Deck 11: Notes, Bonds, and Leases

Question 1

Which of the following is/are not true?

A)The more long-term debt in a firm's capital structure, the greater the risk that the firm will experience difficulty making the required payments when due.
B)The more long-term debt in a firm's capital structure, the greater is the risk of default or bankruptcy.
C)Financial analysts use the long-term debt ratio to assess risk related to long-term borrowing.
D)The debt-equity ratio relates long-term debt to shareholders' equity, indicating the relative mix of long-term financing obtained from lenders versus owners.
E)none of the above

Answer 1

E

Question 2

The amount borrowed initially and the market value of a note or bond at any date subsequent to the initial borrowing equals the present value of the future, or remaining, cash flows discounted at an appropriate interest rate.

Answer 2

True

Question 3

Operating leases are economically similar to purchasing assets with funds obtained from issuing long-term bonds and result in similar accounting.

Answer 3

False

Question 4

Both the lease asset and the lease liability appear on the lessee's balance sheet under the capital lease method, whereas neither appears on the lessee's balance sheet under the operating lease method.

Question 5

The term face value refers to the principal amount printed on the face of the bond certificate.

Question 6

The internal rate of return, often called yield to maturity, is the discount rate that equates the future cash flows to the market value at any date.

Question 7

Firms classify the portion of bonds due within the next year as a noncurrent liability.

Question 8

Firms must disclose in notes to the financial statements the cash flows associated with capital leases and with operating leases for each of the succeeding five years and for all years after five years in the aggregate.

Question 9

Firms must disclose a list of their long-term debt obligations in notes to the financial statements.

Question 10

Modern business usage has come to restrict the word equity to mean only shareholders' equity, both contributed capital and retained earnings.

Question 11

The capital lease method classifies all of the lease payment each period as an operating
use of cash on the statement of cash flows.

Question 12

When the coupon rate equals the historical market interest rate or initial yield to maturity, then the initial issue price equals the face value of the bonds.

Question 13

Historical market interest rate is the discount rate prevailing at the date of the initial borrowing.

Question 14

The more long-term debt in a firm's capital structure, the less the risk that the firm will experience difficulty making the required payments when due.

Question 15

When analyzing leases, the risks of ownership include the risk of interest rate increases, the risk of technological change and other factors that would affect the lessor's ability to lease or sell the asset.

Question 16

Capital leases are economically similar to purchasing assets with funds obtained from issuing long-term bonds and result in similar accounting.

Question 17

The more long-term debt in a firm's capital structure, the less the risk of default or bankruptcy.

Question 18

Firms typically finance long-term assets, particularly property, plant, and equipment, with long-term borrowing or funds provided directly or indirectly by shareholders.

Question 19

U.S.GAAP and IFRS provide for two methods of accounting for long-term leases: the operating lease method and the capital or finance lease method.

Question 20

Common terminology refers to the calculations for amortizing a financial instrument to its maturity value over time as the imputed interest method.

Question 21

Divine Paper, a United States-based company, processes wood pulp into paper products in fixed-asset intensive facilities.It has a large ratio of property, plant, and equipment to total assets and a high debt-equity ratios.Which of the following is/are true?

A)Divine Paper carries higher levels of risk than an electrical utility.
B)Divine Paper does not have the regulated, monopoly status of an electrical utility.
C)Sales of Divine Paper are more sensitive to changes in the level of business activity than those of an electric utility.
D)The higher risk of Divine Paper, relative to an electric utility, raises its borrowing costs and decreases its reliance on debt financing.
E)all of the above

Question 22

Which of the following is/are not true?

A)A bond indenture refers to the financial contract underlying bonds.
B)Bonds appear on the balance sheet under the title Bonds Payable.
C)Bonds typically carry maturity dates longer than approximately ten years .
D)Bonds typically involve many lenders instead of a single lender.
E)Firms need not disclose a list of their long-term debt obligations in notes to the financial statements.

