Chapter 2 & Chapter 3 Practice Questions
What type of bond must be accreted towards par each year?
A bond purchased at a discount Note: When a bond is purchased at a discount, the cost basis must be accreted each year. Accretion means that the cost basis of the bond must be adjusted upward towards par each year so that at maturity the investor's cost basis will equal par of $1000.
An investor holding a Collateralized Mortgage Obligation (CMO) owns A) A type of MBS designed by a broker-dealer B) A US Government guaranteed bond C) A stock portfolio secured by a pool of mortgages D) A bond portfolio secured by a pool of housing stocks
A) A type of MBS designed by a broker-dealer A CMO is mortgage-backed security, structured by a broker-dealer, divided into individual components called 'tranches'.
Characteristics of private activity bonds include which two of the following? I. May trade with a higher yield than other municipal bonds II. May trade with a lower yield than other municipal bonds III. Are often subject to alternative minimum tax IV. Are usually exempt from alternative minimum tax A) I and III B) I and IV C) II and III D) I and IV
A) I and III A private activity bond is issued to finance projects that are primarily for the good of a private corporation. An example is a stadium for a sports team. Interest on private activity bonds is typically subject to alternative minimum tax (AMT). Because of this, they typically trade at a higher yield than bonds that are not subject to AMT. Reference: Textbook Secti
Which of the following are sub-investment grade credit ratings? I. BB+ II. BBB III. B1 IV. Baa3 A) I and III B) I and IV C) II and III D) II and IV
A) I and III BBB- and Baa3 are the lowest investment grade ratings. Any rating below BBB- (for S&P or Fitch) or Baa3 (for Moody's) is considered a sub-investment grade rating.
A bond that was yielding 3.65% yesterday is currently yielding 3.75%. Which two of the following statements are true? I. The bond's price went down since yesterday II. The bond's price went up since yesterday III. The bond's yield is 10 basis points more today. IV. The bonds yield is 1/10th basis point more today. A) I and III B) I and IV C) II and III D) II and IV
A) I and III There is an inverse relationship between bond prices and bond yields. Because the bond's yield is more today, its price fell. Basis points measure the change in interest rate. Each basis point equals 1/100 of a percent. (A change of 1 percent = 100 basis points). A change from 3.65% to 3.75% is a change of 10 basis points.
Money market funds offer all of the following EXCEPT A) Insured by the FDIC B) Higher interest than interest bearing bank accounts C) High degree of safety and liquidity D) Net asset value per share that historically has not fallen below $1.00
A) Insured by the FDIC Money market funds are short-term, liquid and very safe, but are not FDIC insured. Money market funds have historically held their net asset value at $1.00 per share. They pay a slightly higher interest rate than bank savings account or interest bearing checking accounts
All of the following statements are true regarding callable bonds EXCEPT A) Issuers choose to call bonds when current interest rates are higher than the coupon rate of the bond B) Corporate bonds are often callable, but government bonds typically are not C) Corporate callable bonds usually have a higher coupon rate than non-callable bonds D) Issuers no longer pay interest on bonds that have been called
A) Issuers choose to call bonds when current interest rates are higher than the coupon rate of the bond Issuers call bonds when current interest rates have fallen below the coupon they must pay on outstanding bonds. The concept is much like refinancing a mortgage at a lower interest rate. Bonds issued by the federal government are not callable. Issuers pay a higher rate on callable bonds to compensate for the risk that when they are called, investors may not be able to invest their funds at rates as high as those of the called bonds. Interest is no longer paid on bonds that have been called
For which type of certificate of deposit (CD) do resale prices rise and fall with changes in interest rates? A) Negotiable B) Jumbo C) Callable D) Breakable
A) Negotiable Negotiable CDs, which generally are sold to institutions in large denominations, often have multi-year maturities and are priced like bonds on secondary markets. Prices rise when interest rates decline and fall when interest rates increase. But they always pay face value at maturity date.
An investor buys a 6.0% coupon bond to yield 6.1%. What will most likely happen to the price of the bond as maturity approaches? A) The price will increase towards par. B) The price will decrease towards par. C) The price will remain constant. D) The price will fall to zero.
A) The price will increase towards par. This bond has a coupon of 6.0% and a yield-to-maturity of 6.1%, indicating that the bond is trading at a discount. The price of a bond will always trend towards par as maturity approaches. Given that this bond is trading at a discount (e.g. 90% of par), the price would need to increase to arrive at par value.
If an investor living in one state purchases a municipal bond issued by a different state, A) They may need to pay income tax to their home state B) A federal income tax liability will be incurred C) This will trigger the alternative minimum tax D) The interest income will be triple-tax exempt
A) They may need to pay income tax to their home state When an investor buys an out of state municipal bond, they will generally be required to pay taxes on the interest they receive to their home state. The interest will remain exempt from federal income taxes.
A trader quotes a corporate bond as "trading on a 6.7% basis". Which yield is the trader referring to? A) Yield to maturity (YTM) B) Nominal yield (NY) C) Current yield (CY) D) Yield to call (YTC)
A) Yield to maturity (YTM) Yield to maturity is the most widely quoted yield for bonds. If a quote indicates a bond is "trading at X%" or "trading on a X% basis," or "yielding X%," assume yield to maturity is being referenced.
