Debt Financing: Types, Advantages, and Disadvantages for Businesses

Question 1

Which debt instrument represents a long-term obligation with predetermined, periodic interest payments?

Accepted Answer

Bond

Answer

Commercial paper

Answer

Line of credit

Answer

Bridge loan

Question 2

The primary distinction between secured and unsecured debt is:

Accepted Answer

Collateral

Answer

Interest rate

Answer

Repayment term

Answer

Tax implications

Question 3

A sinking fund in debt financing primarily serves to:

Accepted Answer

Gradually repay the principal of a bond

Answer

Cover interest payments

Answer

Provide additional collateral

Answer

Reduce the likelihood of default

Question 4

When evaluating a borrower's creditworthiness, the following is not a relevant factor:

Accepted Answer

Personal wealth

Answer

Financial records

Answer

Credit history

Answer

Industry outlook

Question 5

A rapidly growing tech company with a stable cash flow is considering issuing bonds to finance its expansion. Which of the following is the PRIMARY benefit of using bonds in this scenario?

Accepted Answer

Potentially lower interest rates

Answer

Increased flexibility in repayment terms

Answer

Faster approval and issuance process

Answer

No requirement for personal guarantees

Question 6

Which of the following is not a characteristic of debt financing?

Accepted Answer

Increase in ownership equity

Answer

Fixed interest payments

Answer

Obligation to repay principal

Answer

Potential for default

Question 7

Long-term debt instruments with fixed interest payments and maturities of over five years are known as:

Accepted Answer

Bonds

Answer

Debentures

Answer

Notes

Answer

Commercial paper

Question 8

The process of issuing new debt to replace existing debt is called:

Accepted Answer

Debt refinancing

Answer

Debt restructuring

Answer

Debt consolidation

Answer

Debt issuance

Question 9

A company's capital structure refers to:

Accepted Answer

The mix of debt and equity financing it employs

Answer

The amount of working capital it has

Answer

The proportion of its assets funded by equity

Answer

The total value of its assets

Question 10

The weighted average cost of capital (WACC) is used to calculate:

Accepted Answer

The average cost of financing from all sources

Answer

The cost of equity financing only

Answer

The cost of debt financing only

Answer

The future value of investments

Question 11

Which of the following is NOT a primary benefit of debt financing?

Accepted Answer

Increased control for shareholders

Answer

Tax savings due to interest expense deductibility

Answer

Potentially lower cost of capital compared to equity financing

Answer

Stronger creditworthiness due to the priority of debt repayment

Question 12

A company that issues debt instruments with a maturity of over one year is engaged in:

Accepted Answer

Long-term debt financing

Answer

Short-term debt financing

Answer

Intermediate-term debt financing

Answer

Equity financing

Question 13

In a debt agreement, a covenant that restricts the company from taking on additional debt is referred to as a:

Accepted Answer

Negative covenant

Answer

Positive covenant

Answer

Restrictive covenant

Answer

Protective covenant

Question 14

Which of the following is a legal document that outlines the terms and conditions of a debt issuance?

Accepted Answer

Indenture

Answer

Prospectus

Answer

Registration statement

Answer

Underwriting agreement

Question 15

A bond that grants the holder the option to convert it into a predetermined number of shares of common stock is known as a:

Accepted Answer

Convertible bond

Answer

Callable bond

Answer

Puttable bond

Answer

Zero-coupon bond

Question 16

A loan that is secured by a specific asset of the borrower is referred to as a:

Accepted Answer

Asset-backed loan

Answer

Term loan

Answer

Revolving credit facility

Answer

Debenture

Question 17

A debt obligation that is not secured by any specific asset of the borrower is called:

Accepted Answer

Unsecured loan

Answer

Secured loan

Answer

Subordinated debt

Answer

Convertible debt

Question 18

Differentiate between a secured and an unsecured debt.

Accepted Answer

Secured debt is backed by collateral, while unsecured debt is not.