Question 23

A zero coupon bond provides for _____ periodic payments of interest while the bond is outstanding; and the bond requires payment of all _____ at maturity.

A)six month; principal
B)no; principal and interest
C)annual; principal
D)monthly; principal
E)none of the above

Question 24

Excellent Paper, a United States-based company, processes wood pulp into paper products in fixed-asset intensive facilities.It has a large ratio of property, plant, and equipment to total assets and a high debt-equity ratios.Which of the following is/are not true?

A)Excellent Paper carries a higher levels of risk than an electrical utility.
B)Excellent Paper does not have the regulated, monopoly status of an electrical utility.
C)Sales of Excellent Paper are more sensitive to changes in the level of business activity than those of an electric utility.
D)The higher risk of Excellent Paper, relative to an electric utility, raises its borrowing costs and decreases its reliance on debt financing.
E)Excellent Paper, relative to an electric utility, has more assets to serve as collateral for borrowing.

Question 25

Which of the following is/are not true?

A)Common terminology refers to the financial contract underlying bank loans as a note.
B)Financial contracts underlying bank loans usually appear on the balance sheet under the title Notes Payable.
C)Notes of business firms generally have maturity dates less than approximately ten years.
D)A public market for Notes Payable exists, so the borrower will be able to disengage from the borrowing arrangement prior to maturity.
E)all of the above

Question 26

Which of the following is/are true?

A)Common terminology refers to the financial contract underlying bank loans as a note.
B)Financial contracts underlying bank loans usually appear on the balance sheet under the title Notes Payable.
C)Notes of business firms generally have maturity dates less than approximately ten years.
D)No public market for Notes Payable exists, so the borrower will have difficulty disengaging from the borrowing arrangement prior to maturity.
E)all of the above

Question 27

A _____ bond requires periodic payments of interest plus a portion of the principal throughout the life of the bond.

A)convertible
B)callable
C)zero coupon
D)serial
E)debenture

Question 28

Firms that need cash for long-term purposes, such as acquiring buildings and equipment or financing a business acquisition, and that wish to use debt as a means of obtaining cash, will

A)issue common stock in the capital markets.
B)issue preferred stock in the capital markets.
C)issue paid-in-capital in the capital markets.
D)issue bonds in the capital markets.
E)all of the above

Question 29

Firms that need cash for long-term purposes, such as acquiring buildings and equipment or financing a business acquisition, and that wish to use debt as a means of obtaining cash, will

A)borrow from commercial banks.
B)borrow from insurance companies.
C)borrow from financial institutions.
D)issue bonds in the capital markets.
E)all of the above

Question 30

Which of the following is/are true?

A)The more long-term debt in a firm's capital structure, the less the risk that the firm will experience difficulty making the required payments when due.
B)The more long-term debt in a firm's capital structure, the less is the risk of default or bankruptcy.
C)Financial analysts use the long-term debt ratio to assess risk related to long-term borrowing.
D)The debt-equity ratio relates short-term debt to shareholders' equity, indicating the relative mix of short-term financing obtained from lenders versus owners.
E)none of the above

Question 31

A _____ is a financial contract in which the borrower and the lender agree to certain conditions about repayment, operating policies, other borrowing activities while they are outstanding, and other provisions.

A)preferred stock
B)common stock
C)paid-in-capital
D)bond
E)a restriction on retained earnings

Question 32

Some bonds are _____, which means the issuing firm has the right to repurchase the bonds prior to maturity at a specified price.

A)convertible
B)callable
C)zero coupon
D)serial
E)debentures

Question 33

Charm City Electric is a regulated monopoly providing electric services in a large city.Property, plant, and equipment dominate the asset side of the balance sheet.Which of the following is/are true?