As a general rule, the higher a given debt instrument ranks in the capital structure hierarchy A) the lower its risk to investors and, consequently, the lower its cost of capital to the borrower/issuer B) the higher its risk to investors and, consequently, the lower its cost of capital to the borrower/issuer C) the lower its risk to investors and, consequently, the higher its cost of capital to the borrower/issuer D) the higher its risk to investors and, consequently, the higher its cost of capital to the borrower/issuer
A) the lower its risk to investors and, consequently, the lower its cost of capital to the borrower/issuer As a general rule, the higher a given debt instrument ranks in the capital structure hierarchy, the lower its risk and, consequently, the lower its cost of capital to the borrower/issuer.
Which of the following is equal to 80 basis points? A.) 0.008 B.) 0.00008 C.) 0.08 D.) 0.000008
A.) 0.008 Note: One basis point is equal to .01% or .0001. There are 100 basis points in 1%. To convert basis points to a percentage, move the decimal two places to the left. To convert basis points to a decimal, move the decimal point four places to the left. So 80 basis points becomes .8% or 0.008
If Standard & Poor's assigns an AAA rating to a foreign country, what rating will it usually give to the foreign country's sovereign bonds? A.) AAA B.) One rating below AAA C.) Each bond will be separately rated on its own merits, and ratings could vary. D.) It cannot be determined because there is no relationship between a country's rating and ratings on its sovereign bonds
A.) AAA Note: Normally, the rating assigned to a country will attach to its sovereign debt issues
Of the following ratings, which indicates the strongest credit quality? A.) Aaa B.) Aa1 C.) A D.) A1
A.) Aaa Note: Aaa is the highest rating that Moody's assigns. To further differentiate between categories, Moody's also uses the number 1-3 fo ratings other than Aaa. For example, Aa1 is stronger than Aa2.
A 20 year U.S. treasury bond was bought at a price of $945 in July. By the end of the year, its price had increased to $1075. What most likely caused the price to rise? A.) Interest rates fell B.) Interest rates rose C.) The U.S. Treasury issued new bonds D.) The U.S. Treasury called in older bonds
A.) Interest rates fell Note: the most likely factor that caused a change in the trading value of a bond is a change in prevailing market interest rates. The inverse relationship between bond price and interest rates instructs that when interest rates go down, bond prices go up. Likewise, if rates go up, bond prices go down.
When a bond is trading at par, which of the following is true? A.) Its nominal yield, current yield, and yield-to-maturity will all be equal B. ) The current yield will be lower than the nominal yield, and the yield-to-maturity will be lower than the current yield C. The nominal yield will be lower than the current yield and yield-to-maturity D.) The yield-to-maturity will be higher than the nominal yield, but lower than the current yield
A.) Its nominal yield, current yield, and yield-to-maturity will all be equal Note: When a bond is trading at par, its nominal yield, current yield, and yield-to-maturity will all be equal
Which of the following products would carry the greatest amount of inflation risk? A.) Treasury Bond B.) TIPS C.) Convertible Bond D.) Treasury Bill
A.) Treasury Bond Note: Inflation risk, also known as purchasing power risk, is the risk that the returns from an investment or portfolio will be compromised over time because of inflation. Fixed income securities, such as bonds, area a greater source of this risk than equity securities like stocks, whose returns will tend to fluctuate with inflation. Within the bond category, long term bonds would carry more inflation risk than short term bonds.
For a bond trading at a discount, how does yield to call (YTC) compare to yield to maturity (YTM)? A.) YTC is greater B.) YTM is greater C.) YTC and YTM are equal D.) It depends on the size of the discount
A.) YTC is greater For a bond trading at a discount: YTC -> YTM -> CY -> NY
A bond with ten years to maturity is bought at a price of $860. The annual adjustment to its cost basis will be A.) accretion of $14 B.) accretion of $70 C.) amortization of $14 D) amortization of $70
A.) accretion of $14 Note: Bonds purchased at a discount are accreted, meaning adjusted upwards towards par value each year. The accretion is calculated on a straight-line basis, by dividing the discount off par ($140) by the number of years to maturity (10). Assume a bond's par value is $1000.
The process of adjusting the cost basis of a bond purchased at a premium so that at maturity the investor's cost basis is equal to par is A.) amortization B.) accretion C.) marking down D.) stabilization
A.) amortization Note: Amortization is the process than an investor must follow when a bond is purchased at a premium. The intent is for the investor's cost basis to be adjusted down to par, or $1000 at maturity. If the investor indeed holds the bond to maturity, there would be no gain or loss to the investor.
The risk that the returns of an investment will be negatively impacted by inflation is commonly known as A.) purchasing power risk B.) credit risk C.) call risk D.) interest rate risk
A.) purchasing power risk Note: Purchasing power, or inflation risk, is the risk that the returns of an investment will be adversely impacted by inflation
A bond has a call feature under which it can be called on May 1 of the years 2024, 2026 and 2028. It matures on May 1 of 2030. The yield to call (YTC) calculation assumes A.) the bond is called on 5/1/24 B.) the bond is called on 5/1/26 C.) the bond is called on 5/1/28 D.) the bond is called at the midpoint of the three call dates
A.) the bond is called on 5/1/24 Note: Some bonds have more than one call date. Always assume the first call date in the calculation of YTC.