Answer

Secured debt has a lower interest rate than unsecured debt.

Answer

Secured debt is more difficult to obtain than unsecured debt.

Answer

There is no difference between a secured and an unsecured debt.

Question 19

What is the purpose of a covenant in a debt agreement?

Accepted Answer

To restrict the borrower's actions and ensure financial discipline.

Answer

To provide collateral in case of default.

Answer

To outline the legal terms of the loan.

Answer

To set the interest rate on the loan.

Question 20

What is the primary function of a bond rating?

Accepted Answer

To provide an independent assessment of the creditworthiness of the bond issuer.

Answer

To set the interest rate on a bond.

Answer

To determine the maturity date of a bond.

Answer

To ensure that a bond is priced fairly.

Question 21

What is a call provision in a bond?

Accepted Answer

It allows the issuer to repurchase the bond at a specified price before maturity.

Answer

It requires the issuer to repurchase the bond at a specified price after maturity.

Answer

It permits the bondholder to sell the bond back to the issuer at a specified price.

Answer

It prevents the issuer from redeeming the bond before maturity.

Question 22

What is the key difference between a sinking fund and a capital reserve fund?

Accepted Answer

A sinking fund is used to retire debt, while a capital reserve fund is used for major capital expenditures.

Answer

A capital reserve fund is used to retire debt, while a sinking fund is used for major capital expenditures.

Answer

There is no difference between a sinking fund and a capital reserve fund.

Answer

A sinking fund is a sub-type of capital reserve fund.

Question 23

What is a leveraged buyout transaction?

Accepted Answer

A company is acquired using predominantly debt financing.

Answer

A company is acquired using primarily equity financing.

Answer

A company is acquired using a mix of debt and equity financing.

Answer

A company is sold to its employees.

Question 24

Which of the following is a primary advantage of debt financing for a company?

Accepted Answer

Tax deductions on interest payments

Answer

Increased financial flexibility

Answer

Higher potential return on equity

Answer

Less risk of bankruptcy

Question 25

What type of debt instrument typically has a fixed interest rate and a predetermined maturity date?

Accepted Answer

Bond

Answer

Stock

Answer

Commercial paper

Answer

Convertible bond

Question 26

What is the primary purpose of a sinking fund in relation to debt financing?

Accepted Answer

To gradually accumulate funds to repay the debt

Answer

To provide security for the lender

Answer

To reduce the company's debt-to-equity ratio

Answer

To protect against interest rate fluctuations

Question 27

Which of the following is a key risk associated with debt financing for a company?

Accepted Answer

Interest rate risk

Answer

Inflation risk

Answer

Political risk

Answer

Currency risk

Question 28

What is the main difference between a secured loan and an unsecured loan?

Accepted Answer

Secured loans are backed by collateral, while unsecured loans are not.

Answer

Secured loans have higher interest rates than unsecured loans.

Answer

Unsecured loans are more common than secured loans.

Answer

Secured loans can only be used to finance real estate purchases.

Question 29

Which of the following is a potential source of equity financing for a company?

Accepted Answer

Issuing common stock

Answer

Borrowing money from a bank

Answer

Selling bonds

Answer

Taking on a new partner

Question 30

What is the main purpose of a covenant in a debt agreement?

Accepted Answer

To protect the lender's interests

Answer

To specify the terms of the loan

Answer

To limit the company's ability to borrow additional funds

Answer

To establish a sinking fund for the debt

Question 31

Which of the following is a common type of covenant that restricts a company's financial flexibility?

Accepted Answer

Debt-to-equity ratio covenant

Answer

Interest coverage ratio covenant

Answer

Negative pledge covenant

Answer

Due diligence covenant

Question 32

What is the key distinction between a term loan and a revolving credit facility?

Accepted Answer

Term loans have a fixed repayment schedule, while revolving credit facilities have a flexible repayment schedule.