A)It relies more on long-term debt than shareholders' equity to finance these facilities.
B)It may a debt-equity ratio of 100% or more.
C)The regulated monopoly status practically eliminates the risk of default or bankruptcy, so Charm City Electric faces a relatively low borrowing cost.
D)Charm City Electric's production and transmission facilities can serve as collateral for the long-term.
E)all of the above

Question 34

Investors in bonds sometimes hold a _____ option, meaning they can force the issuing company to repay the bonds prior to maturity under specified contractual conditions.

A)convertible
B)call
C)put
D)serial
E)short-term

Question 35

Big City Electric is a regulated monopoly providing electric services in a large city.Property, plant, and equipment dominate the asset side of the balance sheet.Which of the following is not true?

A)It relies more on long-term debt than shareholders' equity to finance these facilities.
B)It has a debt-equity ratio of 50% or less.
C)The regulated monopoly status practically eliminates the risk of default or bankruptcy, so Big City Electric faces a relatively low borrowing cost.
D)Big City Electric's production and transmission facilities can serve as collateral for the debt.
E)none of the above

Question 36

Which of the following is/are true?

A)A bond indenture refers to the financial contract underlying bonds.
B)Bonds appear on the balance sheet under the title Bonds Payable.
C)Bonds typically carry maturity dates longer than approximately ten years.
D)Bonds typically involve many lenders instead of a single lender.
E)all of the above

Question 37

Loans from commercial banks and other financial institutions often require firms to pledge assets as _____.

A)"senior" tranches
B)derivatives
C)collateral
D)"junior" tranches
E)principal payments

Question 38

Which of the following is not true regarding specific bond provisions?

A)Firms might issue bonds based only on their credit worthiness as an entity.
B)Particular collateral might back up bonds issued by a firm.
C)Unsecured borrowing might carry senior rights or subordinated rights in the event of bankruptcy.
D)Senior debt holders have a higher priority for payment in the event of bankruptcy than subordinated (junior) unsecured lenders.
E)Common stockholders have a higher priority than unsecured bondholders for payment in the event of bankruptcy.

Question 39

General Semiconductor is a European-based designer and manufacturer of semiconductors.It manufactures semiconductors in fixed-asset intensive plants.The moderate fraction of its total assets that are property, plant, and equipment results from depreciating its technology-intensive manufacturing facilities over periods as short as four years.Which of the following is/are true?

A)General Semiconductor has small long-term debt and debt-equity ratios.
B)General Semiconductor incurs substantial technology risk from product obsolescence, with product life cycles of less than two years.
C)Heavy reliance on debt financing would add financing risk and thereby increase borrowing costs even more.
D)All of the above are true.
E)none of the above

Question 40

First Communications Group is a communication services firm whose employees provide advertising, market research, public relations, and other services world-wide.Other than relatively small amounts of equipment, it owns virtually no property, plant, and equipment (it leases most of its office space).Which of the following is/are true?

A)First Communications Group has a low fixed asset intensity.
B)First Communications Group has a low debt-equity ratio.
C)First Communications Group creates value from employees' services, not from operating assets, so there is neither the need nor the ability to borrow long-term using property, plant, and equipment as collateral.
D)all of the above are true
E)none of the above

Question 41

When the stated interest rate for a loan equals the yield required by the lender, then the amount borrowed equals the

A)principal amount of the loan.
B)principal amount of the loan plus a premium.
C)principal amount of the loan less a discount.
D)fair amount of the loan.
E)fair amount of the loan less a discount.

Question 42

The approach which dominates current financial reporting of financial instruments [uses the historical market interest rate to compute the carrying value of notes and bonds while these obligations are outstanding] is the _____ approach.

A)amortized cost
B)un-amortized cost
C)imputed cost
D)future value
E)liquidation value

Question 43

Investors in bonds might exercise a _____ option if interest rates increase, and investors can reinvest the cash proceeds in debt securities with a higher yield.