An investor would most likely buy a floating rate security issued by the U.S. Treasury for which of the following reasons? A.) to protect against interest rate volatility B.) to benefit from interest rate arbitrage 3.) to hedge a portfolio from systemic risk 4.) to receive interest that is tax exempt at the federal level
A.) to protect against interest rate volatility Note: Floating rate securities feature an interest rate that varies or "floats" based on the performance of an underlying benchmark rate. Investors purchase them to protect against volatile interest rates, as these securities can help reduce the risk of locking in a low rate for a long period of time
When interest rates change, the expectation is that the price of a short-term bond A.) will fluctuate less than the price of a long-term bond B.) will fluctuate in the opposite direction from that of a long-term bond C.) will fluctuate more than the price of a long-term bond D.) will only fluctuate if there is significant demand for the bond
A.) will fluctuate less than the price of a long-term bond Note: when interest rates change, the price of a long-term bond will fluctuate more than the price of a short-term bond
For a bond that Moody's rates Aa1, what is the corresponding S&P rating? A) AAA B) AA+ C) Baa D) Baa
B) AA+ Moody's ratings use upper and lower case letters (Aa), while S&P uses all caps. Remember that "The poor wear caps." Moody's uses a 1 to indicate higher quality within a given rating. S&P uses a +.
An issuer may use SOFR as a benchmark to A) Determine the tax liability of an interest payment to an investor B) Adjust the coupon rate that it will pay to an investor C) Calculate the capital gains tax from the sale of a bond D) Calculate the amount of new debt that it needs to issue to raise capital for the next fiscal year.
B) Adjust the coupon rate that it will pay to an investor SOFR may be used as a benchmark to set a new coupon rate on a bond. The SOFR (Secured Overnight Financing Rate) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities. Benchmark rates are used for variable rate bonds; the coupon rate remains the same until maturity for fixed-rate instruments
Which two of the following are characteristics of municipal notes? I. They are used for interim financing II. They are used for long term financing III. They are issued in anticipation of funding from another source IV. They are issued in discount form only A) II and IV B.) I and III C) I and IV D) II and III
B) I and III Municipal notes are used for interim, or temporary financing, in anticipation of funding received from another source. They are issued in both coupon and discount form.
A customer purchased a 5% U.S. government bond yielding 6%. A year before the bond matures, new U.S. government bonds are being issued at 4%, and the customer sells the 5% bond. The customer probably I. bought it at a discount I. bought it at a premium III. sold it at a discount IV. sold it at a premium A) I and II B) I and IV C) II and III D) II and IV
B) I and IV When the customer purchased the bond the YTM was greater than the nominal yield. This means that the bond was purchased at a discount as the investor will realize a capital gain upon maturity. Interest rates and bond prices move in opposite directions, so when interest rates decrease to 4% the price of the 5% bond will increase as it has a higher coupon and is more attractive to investors. The customer will then be able to sell the bond at a premium.
In the event of a bankruptcy, rank the following in order of claim to corporate assets, highest to lowest. I. Common Stock II. Subordinated Debentures III.Preferred Stock IV. Secured Debt A) IV, III, II, I B) IV, II, III, I C) II, IV, III, I D) I, III, II, IV
B) IV, II, III, I In the event of a corporate liquidation, secured debt has the highest claim to corporate assets, followed by unsecured debt (debentures). Preferred stock has a higher claim than common stock, which is last in line.
The calculation of accrued interest for government bonds A) Is based on 360 day years B) Includes the last interest payment date C) Is not included on the confirmation D) Is subtracted from the price owed to the seller
B) Includes the last interest payment date The accrued interest calculation for a government bond is based on actual day years and months. It is added to the price the seller receives at settlement and included in the total price. The calculation includes interest on the prior coupon date up to, but not including, the settlement date.
Which of the following is TRUE of the yield of a bond that is trading at a price that is $80 more than its face value? A) Its current yield will be higher than its coupon yield B) Its coupon yield will be higher than its current yield C) Its current yield will be the same as its coupon yield D) Its current yield will be $80 less than its coupon yield
B) Its coupon yield will be higher than its current yield Coupon yield stays constant over the life of a bond while current yield changes with bond's market price. If a bond is trading above face value, its current yield will be lower than its coupon yield. If a bond is trading below face value, current yield will be the greater of the two. Current yield goes up as bond prices decrease, and vice versa.
Which one of the following is not a type of money market instrument? A) Commercial paper B) Mortgage-backed security C) Banker's Acceptance D) Certificate of Deposit
B) Mortgage-backed security Money market instruments have maturities of less than one year. The most important types of money market instruments are U.S. Treasury bills, commercial paper, banker's acceptances and certificates of deposit.
When does settlement normally occur for government securities? A) T B) T+1 C) T+2 D) T+3
B) T+1 Settlement for government securities usually occurs on the day after trade date (T+1).
In the fixed income market, the risk that is created by a downward trend in interest rates is referred to as A) interest rate risk B) reinvestment rate risk C) principal risk D) market risk
B) reinvestment rate risk Downward trends in interest rates cause reinvestment risk because it may be difficult to find comparable yields for reinvestment of principal or interest payments. Interest rate risk occurs as interest rates increase, causing a subsequent decline in bond prices.
In the United States, certificates of deposit are insured for up to $250,000 per depositor by A) the US Treasury. B) the Federal Deposit Insurance Corp (FDIC). C) the Securities Investor Protection Corp. (SIPC). D) the MSRB.
B) the Federal Deposit Insurance Corp (FDIC). The FDIC is an independent agency created by the U.S. government. It protects bank deposits for up to $250,000 per depositor, per institution, if a bank fails.
