Question 1
A bond’s price decreases from par value to $925 due to a change in interest rates. All other things equal, this a good example of which of the following?
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interest rate risk
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default risk
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liquidity risk
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reinvestment risk
Question 2
A company is planning to raise $2 million to finance a new plant. Which statement regarding the cost of debt is true?
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The company would prefer to issue a bond without a call provision if its management thinks that interest rates are almost certain to decrease in the foreseeable future.
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If two tiers of debt are used (with one senior and one subordinated debt class) to raise the $2 million, the senior debt will carry ahigher interest rate.
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If debt is used to raise the $2 million, with $0.7 million as first mortgage bonds on the new plant and $1.3 million as debentures, the interest rate on the first mortgage bonds would be lower than it would be if the entire $2 million were raised by selling first mortgage bonds.
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If debt is used to raise the $2 million, the cost of the debt would be lower if the debt were in the form of an unsecured term loan rather than a mortgage bond.
Plant
Plant
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