Answer

Term loans are typically unsecured, while revolving credit facilities are secured.

Answer

Term loans are typically provided by investment banks, while revolving credit facilities are provided by banks.

Answer

Term loans have a higher interest rate than revolving credit facilities.

Question 33

True or False: Debt financing always results in the dilution of shareholder ownership.

Accepted Answer

False

Answer

True

Question 34

True or False: Debt financing should be considered a viable option for businesses regardless of their financial circumstances.

Accepted Answer

False

Answer

True

Question 35

Which of the following is NOT a potential disadvantage of debt financing?

Accepted Answer

Improves financial flexibility

Answer

May require regular interest payments

Answer

Increases risk to the business

Question 36

A bond is a:

Accepted Answer

Debt security

Answer

Short-term loan

Answer

Derivative

Answer

Equity security

Question 37

Which of the following is a characteristic of unsecured debt?

Accepted Answer

Not backed by collateral

Answer

Is usually used for large-scale projects

Answer

Typically has a lower interest rate

Answer

Often has a longer maturity period

Question 38

The term 'interest coverage ratio' refers to:

Accepted Answer

The ability of a company to pay interest on its debt

Answer

The rate at which a loan is repaid

Answer

The ratio of total assets to total liabilities

Answer

The number of times a bond has been refinanced

Question 39

Which of the following is a potential disadvantage of using debt financing?

Accepted Answer

Increases financial risk

Answer

Enhances financial flexibility

Answer

Lowers cost of equity

Answer

Provides tax benefits

Question 40

A sinking fund:

Accepted Answer

Helps retire debt over time

Answer

Reduces interest payments

Answer

Extends the maturity date of the debt

Answer

Provides collateral for the loan

Question 41

The weighted average cost of capital (WACC) is used to:

Accepted Answer

Calculate the overall cost of financing

Answer

Determine the return on equity

Answer

Estimate the future value of a bond

Question 42

Which of the following is a characteristic of convertible debt?

Accepted Answer

Can be converted into equity

Answer

Is secured by collateral

Answer

Is typically short-term

Answer

Has a fixed interest rate

Question 43

A capital structure is:

Accepted Answer

The mix of debt and equity financing used by a company

Answer

The current market value of a company

Answer

The ratio of assets to liabilities

Question 44

Which type of debt instrument typically has a shorter maturity and is unsecured?

Accepted Answer

Promissory note

Answer

Convertible bond

Answer

Mortgage

Answer

Debenture

Question 45

What is the purpose of a covenant in debt financing?

Accepted Answer

To restrict the borrower's activities or financial ratios

Answer

To provide additional security for the lender

Answer

To modify the terms of the loan agreement

Question 46

When evaluating the cost of debt financing, which factor is of primary importance?

Accepted Answer

Interest rate

Answer

Loan fees

Answer

Maturity date

Answer

Principal amount

Question 47

What is the purpose of a sinking fund in debt financing?

Accepted Answer

To accumulate funds for the repayment of debt at maturity

Answer

To reduce the interest expense on the debt

Answer

To secure the loan against the borrower's assets

Answer

To provide additional liquidity to the borrower

Question 48

Which type of debt financing is typically secured by real property?

Accepted Answer

Mortgage

Answer

Promissory note

Answer

Convertible bond

Answer

Debenture

Question 49

What is a distinguishing feature of a balloon payment in debt financing?

Accepted Answer

A large, lump-sum payment due at the end of the loan term

Answer

A reduced interest rate for the final payment

Answer

A penalty for early repayment of the loan

Answer

An increased principal payment made during the loan term

Question 50

Which of the following is a potential benefit of debt financing?

Accepted Answer

Tax deductibility of interest payments

Answer

Increased ownership control for the lender

Answer

Reduced cost compared to equity financing

Question 51

Which of the following is a type of convertible debt?

Accepted Answer

Convertible bond

Answer

Promissory note

Answer

Mortgage

Answer

Debenture