DEF Corporate debenture is quoted at 103 and pays a $10 semiannual coupon. What is the current yield of this bond? A.) 0.90% B.) 1.90% C.) 9.70% D.) 19.40%
B.) 1.90% Note: The current yield of a bond is found by dividing the annual interest by the bond's market price. Therefore CY = Annual Interest / Current Market Price Note: In this case, we divide the annual interest, which is $20 ($10 semiannual coupon x 2), by the market price of $1030, to arrive at the current yield of 1.9%. Bonds are quoted as a percentage of par, which is 1000. Therefore, a quote of 103, means 103% of par or $1030.
A customer purchased a Treasury Bond in a regular way transaction on Monday, April 4th. The bond is J&J bond. How many days of accrued interest will the seller receive? A.) 80 B.) 94 C.) 96 D.) 79
B.) 94 Note: Treasury bonds accrue interest on an actual day basis and use 365 days a year. They settle T + 1, in this case on Tuesday, April 5th. Interest accrues from the last interest payment date (January 1st), up to, but not including the settlement date.
A bond has lost value due to an increase in interest rates. This is best explained by A.) Call Risk B.) Interest Rate Risk C.) Credit Risk D.) Reinvestment Risk
B.) Interest Rate Risk Note: Interest rate risk is the risk that rising interest rates will diminish the value of a bond
Which of the following best describes duration? A.) It is a measure of how the Treasury yield curve will adjust when general interest rates change. B.) It is a measure of how much a bond's price will change when interest rates fluctuate C.) It is the length of time that a bond remains outstanding prior to it being called or redeemed by the issuer. D.) It is the length of time between call dates or interest payment dates on a bond
B.) It is a measure of how much a bond's price will change when interest rates fluctuate. Note: Duration is commonly used method of gauging a bond's sensitivity to changing interest rates
Which of the following statements is correct regarding accrued interest? A.) It is taxed as a capital gain and does not impact the cost basis of a bond B.) It is taxed as ordinary income and does not impact the cost basis of a bond C.) It is taxed as ordinary income and increases the cost basis of a bond D.) It is compensation to the buyer for the next schedule interest payment
B.) It is taxed as ordinary income and does not impact the cost basis of a bond Note: Accrued interest is taxed as ordinary income and does not impact the cost of a bond
Retiring an outstanding bond issue at maturity by using money from the sale of a new offering is known as A.) Redeeming B.) Refunding C.) Restructuring D.) Serial Retirement
B.) Refunding
In interest bearing corporate bonds, accrued interest that is due the seller must be included in settlement. According to industry rules, the accrued interest must be calculated up to what date? A.) T B.) T + 1 C.) T + 2 D.) T + 3
B.) T + 1 Note: For interest-bearing fixed income securities, interest accrues up to (but not including) the settlement date, which is the second business day following the trade date (T+2). Put differently, accrued interest includes the trade date and T +1, but not on T+2 (settlement). On T+2, the interest accrues to the buyer of the bond
An investor is evaluating the purchase of a corporate bond with 12 years to maturity. Under a call feature, it can be called in 8 years. Another feature that can impact the amount of call risk is A.) the credit standing of the issuer B.) any premium to par payable on the call date C.) the amount of common stock into which the bond may convert D.) any penalty the investor will pay for calling the bond early
B.) any premium to par payable on the call date Note: a call is always at the option of the issuer, never the investor. Normally, a call feature creates extra risk by shortening the investor's holding period, especially in times of falling interest rates. Issuers may agree to pay an additional price (call premium) above par for the call option
If a municipal issue is quoted as "Orange County, LA, General Obligation bonds: 6.25% of 2035 at 6.45%, the bonds are selling A.) at a premium B.) at a discount C.) at par D.) flat
B.) at a discount Note: 6.25% represents the nominal yield or coupon rate, and 6.45% represents the yield-to-maturity. When the YTM is greater than the NY, the bond is trading at a discount as the investor will earn a capital gain upon maturity, thus yielding a higher rate than just the 6.25% coupon payments
A municipal bond that is offered at a yield to maturity higher than the coupon rate is recognized as trading A.) at par B.) at a discount C.) at a premium D.) flat
B.) at a discount Note: if a bond's yield to maturity is more than the coupon rate, the bond is trading at a discount. The YTM calculation reflects the impact on the investor's return of the amount of premium or discount paid when the bond is purchased. If the bond is purchased at a discount, the investor's rate of return on the bond is more than the stated rate, or coupon, of the bond when it was issued
Which type of bonds are not callable? A.) corporate B.) federal government C.) municipal general obligation D.) municipal agency
B.) federal government Note: most corporate and municipal bonds with maturities over 10 years are callable for a certain period. However, bonds issued by the federal government are not callable.
Which of the following is a major factor in determining the price of long-term bonds? A.) number of outstanding shares of common stock B.) interest rates C.) discounts and premiums D.) bid-ask spreads
B.) interest rates Note: Interest rates have a significant impact on the prices of bonds because a bond's price changes as the bond's interest rate differs from prevailing market interest rate. When prevailing market interest rates are higher than a bond's interest rate, the price of a bond will fall. If the bond's interest rate is higher than the prevailing market interest rate, the price of the bond will increase. This is called an inverse relationship because when one goes up, the other goes down.