A)convertible
B)call
C)put
D)serial
E)short-term

Question 44

The amount borrowed initially and the market value of a note or bond at any date subsequent to the initial borrowing equals

A)the sum of the future cash flows.
B)the present value of the future, or remaining, cash flows discounted at an appropriate interest rate.
C)the future cash flows discounted at the initial market interest rate.
D)the future cash flows discounted at the subsequent market interest rate.
E)the future value of present cash flows discounted at an appropriate interest rate.

Question 45

Notes, bonds, leases and derivatives are _____.

A)present values of future cash flows
B)financial instruments
C)collateralized debt obligations
D)unsecured debt obligations
E)investment trusts

Question 46

The conversion option of convertible bonds has value because the holder can benefit from some of the later increases in the market value of the firm's _____ after issuance of the bonds.

A)preferred stock
B)paid-in-capital
C)treasury stock
D)common stock
E)debentures

Question 47

A firm classifies liabilities which fall due after the operating cycle, usually greater than one year, as

A)a current liability.
B)a long-term asset.
C)a noncurrent liability.
D)part of shareholders' equity.
E)contingent liability.

Question 48

_____ of a note or bond at any date subsequent to the initial borrowing equals the present value of the future, or remaining, cash flows discounted at an appropriate interest rate.

A)The amount borrowed initially
B)The market value
C)The liquidation value
D)The net realizable value less selling costs
E)choices a and b

Question 49

On the date of initial issuance of a financial instrument , the market value will equal

A)the initial issue proceeds [the amount borrowed].
B)the sum of the future cash flows.
C)the maturity value of the instrument.
D)the par value of the instrument.
E)the par value of the instrument minus the premium or plus a discount.

Question 50

A callable bond

A)must be retired from a sinking fund maintained by the bond issuer.
B)may be retired at a specified price at the option of the bond purchaser.
C)may be reacquired by the issuing company at a specified price.
D)are registered with an agent to insure correct payment of bond interest amounts.
E)are convertible into common stock at par values.

Question 51

Bonds whose indentures contain a provision which requires the issuing firm to make a provision for partial early retirement of the bond issue include serial bonds and _____ bonds.

A)callable
B)refunded
C)sinking fund
D)convertible
E)zero coupon

Question 52

What determine(s) the risk of investing in a bond issue, which in turn affects the interest rate investors demand and therefore the bond's price?

A)industry economic characteristics
B)the financial health of a firm
C)particular provisions of a bond issue
D)all of the above
E)none of the above

Question 53

Firms typically borrow from banks, insurance companies, and other financial institutions by signing a note, which specifies the terms of the borrowing arrangement.The initial valuation of the loan equals _____.

A)the future value of the present cash payments discounted at the yield required by the borrower.
B)the future value of the present cash payments discounted at the yield required by the lender.
C)the present value of the future cash payments discounted at the yield required by the borrower.
D)the present value of the future cash payments discounted at the yield required by the lender.
E)the future value of the present cash payments undiscounted.

Question 54

_____bonds permit the holder to exchange the bonds for shares of the firm's common stock under certain conditions.

A)Derivative
B)Convertible
C)zero coupon
D)Serial
E)Debenture

Question 55

The amount reported on the balance sheet throughout the life of a loan (that is, its carrying value) equals

A)the future value of the remaining cash flows discounted at the historical market interest rate.
B)the present value of the remaining cash flows discounted at the historical market interest rate.
C)the future value of the remaining cash flows discounted at the current market interest rate.
D)the present value of the remaining cash flows discounted at the current market interest rate.
E)the future value of the remaining cash flows discounted at the fair market interest rate.

Question 56

A firm classifies mortgages, notes, bonds, and leases which were used to acquire its long-term assets that fall due after the operating cycle, (usually greater than one year) as

A)a current liabilities.
B)a long-term asset.
C)a long-term liabilities.
D)part of shareholders' equity.
E)contingent liabilities.

Question 57

Bonds whose indentures contain a provision which gives the issuing company the option to retire portions of the bond issue before maturity if it so desires, but the provision does not require the company to do so are called _____ bonds.

