"Fixed Income": Defining Elements

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Questions 1:

Which of the following embedded options most likely provides a right to the issuer?

A 、Conversion provision

B、 Put feature

C、 Call feature

Questions 2:

An analyst reviews a corporate bond indenture that contains these two covenants:

1 The borrower will pay interest semiannually and principal at maturity.

2 The borrower will not incur additional debt if its debt-to-capital ratio is more than 50%.

What types of covenants are these?

A 、Covenant 1 is affirmative, and Covenant 2 is negative.

B、 Both are affirmative covenants.

C、 Covenant 1 is negative, and Covenant 2 is affirmative.

View answer resolution

【Answer to question 1】C

【analysis】

C is correct. The right to call the issue is beneficial to the issuer when interest rates fall.

A is incorrect because the conversion provision grants the bondholder the right to convert the bond for a specified number of shares of common stock. Such a feature allows the bondholder to take advantage of favorable movements in the price of the issuer’s common stock.

B is incorrect because the right to put the issue is an option granted to the bondholder to sell the bond back to the issuer at a predetermined price on specified dates before maturity.

【Answer to question 2】A

【analysis】

A is correct. Paying interest and principal is one of the most common affirmative covenants. Negative covenants set forth certain limitations and restrictions on the borrower’s activities. The more common restrictive covenants are those that impose limitations on the borrower’s ability to incur additional debt, such as specifying a debt-to-capital ratio, unless certain tests are satisfied.

B is incorrect because Covenant 2 is a negative covenant.

C is incorrect because the types of covenants has been reversed.

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