issuer is that the

  A. Bond requires a low issuance cost.

  B. Bond requires no interest income calculation to the holder or issuer until maturity.

  C. Interest can be amortized annually by the APR method and need not be shown as an interest expense to the issuer

  D. Interest can be amortized annually on a straight-line basis but is a noncash outlay

  Correct Answer: D

  Zero-coupon bonds do not pay periodic interest. The bonds are sold at a discount from their face value, and the investors do not receive interest until the bonds mature. The issuer does not have to make annual cash outlays for interest. However, the discount must be amortized annual and reported as interest expense.

• Question 676:

  Serial bonds are attractive to investors because

  A. All bonds in the issue mature on the same date

  B. The yield to maturity is the same for all bonds in the issue.

  C. Investors can choose the maturity that suits their financial needs.

  D. The coupon rate on these bonds is adjusted to the maturity date.

  Correct Answer: C

  Serial bonds have staggered maturities; that is, they mature over a period (series) of years. Thus, investors can choose the maturity date that meets their investment needs. For example, an investor who will have a child starting college in 16 years can choose bonds that mature in 16 years

• Question 677:

  Which one of the following characteristics distinguishes income bonds from other bonds?

  A. The bondholder is guaranteed an income over the life of the security.

  B. By promising a return to the bondholder, an income bond is junior to preferred and common stock.

  C. Income bonds are junior to subordinated debt but senior to preferred and common stock.

  D. Income bonds pay interest only if the issuing company has earned the interest.

  Correct Answer: D

  An income bond is one that pays interest only if the issuing company has earned the interest, although the principal must still be paid on the due date. Such bonds are riskier than normal bonds

• Question 678:

  Debentures are

  A. Income bonds that require interest payments only when earnings permit.

  B. Subordinated debt and rank behind convertible bonds.

  C. Bonds secured by the full faith and credit of the issuing firm

  D. A form of lease financing similar to equipment trust certificates

  Correct Answer: C

  Debentures are unsecured bonds. Although no assets are mortgaged as security for the bonds, debentures are secured by the full faith and credit of the issuing firm. Debentures are a general obligation of the borrower. Only, companies with the best credit ratings can issue debentures because only the company's credit rating and reputation secure the bonds.

• Question 679:

  If a $1,000 bond sells for $1,125, which of the following statements are true?

  I. The market rate of interest is greater than the coupon rate on the bond.

  II. The coupon rate on the bond is greater than the market rate of interest.

  III. The coupon rate and the market rate are equal

  IV.

  The bond sells at a premium.

  V.

  The bond sells at a discount.

  A.

  I and IV

  B.

  I and V

  C.

  II and lV

  D.

  II and V

  Correct Answer: C

  The excess of the price over the face value is a premium. A premium is paid because the coupon rate on the bond is greater than the market rate of interest. In other words, because the bond is paying a higher rate than other similar bonds, its price is bid up by investors.

• Question 680:

  Each share of nonparticipating, 8%, cumulative preferred stock in a company that meets its dividend obligations has all of the following characteristics except

  A. Voting rights in corporate elections.

  B. Dividend payments that are not tax deductible by the company.

  C. No principal repayments

  D. A superior claim to common stock equity in the case of liquidation.

  Correct Answer: A

  Dividends on cumulative preferred stock accrue until declared; that is, the book value of the preferred stock increases by the amount of any undeclared dividends. Participating preferred stock participates with common shareholders in excess earnings of the company. In other words, 8% participating preferred stock might pay a dividend each year greater than 8% when the corporation is extremely profitable. Therefore, nonparticipating preferred stock will receive no more than is stated on the face of the stock. Preferred shareholders rarely have voting rights. Voting rights are exchanged for preferences regarding dividends and liquidation of assets.