A company with a Ba1 rating from Moody's and a BB+ rating from S&P would be classified as which of the following? A.) investment grade B.) non-investment grade C.) medium grade D.) highest quality
B.) non-investment grade Issuers rate 'Ba1' and below by Moody's Investor Service and 'BB+' and below by S&P are referred to as non-investment grade or high yield. Due to having greater default risk, high yield bonds pay more interest than investment grade debts. Issuers rated 'Ba3' and above by Mood's Investor Service, and 'BBB-' and above by S&P are referred to as investment grade textbook 2.3.5
An investor holds a callable bond when interest rates are falling. In this situation the investor is most likely to be impacted by A.) systematic risk B.) reinvestment rate risk C.) liquidity risk D.) credit risk
B.) reinvestment rate risk Note: an issuer is likely to call bonds when interest rates are falling to reduce the cost of servicing its outstanding debt. When the bond is called, the investor will have money to invest, but may not be able to achieve a comparable interest rate as was paid by the called bond. This is reinvestment rate risk, and impacts investors that purchase callable bonds. Zero coupon bonds do not have reinvestment rate risk.
If a corporation fails to make a payment on an outstanding debt obligation, A.) it must make a double payment the next time interest is to be paid B.) the bond will default C.) all bondholders must be notified within 24 hours D.) the chief financial officer of the corporation must arrange for an escrow payment to be made prior to the next interest payment cycle
B.) the bond will default Note: the bond will default if the issuer fails to make an interest or principal payment on the security. The issuer is legally obligated to make these payments, per the conditions of the security
Two bonds have relatively equal credit quality and terms to maturity. Which of the following statements is true? A.) the bond with the higher coupon will trade at a lower price B.) the bond with the higher coupon is more marketable C.) then bond with the lower coupon is more liquid
B.) the bond with the higher coupon is more marketable Note: All other factors being equal, bonds with higher coupons are more marketable, and more attractive to investors than bonds with lower coupons. Investors will pay more for the bond with the higher coupon unless it is more risky. Bonds of equal credit quality and terms to maturity will likely have similar yields, but their coupon rate of interest may be very different
An investor buys an 8% coupon bond to yield 7%. What will most likely happen to the price of a bond as maturity approaches? A.) the price will increase towards par B.) the price will decrease towards par C.) the price will remain constant D.) the price will fall to zero
B.) the price will decrease towards par Note: This bond has a coupon of 8.0% and a yield-to-maturity of 7.0%. Indicating that the bond is trading at a premium. The price of a bond will always trend towards par as maturity approaches. Given that this bond is trading at a premium (e.g., 105% of par), the price would need to decrease to arrive at par value.
ABC Corporate debenture is trading at $920 and pays a $20 semiannual coupon. What is the current yield of this bond? A) 2.20% B) 3.40% C) 4.30% D) 5%
C) 4.30% The current yield of a bond is found by dividing the annual interest by the bond's market price. In this case, we divide the annual interest, which is $40 ($20 semiannual coupon x2), by the market price of $920, to arrive at the current yield of 4.3%
In a book-entry format, ownership of the security is recorded by A) The issuer B) Corporate counsel C) Central depository D) Clearing house
C) Central depository When a book-entry format is used, ownership is recorded by a central depository, rather than by the issuer. This has become the most common method of tracking ownership.
Advantages of book entry form of ownership for U.S. government securities include all of the following EXCEPT A) Reduced printing costs for the U.S. government B) Increased protection for investors from loss and theft of securities C) Faster regular way settlement terms than apply to government securities issued in other forms D) Ease of transfer between parties when securities are bought and sold
C) Faster regular way settlement terms than apply to government securities issued in other forms All Treasury securities are issued in book entry form, which reduces printing costs for the U.S. government and supplies increased protection and ease of transfer for investors and the securities firms they do business with.
All of the following are means of backing general obligation bonds EXCEPT A) Acts of state legislature B) Ad valorem taxes C) Hotel occupancy taxes D) Sales taxes
C) Hotel occupancy taxes Although they are a form of tax, hotel occupancy taxes are used for backing revenue bond issues because they are more of a user fee. Property (ad valorem) taxes and sales taxes, along with acts of state legislature for appropriation of funds are common backing for GO bonds.
With regard to securities issued by the federal government, which two of the following statements are TRUE? I. Interest is exempt from taxation at the federal level II. Interest is taxable at the federal level III. Capital gains are subject to full taxation IV. Capital gains are not taxable A) I and III B) I and IV C) II and III D) II and IV
C) II and III Interest on government securities is taxable at the federal level. Capital gains are fully taxable as well.
What does yield to maturity (YTM) measure in a bond, assuming the bond is held to its scheduled maturity? A) Yield B) The value of interest payments C) Total return D) Yield discounted by time value
C) Total return YTM measures the total return of a bond, held from the current date through scheduled maturity. It includes both scheduled interest payments and any capital gain or loss ? i.e., the difference, if any, between the current price and maturity value. The denominator in YTM is the current bond price. So, YTM changes as current bond prices change.
The denominator in the calculation of a bond's current yield is A) annual coupons. B) face value. C) current price. D) maturity in years.
C) current price. Current yield is calculated as the sum of the annual coupons (the numerator) divided by current price (the denominator)
At maturity, an investor who holds a 6% bond issued by ABC Corporation will receive A.) 103 B.) 106 C.) 1030 D.) 1060
C.) 1030 Note: At maturity, a corporate bondholder will receive the face amount, or par value of the bond ($1000), plus the remaining semi-annual interest payment. A bond with a coupon of 6% pays $60 of interest per year, or $30 semiannually. $1000 + $30 = $1030.
