Question & Answer

Explain how the credit crisis that began in 2008 affected the default rates of junk bonds and the risk premiums offered on newly issued junk bonds. (LO2)

 If bond yields in Japan rise, how might U.S. bond yields be affected? Why? (LO3)

Why can convertible bonds be issued by firms at a higher price than other bonds? (LO2)

Are variable-rate bonds attractive to investors who expect interest rates to decrease? Explain. Would a firm that needs to borrow funds consider issuing variable-rate bonds if it expects interest rates to decrease in the future? Explain. (LO2)

What are the advantages and disadvantages to a firm that issues low- or zero-coupon bonds? (LO2)

What are debentures? How do they differ from subordinated debentures? (LO2)

Explain the use of bond collateral and identify the common types of collateral for bonds. (LO2)

Explain the use of call provisions on bonds. How can a call provision affect the price of a bond? (LO2)

What are protective covenants? Why are they needed? (LO2)

Explain the use of a sinking-fund provision. How can it reduce the investor’s risk? (LO2)

What is a bond indenture? What is the function of a trustee with respect to the bond indenture? (LO2)

Many financial institutions borrow heavily in the money markets using mortgages and mortgage-backed securities as collateral. Write a short essay about the lessons of the credit crisis to the deficit units and the surplus units that participate in the money markets. Should money markets be regulated to a greater degree to ensure proper collateral in money markets? 

Explain how the Covid-19 pandemic affected the credit risk premium and liquidity in the commercial paper market. (LO1)

Explain why investors that provided guarantees on commercial paper were exposed to so much risk during the credit crisis. (LO1)

Explain how systemic risk is related to the commercial paper market. That is, why did problems in the market for mortgage-backed securities affect the commercial paper market? (LO1) 

Explain how the credit crisis affected the credit risk premium in the commercial paper market. (LO1) 

Explain why the credit crisis affected the ability of financial institutions to access short-term financing in the money markets. (LO1)

Explain the lesson to be learned about the repo market based on the experience of Bear Stearns. (LO1)

Explain how the bankruptcy of Lehman Brothers (a large securities firm) reduced the liquidity of the commercial paper market. (LO1)

How have money market rates changed since the beginning of the semester? Consider the current economic conditions. Do you think money market rates will increase or decrease during the semester? Offer some logic to support your answer. (LO1)

Apply the term structure of interest rate theories that were discussed in Chapter 3 to explain the shape of the existing commercial paper yield curve. (LO1)

Assume that interest rates for most maturities are unusually high. Also assume that the net working capital (defined as current assets minus current liabilities) levels of many corporations are relatively low in this period. Explain how the money markets play a role in this relationship between the interest rates and the level of net working capital. (LO1)

How do you think the shape of the yield curve for commercial paper and other money market instruments compares to the yield curve for Treasury securities? Explain your logic. (LO1)

You have the choice of investing in toprated commercial paper or commercial paper that has a lower risk rating. How do you think the risk and return performances of the two investments differ? (LO1)

The maximum maturity of commercial paper is 270 days. Why would a firm issue commercial paper instead of longerterm securities, even if it needs funds for a long period of time? (LO1)