Chapter 4 Practice Question Answers
- 1. Answer: C. Term bonds are those in which the entire issue is scheduled to reach maturity on the same date and offers a single interest rate. A serial bond is a bond issue whose maturities are staggered in equal installments over a specific time period.
With term bonds the issuer has the ability to redeem the bonds early if it chooses. Term bonds generally require that the issuer make periodic payments into a sinking fund to be assured that the issuer will have the required funds when the principal comes due; however, this not an advantage to the issuer. Serial bonds have the advantage of requiring fewer interest expenses over the life of the bond.
- 2. Answer: A. A sinking fund redemption requires the issuer to set money aside regularly in a reserve account for the redemption of the bonds before maturity.
- 3. Answer: D. With a competitive bid, the bond is already structured before the underwriter is chosen, so the underwriter will not help with that. The financial advisor can help to prepare the offering instead. Voter approval is usually required with competitive bid offerings, and bond counsel offers a legal opinion in both competitive and negotiated bids.
- 4. Answer: B. The maintenance of a sinking fund reduces credit risk and assures investors of repayment. Greater investor confidence results in greater marketability, so a bond issue with a sinking fund provision typically has a higher credit rating and lower interest payments.
- 5. Answer: B. Credit enhancement is a legally binding pledge of financial support coming from a source other than the issuer that virtually guarantees repayment of the bond and serves to improve the creditworthiness of the bond. Bonds with credit enhancements have higher credit ratings than ones without. Advance refunding, insurance covenants, and letters of credit are all credit enhancements. A high debt service coverage ratio does not involve an outside sour