On Friday September 1st a customer purchases a municipal bond for a regular way settlement,. The bond pays semi-annual interest on December 1 and June 1. How many days of accrued interest are added to the buyer's price? A.) 91 days B.) 93 days C.) 94 days D.) 95 days
C.) 94 days Note: Regular way settlement for municipal bonds is T + 2 business days, and the accrued interest calculation is based on 30-day months. There are 30 days in June, 30 days in July, 30 days in August, and 4 in September due to the weekend (settlement date is Tues Sept ). The buyer's price includes interest that goes up to, but does not include the settlement date. *this question reflects a regular way settlement of T + 2, effective as of Sept 5. 2017
A zero coupon municipal security is most appropriate for which of the following investors? A.) A middle aged investor in a high tax bracket who is looking to generate as much tax-free income as possible B.) A retired individual who would like a regular income stream to supplement pension income C.) A working adult who would like funds available to pay off her mortgage in 10 years so that she can retire D.) A parent who is planning a college education fund for a child and wants to access funds that will not be taxed if used for qualified education expenses
C.) A working adult who would like funds available to pay off her mortgage in 10 years so that she can retire Note: Zero coupon bonds are purchased at a discount and mature to face value. They are most suitable for investors that would like to plan for a lump sum to be available at a defined date in the future
Which of the bonds listed below would have the greatest price volatility? A.) a variable rate bond B.) a short-term investment grade bond C.) a long-term zero coupon bond D.) a treasury note
C.) a long-term zero coupon bond Note: Because zero coupon bonds pay no interest until maturity, their prices fluctuate more than other types of bonds in the secondary market. Variable bonds have little price fluctuation because their rates adjust to current interest rates. Also long-term bonds are generally more volatile than short-term bonds.
Which of the following is not relevant when calculating a bond's yield to maturity? A.) the discount or premium to par value B.) the annual coupon C.) call provisions D.) time remaining to maturity
C.) call provisions Note: Yield to Maturity (YTM) accounts for the discount or premium to par value, annual coupons,. and time remaining to maturity. Call provisions impact the Yield to Call (YTC) but not YTM.
If the price of a bond decreases, what happens to its current yield? A.) no change B.) decrease C.) increase D.) impossible to determine
C.) increase Note: If the price of a bond decreases, which means that the bond is trading at a discount to par, its current yield will increase
All of the following statements are true about bonds that trade flat EXCEPT A.) no accrued interest is added at settlement B.) the issuer may be in default C.) the bond is trading and interest D.) the bond is settled on an interest paying date
C.) the bond is trading and interest Note: Bonds that trade flat do not include accrued interest in their settlement price. This could be because the issuer is in default and interest is not being paid, or because the bond is settling on an interest payment date. "And interest" means that accrued interest is included in the settlement price.
All of the following statements are true about non-investment grade bonds EXCEPT A.) they are also called junk bonds B.) they are frequently classified as high yield bonds C.) they are typically more liquid than investment grade bonds D.) costs of trading are often higher than costs associated with trading investment grade bonds
C.) they are typically more liquid than investment grade bonds Note: this is an except question. Non-investment grade bonds usually carry a higher degree of risk and pay more interest, and thus are often referred to as high yield bonds (formerly junk bonds). The markets for these bonds is typically not as liquid, so the costs associated with trading them are higher than those associated with trading investment grade debt.
Secondary market transactions in corporate in municipal securities settle A.) the following business day B.) the same business day C.) two business days later D.) five business days later
C.) two business days later Note: Transactions in corporate and municipal securities settle in two business days following the trade date
A corporate bond that is currently trading at 95 pays a semi-annual coupon of $25. What is the current yield?
CY = Annual Interest / Market Price ($25 x 2) / 950 = 0.0526 = 0.0526
An assessment by an independent agency of an issuers ability and willingness to make full and timely payments of amounts due on its debt obligations is known as
Credit Rating Note: A credit rating is an assessment of an independent rating agency of a company's ability and willingness to make full and timely payments of amounts due on its debt obligations.
A bond with a par value of $1,000 is quoted at 109. To buy one bond at this price, an investor pays A) $991.00 B) $1,000.00 C) $1,009.00 D) $1,090.00
D) $1,090.00 Bonds are quoted as a percentage of par value. Therefore, a quote of 109 reflects 109% of $1,000 or $1,090. When converting a quote to a price, simply multiply the quote by 10.
A firm has sold securities to dealers with the intention of buying back the securities at a future date. This transaction is an example of A) A bankers acceptance B) A reverse repo C) A swap D) A repurchase agreement
D) A repurchase agreement A repurchase agreement occurs when securities are loaned with the agreement to buy them back, usually the next da
What type of entity issues commercial paper? A) Municipalities B) Government agencies C) Mortgage lenders D) Corporations
D) Corporations Commercial paper is a negotiable, unsecured debt instrument issued by a corporation to finance short-term operating expenses and working capital needs. Maturities may not exceed 270 days.
