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Q1- An investment bank's financing commitment does not include, among other things, which of the following?
A. Commitment letter
B. Institutional letter
C. Engagement and Fee letter
Correct Answer is B
Explanation: Letter of commitment for the bank debt, as well as a bridge facility (to be provided by the lender in lieu of a bond financing if the capital markets are not available at the time the acquisition is consummated)
• Letter of engagement with the investment banks in order for them to underwrite the bonds on the issuer's behalf
• A fee letter that specifies the various fees that will be paid to the investment banks in connection with the financing.
Q2-When evaluating the management team of a potential LBO candidate, what characteristics do sponsors seek to find out?
I. Proven track record of successfully completing accretive acquisitions
II. Extensive previous experience with a leveraged capital structure
II. Extensive previous experience with a leveraged capital structure Significant prior compensation is the third point to mention.
IV. Poison pill implementation history
A. I and II
B. I and III
C. I, II, III, and IV
Correct Answer is A
Explanation: A proven management team helps to increase the attractiveness (and therefore the value) of a potential LBO acquisition target. Because of the need to operate under a highly leveraged capital structure with aggressive performance targets in an LBO scenario, having talented management is critical to success. The ability to operate under such conditions in the past, as well as success in integrating acquisitions or implementing restructuring initiatives, is highly valued by potential sponsors.
Q3-Which of the following is a common strategy for financial sponsors to exit their investments?
I. Refinancing
II. IPO
III. Sale to a strategic buyer
IV. Sale to another sponsor
A. II and IV
B. I, II, and III
C. II, III, and IV
Correct Answer is C.
Explanation: Sponsor exits are achieved through the sale of their investments to another company or sponsor, as well as through initial public offerings (IPOs). For a sponsor, refinancing is a method of monetization rather than an exit strategy.
Q4-When it comes to dividend recapitalizations, which of the following is a weakness?
A. Less sponsor equity
B. Adds additional leverage
C. Cash return
Correct Answer is B
Explanation: During a dividend recap, the target company raises funds through the issuance of additional debt in order to pay a dividend to its shareholders. As a "add-on" to the target's existing credit facilities and/or bonds, as a new security at the Hold Co level, or in the context of a complete refinancing of the existing capital structure, the incremental indebtedness can be issued in a variety of ways. The additional leverage has a negative impact on the issuer's credit strength, thereby raising the overall risk profile.
Q5- What is the motivation for taking a leveraged buyout company public if it does not provide the sponsor with a complete exit strategy?
A. Allows sponsors to realize a portion of their investment while preserving potential future upside.
B. Because they are required to do so by LP agreements
C. Because they are required to do so by GP agreements
Correct Answer Is A.
Explanation: Although initial public offerings (IPOs) do not provide sponsors with a complete monetization of their equity investment up front, they do provide sponsors with a liquid market for their remaining equity investment while also preserving the opportunity to participate in any potential future upside. Depending on the state of the equity capital markets, an initial public offering (IPO) may also provide a compelling valuation premium over an outright sale.
Q6- The period of a bridge loan is typically
A. 1 year
B. 2 years
C. 3 years
Correct Answer is A
Explanation: A bridge loan is a short-term loan that is used to bridge the gap between a company's inability to obtain permanent financing and its ability to obtain permanent financing. They are usually only valid for a year or less after they are issued. If the bridge is still unpaid after one year, the borrower is typically required to pay a conversion fee to the lender.
Q7- When interest rates are falling, which type of risk does call protection help debt investors to mitigate the most?
A. Credit risk
B. Operational risk
C. Reinvestment risk
Correct answer is C
Explanation: Call premiums protect investors from having debt with an attractive yield refinanced before the debt's maturity date, thereby reducing the risk of reinvestment in the event that interest rates in the market decrease. In bond investing, reinvestment risk refers to the possibility that future coupons from the bond will not be reinvested at the current interest rate at the time the bond was purchased.
Q8- What is the current yield of a $1,000 bond (face value) with a coupon of 6.0% that is trading at par?
A. 5.9%
B. 6.0%
C. 6.6%
Correct Answer B
Explanation: The coupon rate is the percentage of interest that will be paid to the purchaser of a bond by the issuing entity (the issuer). Bonds trading at par with 6.0 percent interest earn a coupon rate of 6.0 percent on a $1,000 investment.
Q9-What percentage of committed funds are limited partners typically required to pay general partners as a management fee?
A. 2%
B. 5%
C. 10%
Correct Answer A.
Explanation: LPs typically pay a management fee of 1% to 2% per year on committed funds to compensate the GP for fund management. Furthermore, once the LPs have received a return on every dollar of committed capital plus the required investment return threshold, the sponsor typically receives a 20% "carry" on every dollar of investment profit ("carried interest").
Q10-Bonds issued by Companies typically pay interest payments
A. Annually
B. Semiannually
C. Quarterly
Correct Answer B
Explanation: Companies generally pay bondholders on a semiannual basis.
Q11- Who makes the decision about the preferred financing structure for a particular LBO?
A. Target company
B. Sponsor
C. Investment Bank
Correct Answer Is B
Explanation: However, while investment banks collaborate closely with sponsor clients to determine the most appropriate financing structure for a particular transaction, the preferred financing structure for an LBO is ultimately determined by the sponsor.
Q12- What are the circumstances in which a strategic buyer might use an LBO analysis?
A. To understand the debt capacity of their company
B. To understand the price a financial sponsor bidder can afford to pay when competing for an asset in an auction process
C. To help spread comparable companies’ analysis
Correct Answer is B
Explanation: It helps a strategic buyer figure out how much a rival bidder might be willing to pay for a target. For example, an LBO analysis, as well as those from other valuation methods, is used to figure out how much a rival bidder might be willing to pay for the target.
Q13- In an LBO analysis, what are the most important variables to look at for sensitivity analysis?
I. Purchase price
II. Financing structure
III. Historical dividends
IV. Exit multiple
A. I and II
B. II and III
C. I, II, and IV
Correct Answer is C
Explanation: The output of an LBO valuation is based on key variables such as financial projections, purchase price, and financing structure, as well as the exit multiple and year of the transaction, among others. Sensitivity analysis is carried out on these key value drivers in order to produce a range of IRRs that can be used to frame the target's valuation.
Q14- What is typically the primary source for the Management Case financial projections that are used in the LBO model during an organized merger and acquisition sale process?
A. Comparable company’s analysis
B. Research estimates
C. CIM
Correct answer is C
Explanation: When conducting an LBO analysis, the first step is to gather, organize, and analyze all of the available information on the target, its industry, and the specifics of the transaction in order to make an informed decision. This level of detail is provided to prospective buyers during an organized sale process by the sell-side advisor, who also provides financial projections that are typically used as the basis for the initial LBO model. Most of this information is contained in a CIM, with additional information being provided through a management presentation and data room.
Q15- Which of the following historical financial data points is the least useful for framing projections and performing LBO analysis in the present time frame?
A. Interest expense
B. EBITDA and EBIT margins
C. Capex
Correct Answer is A.
Explanation: When constructing a pre-LBO model, the historical income statement is typically constructed only through EBIT, as the target's prior annual interest expense and net income are no longer relevant due to the fact that the target will be recapitalized as part of the LBO transaction.
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