A)callable
B)refunded
C)sinking fund
D)serial
E)convertible

Question 58

_____ often advise corporate borrowers on the sorts of financial instruments the lending market appears to prefer at the time the firm wants to borrow.

A)Stockbrokers
B)Investment bankers
C)Underwriters
D)Board of Directors
E)Chief Financial Officers

Question 59

The typical _____ bond pays interest periodically, usually every six months, during the life of the bond and repays the principal amount borrowed at maturity.

A)derivative
B)multi-coupon
C)zero coupon
D)serial
E)debenture

Question 60

When the bond indenture provides that stated amounts of principal will become due during the term of the bond, the bond is called a _____ bond.

A)sinking fund
B)serial
C)callable
D)refunded
E)convertible

Question 61

In return for promising to make future payments, a firm receives cash or other assets with a measurable cash-equivalent value.The firm records a long-term liability for that amount and determines the market interest rate by finding the

A)internal rate of return.
B)external rate of return.
C)applicable federal rate.
D)prime lending rate published in The Wall Street Journal.
E)federal funds rate.

Question 62

On January 1, Year 4, Jones Realty Company issued 8 percent term bonds with a face amount of $1 million due January 1, Year 14.Interest is payable semi-annually on January 1 and July 1.On the date of issue, investors were willing to accept an effective interest rate of 6 percent.Assume the bonds were issued on January 1, Year 4.for $1,148,959.Using the effective interest amortization method, Jones Realty Company recorded interest expense for the six months ended June 30, Year 4, in the amount of

A)$40,000
B)$80,000
C)$68,938
D)$34,469
E)none of the above

Question 63

When using the effective interest method the amount of interest expense each period equals the

A)current market interest rate times the carrying value of the financial instrument at the date of issuance.
B)current market interest rate times the carrying value of the financial instrument at the beginning of each period.
C)historical market interest rate times the carrying value of the financial instrument at the date of issuance.
D)historical market interest rate times the carrying value of the financial instrument at the beginning of each period.
E)fair market interest rate times the carrying value of the financial instrument at the date of issuance.

Question 64

U.S.GAAP requires that all long-term monetary liabilities appear on the balance sheet at the

A)future value of the present cash payments.
B)total value of the future cash payments.
C)imputed value of the future cash payments.
D)present value of the future cash payments.
E)historical cash proceeds from debt issuance.

Question 65

In return for promising to make future payments, a firm receives cash or other assets with a measurable cash-equivalent value.The firm records a long-term liability for that amount and the book value of that borrowing at any time equals the

A)future value of all the then-remaining promised payments using the historical market interest rate applicable at the time the firm originally incurred the liability.
B)current value of all the then-remaining promised payments using the historical market interest rate applicable at the time the firm originally incurred the liability.
C)present value of all the then-remaining promised payments using the market interest rate applicable at the current time.
D)present value of all the then-remaining promised payments using the historical market interest rate applicable at the time the firm originally incurred the liability.
E)future value of all the then-remaining promised payments using the using the market interest rate applicable at the current time.

Question 66

On February 1, Year 1, Centra issues $100,000 semi-annual 12% bonds at par plus accrued interest.The interest is payable on July 1 and January 1 of each year.What entry is necessary to record the issuance of the bonds on February 1?

A)Cash 100,000 Bonds Payable 100,000
B)Cash 101,000 Bonds Payable 101,000
C)Cash 100,000 Interest Payable 1,000
Bonds Payable 101,000
D)Cash 101,000 Bonds Payable 100,000
Interest Payable 1,000
E)none of the above

Question 67

In historical cost accounting, the discounting process uses the original interest rate appropriate for the particular borrower at the time it incurred the obligation.That rate will have depended on the amount and terms of the borrowing arrangement as well as the risk that the borrower will default on the obligations.The rate is known as the

A)prime interest rate.
B)explicit interest rate.
C)imputed interest rate.
D)federal funds rate.
E)applicable federal rate.