An investor who purchases Treasury Bills can expect which of the following? I. Interest that is paid on a monthly basis II. The face value of the bill paid at maturity III. A minimum investment of $1,000 IV. A minimum investment of $100 A) I and III B) I and IV C) II and III D) II and IV
D) II and IV Treasury Bills are purchased at a discount and mature to face value, no periodic interest is paid (i.e. they are zeroes). The minimum purchase amount of Treasury Bills is $100.
A zero coupon municipal security is most appropriate in which two of the following situations? I. A middle aged investor in a high tax bracket who is looking to generate as much tax-free income as possible II. A grandmother who would like to have a specified amount of money available to pay for her grandchild's college education in 10 years III. A retired investor who holds a diversified portfolio of growth security and wishes to receive tax free income from 20% of his portfolio IV. A head of household who is saving money to purchase a vacation home in 15 years A) I and III B) I and IV C) II and III D) II and IV
D) II and IV Zero coupon bonds are purchased at a discount and mature to face value. They are most suitable for investors that would like to plan for the availability of a lump sum at a defined date in the future. They do not pay interest income regularly; the interest is considered the difference between the purchase price and the par value.
When compared to a bond with a low credit rating, a bond that carries a high credit rating is A) Subject to a higher risk of issuer default B) Likely to pay a higher interest rate C) Less liquid D) More likely to receive interest and principal payments
D) More likely to receive interest and principal payments A credit rating measure the issuer's ability to pay interest and principal (default risk). More risk means the potential for more reward, so bonds with lower credit ratings will generally pay a higher rate of interest. A bond with a high credit rating would be more liquid.
What is the distinguishing characteristic of a high-yield bond? A) No collateral B) Unattractive interest rate C) Already in default D) Rating below investment-grade
D) Rating below investment-grade High-yield bonds, previously called junk bonds, have ratings below investment grade. Bonds rated below investment-grade often pay higher yields to compensate for the lack of quality, but they are not necessarily speculative or in default, and they can be attractive to investors with some risk tolerance and a need for high yield.
ABC Law Firm has just changed the rating of the Friendly School District bonds from BBB+ to AA-. As the result, A) The yield on these bonds would rise while their price would fall B) School districts in general would be viewed as generally unattractive investments C) The issuer will likely be facing an increase in insurance payments D) The price of these bonds would increase while their yields would fall
D) The price of these bonds would increase while their yields would fall The rating of these bonds has increased. The expectation , therefore, would be to see a decrease in yield and an increase in price.
A municipal bond will mature in 15 years, and is callable on three specific dates prior to maturity. In addition, this bond has two years of call protection. This call protection A) Will benefit the issuer if interest rates drop B) Will benefit the investor if interest rates rise C) Will have no bearing on the marketability of the bond D) Will benefit the investor if interest rates drop
D) Will benefit the investor if interest rates drop Call protection will benefit an investor if interest rates fall, as the issuer will be unable to call the bond after interest rates have declined, thereby preserving the same cash flow payments to the investor.
A buyer is not responsible for paying a seller any accrued interest since the last coupon payment in a bond that trades A) thin. B) ex-coupon. C) round lot. D) flat.
D) flat. If a bond trades "flat," the buyer is not responsible for paying interest that has accrued since the last interest payment.
Which of the following is true regarding the impact of inflation on the U.S. dollar based fixed-income security A.) Inflation will increase the value of the dollar, thereby increasing demand and the price for USD bonds B.) Inflation will increase the purchasing power of interest payments and therefor increase the price C.) Inflation will likely lead to lower interest rates and therefor increasing the price of USD bonds D.) Deflation will increase the purchasing power of USD bonds
D.) Deflation will increase the purchasing power of USD bonds Note: In an inflationary environment, the pricing of goods are increasing. This will lead to lower purchasing power for fixed income securities. Also, inflation generally leads to higher interest rates, which will lead to a fall in price for bonds. Deflation, on the other hand, means products are cheaper, yielding higher purchasing power.
Call premiums perform which of the following? A.) Require issuers to notify the sponsor when retiring a bond B.) Require investors to notify the issuer when retiring a bond C.) Protect issuers from having debt with an attractive yield refinanced long before maturity D.) Protect investors from having debt with an attractive yield refinanced long before maturity
D.) Protect investors from having debt with an attractive yield refinanced long before maturity Note: Call premiums mitigate reinvestment rate risk in the event interest rates decline by requiring the issuer to a pay premium if refinancing the bonds prior to maturity. For example, a 10 year bond with a 10 year maturity might have a call premium of 105% after the first call date. This would require the issuer to pay investors 105% of par to call away the issue
Term, or dollar bonds, mature at a specified date in the future, commonly known as the maturity date. Term bonds can also be repaid prior to maturity if.. A.) The company's stockholders approve the action. B.) The CEO of the company authorizes early retirement of the debt C.) If the company charter has a provision for early repayment of the bonds D.) The bonds are called by the issuer
D.) The bonds are called by the issuer Note: Bonds can be repaid prior to their stated maturity date if they are called by the issuer.
A refunding occurs when A.) An investor sells his bond prior to maturity date. B.) The issuer of the bond repays the principal prior to its maturity date C.) Interest rates have increased since the issuer's last bond offering was made D.) The issuer replaces a high coupon bond with a low coupon bond in the wake of falling interest rate
D.) The issuer replaces a high coupon bond with a low coupon bond in the wake of falling interest rates. Note: An issuer might engage in a refunding when interest rates have declined. The issuer will sell a bond with a lower coupon now that rates have fallen, and redeem the bond with the higher coupon.
