Which of the following corporate debt instruments issued by the same corporation would tend to offer the highest yield?
A. 10-year convertible bond
B. 10-year non-convertible bond
C. 15-year subordinated debenture
D. 15-year collateral trust certificate
EXPLANATION: bonds with longer terms pay higher interest rates to investors, just as you would expect to pay a higher rate on a 30-year vs. a 15-year mortgage. So, you can eliminate choice A and B. Now that you're left with two 15-year bonds, ask yourself which one is more secure? Choice D has collateral behind it (a portfolio of securities). So, eliminate D, and you're left with C. Subordinated debenture holders are the lowest creditors in the pecking order.
ANSWER: C
Showing posts with label types of bonds. Show all posts
Showing posts with label types of bonds. Show all posts
Saturday, May 9, 2009
Saturday, January 17, 2009
Types of corporate bonds
This is the type of question I would expect to see on the Series 6, 7, and 65 exams. Notice how it makes you think as opposed to asking you to recall memorization points.
The XTZ Corporation will issue three series of bonds. Each offer is of the same size and term to maturity. XTZ will issue secured bonds, a series of debentures, and a series of subordinated debentures. Therefore,
A. The subordinated debentures would offer the lowest yield to investors
B. The secured bonds would offer the lowest yield to investors
C. XTZ is reducing the leverage component of its capital structure
D. The debentures would offer the lowest yield to investors
EXPLANATION: when bond investors take on more risk, they demand a higher yield. The secured bonds, backed by collateral, are the safest in terms of default risk, so they would offer the lowest yield here. Subordinated debentures put the investors at the bottom of the pecking order in bankruptcy and, therefore, have to offer a higher yield. Whenever a company issues bonds, they are using and, therefore, increasing leverage. The other way to capitalize is to sell ownership positions called "equity securities," which include common and preferred stock. Notice how analytical one needs to be to get the difficult exam questions right.
ANSWER: B
The XTZ Corporation will issue three series of bonds. Each offer is of the same size and term to maturity. XTZ will issue secured bonds, a series of debentures, and a series of subordinated debentures. Therefore,
A. The subordinated debentures would offer the lowest yield to investors
B. The secured bonds would offer the lowest yield to investors
C. XTZ is reducing the leverage component of its capital structure
D. The debentures would offer the lowest yield to investors
EXPLANATION: when bond investors take on more risk, they demand a higher yield. The secured bonds, backed by collateral, are the safest in terms of default risk, so they would offer the lowest yield here. Subordinated debentures put the investors at the bottom of the pecking order in bankruptcy and, therefore, have to offer a higher yield. Whenever a company issues bonds, they are using and, therefore, increasing leverage. The other way to capitalize is to sell ownership positions called "equity securities," which include common and preferred stock. Notice how analytical one needs to be to get the difficult exam questions right.
ANSWER: B
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