Question 68

In Year 7, Nortel Manufacturing issued $100,000 semi-annual 12% bonds at par.Interest is payable on July 1 and January 1.What entry is necessary at December 31, Year 9?

A)Interest Expense 6,000 Cash 6,000
B)Interest Expense 6,000 Bonds Payable 6,000
C)Interest Expense 6,000 Interest Payable 6,000
D)Interest Expense 12,000 Interest Payable 12,000
E)Cash 6,000 Interest Payable 6,000

Question 69

Bonds whose indentures contain a provision which requires the issuing firm to make a provision for partial early retirement of the bond issue are sinking fund bonds and _____ bonds.

A)callable bonds
B)refunded bonds
C)serial bonds
D)convertible bonds
E)zero coupon bonds

Question 70

On January 1, Year 4, Jones Realty Company issued 8 percent term bonds with a face amount of $1 million due January 1, Year 14.Interest is payable semi-annually on January 1 and July 1.On the date of issue, investors were willing to accept an effective interest rate of 6 percent.Assume the bonds were issued on January 1, Year 4.for $1,148,959.The bonds were issued on January 1, Year 4, at

A)a premium.
B)an amortized value.
C)a discount.
D)face value.
E)par value.

Question 71

A bond that does not require a periodic cash payment, but instead promises a single payment at maturity, is called a _____ bond.

A)sinking fund
B)zero coupon
C)debenture
D)perpetual
E)convertible

Question 72

Common terminology refers to the calculations for amortizing a financial instrument to its maturity value over time as the _____ interest method.

A)efficient
B)economical
C)market
D)effective
E)imputed

Question 73

Bonds are issued at greater than par value when

A)the bonds are risk free.
B)the market interest rate is less than the stated interest rate on the bond.
C)the market rate of interest is declining.
D)the market interest rate is greater than the stated interest rate on the bond.
E)the market interest rate equals the stated interest rate on the bond.

Question 74

Borrowers who retire long-term liabilities debit the liability account for its current book value, credit Cash, and recognizes any difference on the retirement of the debt as a

A)gain when book value exceeds cash disbursement (credit).
B)gain when cash disbursement exceeds book value (credit).
C)loss when book value exceeds cash disbursement (debit).
D)a financing loss (debit).
E)cannot be determined from the above information.

Question 75

A firm classifies liabilities which fall due within the operating cycle, usually one year, as

A)a current liability.
B)a long-term liability.
C)a noncurrent asset.
D)part of shareholders' equity.
E)a contingent liability.

Question 76

Debentures that the holder (lender) can exchange, possible after some specific period of time has elapsed, for a specific number of shares of common stock or, perhaps, preferred stock of the borrower are called _____ bonds.

A)sinking fund
B)zero coupon
C)serial
D)convertible
E)callable

Question 77

An initial issue price equal to the face value of the bonds means that the implicit interest rate equals the _____.

A)fair interest rate
B)average interest rate
C)future interest rate
D)yield to maturity
E)past interest rate

Question 78

A document or agreement giving the terms of the bond and the rights and duties of the borrower and other parties to the contract that provides some protection to the bondholders and typically limits the borrower's right to declare dividends, to make other distributions to owners, and to acquire other businesses is known as a

A)bond sinking fund agreement.
B)serial bond funding agreement.
C)bond indenture.
D)creditor indenture.
E)business trust indenture.

Question 79

The most common type of corporate bond, except in the railroad and public utility industries, that carries no special collateral and the borrower issues it on the general credit of the business is called a

A)sinking fund bond.
B)serial funded bond.
C)debenture bond.
D)convertible bond.
E)zero coupon bond.

Question 80

The interest rate that discounts a series of future cash flows to its present value is called the

A)internal rate of return.
B)external rate of return.
C)creditors rate of return.
D)prime lending rate published in The Wall Street Journal.
E)federal funds rate.