An investor wishes to establish a college education fund for his son who is 3 years old. He is interested in ensuring that $100,000 will be available when the child reaches age 18. An instrument that may be well suited to meeting these objectives is a A.) Blue chip stock B.) Treasury bond C.) AAA corporate bond D.) Zero coupon bond
D.) Zero coupon bond Of these choices, a zero coupon bond can assure that a fixed amount of money is available at a particular time. Zero coupon bonds are purchased at a deep discount and mature to their face amount. They are well suited for planning for long-range goals, such as a child's education.
An issuer is most likely to call a bond which has A.) a low coupon and a call premium when interest rates are rising B.) a low coupon and no call premium when interest rates are rising C.) a high coupon and a call premium when interest rates are falling D.) a high coupon and no call premium when interest rates are falling
D.) a high coupon and no call premium when interest rates are falling Note: Issuers strive to keep their cost of borrowing as low as possible. To do this, they call bonds with high coupons when rates have fallen. They can then issue new bonds at a lower rate and reduce borrowing costs. A call premium is an additional amount that must be paid to call the bonds. To keep costs as low as possible, the issuer would prefer to call a bond with no call premium
A corporate bond is trading "with" interest. This means that A.) there is heightened demand for the bond B.) accrued interest is deducted from the price of the bond C.) the seller of the bond makes an additional interest payment to the buyer of the bond D.) accrued interest is included it its price
D.) accrued interest is included it its price Note: a bond is said to be trading "with" interest or "and" interest when accrued interest is included in its price
The date on which the interest on a new municipal issue will begin accruing is the A.) filing date B.) delivery date C.) closing date D.) dated date
D.) dated date Note: Interest begins accruing on a new issue as of the dated date
An investor who has purchased a new municipal bond issue notices a "dated date" of June 15. This is the date that A.) all future interest payments will be made on the bond B.) represents the first semi-annual interest payment date for the bond, the other being December 15 C.) the bond will first become available for investors to purchase. D.) interest begins to accrue for a new issue, and will only be important for the first interest payment on the bond
D.) interest begins to accrue for a new issue, and will only be important for the first interest payment on the bond Note: the "dated date" is the date when interest begins to accrue on a new municipal bond issue. The date is used to determine the amount of the first interest payment only. Subsequent interest payments will be based on the semi-annual interest (coupon) payment dates for the bond. The dated date will no longer be relevant at this point
For bonds with call features, which type of economic environment generally increases call risk? A.) expansions B.) recessions C.) periods of rising interest rates D.) periods of falling interest rates
D.) periods of falling interest rates Note: Call risk increases during times of falling interest rates. In these times, bond issuers can use calls to refinance old bonds into new bonds with lower coupons
A municipal bond issue is structured whereby a portion of the issue is retired each year. This is an example of a A.) term bond B.) balloon bond C.) sinking fund D.) serial bond
D.) serial bond Note: this is an example of a serial bond structure. In this scenario, outstanding bonds are retired at different intervals with a portion of the issue maturing each year.
When a bond is bought for a premium to par value and held to maturity, the maximum number of years that it must be amortized, for tax cost purposes, is A.) 5 years B.) 10 years C.) 15 years D.) until maturity
D.) until maturity Note: The process of accretion (in discount bonds) continues until the bond is sold, or until bond maturity
When compared to a bond with a high credit rating, a bond with a low credit rating usually is I. is more marketable II. is less marketable III. offers a higher yield IV. offers a lower yield
II. is less marketable III. offers a higher yield Note: most investors are concerned with safety of principal, so bonds with lower credit ratings are less marketable that highly rated bonds. Bonds with low credit ratings must offer a higher yield to offset their reduced degree of safety.
Which two of the statements below define settlement terms of U.S. government and municipal securities? I. regular way settlement for U.S. Treasury securities is T + 3 II. regular way settlement for municipal securities is T + 1 III. cash settlement for municipal securities is the same day as the trade IV. the terms of cash settlement for municipal securities and U.S. Treasury securities are the same
III. cash settlement for municipal securities is the same day as the trade IV. the terms of cash settlement for municipal securities and U.S. Treasury securities are the same Note: Regular way settlement for U.S. Treasury securities is T + 1. For municipal securities regular way settlement is T + 2. Cash settlement for both U.S. Treasury and municipal securities is the same day as the trade date.
An investor purchases a 6% bond for 115. Rank the yield computations for this from bond highest to lowest. I. Current Yield II. Nominal Yield III. Yield to Call IV. Yield to Maturity
Nominal Yield, (Coupon Yield), Current Yield, Yield to Maturity, Yield to Call Note: When the bond is trading at a premium it goes from highest to lowest: NY -> CY -> YTM -> YTC
When a bond's market price increases, what is the impact on its nominal yield?
There will be no change on it's nominal yield Note: Nominal yield is the bonds annual interest or coupon rate. It is a percentage of par value and fixed over the life of the bond.
A corporate bond that has a sinking fund provision A.) has more default risk than other corporate issues without this provision B.) can be offered at a lower interest rate than other bonds C.) is usually retired in whole at the discretion of the trustee D.) is exempt from the Trust Indenture Act of 1939
can be offered at a lower interest rate than other bonds Bonds that are retired through a sinking fund have less default risk, because the issuer is making payments in advance to a trustee to buy bonds in the open market. The reduction of principal risk allows the issuer to offer these bonds at a lower interest rate
