Debt

The best answer is C. A "double barreled" bond is a municipal revenue bond whose principal and interest payments are backed by a revenue pledge; however, if the revenues are insufficient to cover the debt service requirements, the municipality will use its ad valorem taxing power to meet the deficit.

A "double barreled" municipal issue has: I primary backing of a general obligation pledge II primary backing of a revenue pledge III secondary backing of a general obligation pledge IV secondary backing of a revenue pledge A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. The feasibility study performed prior to the issuance of revenue bonds is an economic study that projects revenues and costs for the facility to determine if there will be sufficient net revenues to service the debt. The effect of any competing facilities is included in the study. Legal aspects, such as the trust indenture, are not included in the feasibility study. These are evaluated by the bond counsel. The rest would be evaluated in the feasibility study.

All of the following are evaluated in the feasibility study prepared prior to the issuance of revenue bonds EXCEPT: A. expected demand for the facility B. effect of competing facilities C. expected operating costs of the facility D. bond trust indenture

The best answer is A. CMO holders receive monthly payments derived from the underlying mortgage backed pass-through certificates. Thus, interest payments are made monthly.

Holders of CMOs receive interest payments: A. monthly B. quarterly C. semi-annually D. yearly

The best answer is C. The longer the maturity, the more volatile the price movements of the bond as interest rates move. The longest maturity listed here is T-Bonds. Savings bond prices are not affected by interest rate movements. These are non-negotiable instruments that are not traded - instead they are redeemable with the government at any time.

If interest rates rise, which of the following U.S. Government debt instruments would show the greatest percentage drop in value? A. Treasury Bills B. Treasury Notes C. Treasury Bonds D. Savings (EE) Bonds

The best answer is B. Municipalities impose debt ceilings on the dollar amount of bonds that can be issued backed by ad valorem taxing power (G.O. bonds). These are non-self supporting debts that are carried on the "backs" of taxpayers. To raise this limit requires a public referendum. Self supporting or self liquidating debts are financed by some enterprise activity. These are revenue bond issues. Since they pay their own way from the pledged revenue source only, they are not subject to constitutional debt limits.

Constitutional debt limits are imposed on: A. self-supporting debt B. non-self supporting debt C. self-liquidating debt D. all of the above

The best answer is B. Quote providers such as Bloomberg and Reuters give dealer to dealer prices (the "wholesale" market) for corporate bonds daily. The Bond Buyer is the municipal new issue newspaper. Moody's and Fitch's rate bonds - they are not quote providers.

Current dealer offerings of corporate bonds can be found in: A. Bond Buyer B. Bloomberg C. Moody's D. Fitch's

The best answer is A. An issuer is least likely to call bonds which have low interest rates (low financing cost to the issuer) and high call premiums (the least expensive for the issuer to call in these bonds) - all of these issues are callable at par. The issuer will want to refinance the one with the highest coupon. The issuer would call these bonds and sell new bonds at lower current rates.

All of the following callable municipal bonds are trading at an 8% basis. Which is LEAST likely to be called? A. 6 3/4% coupon rate callable at 100 in 2017 B. 7 1/2% coupon rate callable at 100 in 2017 C. 8% coupon rate callable at 100 in 2017 D. 8 3/4% coupon rate callable at 100 in 2017

The best answer is B. "Sallie Mae" is the Student Loan Marketing Association. Sallie Mae raises money to lend to college students. It does this primarily by issuing debentures to the public. These debentures are backed by the faith and credit of this agency. Sallie Mae is another agency that is "privatized." Sallie Mae stock is listed and trades on NASDAQ.

Sallie Mae debentures are backed by: A. the full faith and credit of the U.S. Government B. the full faith and credit of the Student Loan Marketing Association C. designated pooled mortgages D. designated pooled student college loans

The best answer is C. The U.S. Government issues Treasury Bonds (and Treasury Bills and Notes) in book entry form, in minimum denominations of $100.

Treasury Bonds are issued by the U.S. Government in: I bearer form II book entry form III minimum denominations of $100 IV minimum denominations of $10,000 A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. When bonds are trading at a premium, the stated yield or nominal yield will be the highest, since it is the annual income divided by par value. Current yield is lower because it is annual income divided by the current market price (which is at a premium to par). Basis (or yield to maturity) is even lower because it not only considers that the current market price is at a premium to par; it also pro-rates the loss of the premium over the life of the bond, reducing the annual yield below the current yield.

When a bond trades at a premium, which bond yield will be the highest? A. Nominal B. Yield to maturity C. Current D. Basis

The best answer is D. When bonds are trading at a premium, the stated yield or nominal yield will be the highest, since it is the annual income divided by par value. Current yield is lower because it is annual income divided by the current market price (which is at a premium to par). Basis (or yield to maturity) is even lower because it not only considers that the current market price is at a premium to par; it also pro-rates the loss of the premium over the life of the bond, reducing the annual yield below the current yield.

When a bond trades at a premium, which bond yield will be the lowest? A. Nominal B. Stated C. Current D. Basis

The best answer is A. Convertible bonds are issued at lower interest rates than non-convertible issues; which bondholders accept in return for price appreciation potential based upon the market value of the common stock (since the bond is convertible into a fixed number of shares of common).

When comparing convertible to non-convertible corporate bonds, convertible bonds have: I lower yields II higher yields III price appreciation potential based on the market price of the common stock IV no price appreciation potential based upon the market price of the common stock A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. When evaluating debt securities, all of the risks listed must be considered - credit risk; purchasing power risk; legislative risk; and interest rate risk.

When considering the purchase of municipal debt securities, investors must evaluate which of the following risks? I Credit Risk II Purchasing Power Risk III Legislative Risk IV Interest Rate Risk A. I only B. I and IV C. II, III, IV D. I, II, III, IV

The best answer is A. When a recession is expected, investors sell corporate bonds (increasing their yields) and buy government bonds (decreasing their yields). Thus, the spread between corporate and government bond yields will widen.

When it is expected that a recession will occur, which statement is TRUE? A. The yield spread between corporate and government bonds will widen B. The yield spread between corporate and government bonds will narrow C. The yield spread between corporate and government bonds will not be affected D. An arbitrage opportunity will exist between corporate and government bonds

The best answer is C. When the yield curve is "inverted," short term rates are higher than long term rates. To maximize income during this period, a customer would liquidate long term (lower rate) holdings and invest in short term (higher rate) holdings.

When the yield curve is inverted, which of the following statements are TRUE? I Short term rates are lower than long term rates II Short term rates are higher than long term rates III To maximize income, an investor should invest in short term maturities IV To maintain income, an investor should invest in long term maturities A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. One basis point = .01% in interest, or .01% of $1,000 par in annual interest = $.10. 100 basis points equal 1% of annual interest on a $1,000 per bond = $10.00.

100 Basis Points equal: A. $.01 B. $.10 C. $1.00 D. $10.00

The best answer is A. Since 1 Basis Point = .01% = $.10, 140 Basis Points = 1.40% = $14.00.

140 Basis points equal: A. 1.4% B. 14% C. 140% D. 1400%

The best answer is C. Commercial paper is corporate money market debt which is NOT eligible for Fed trading. Treasury bills are issued by the U.S. Government. Repurchase agreements are entered into between Government securities dealers; and banker's acceptances are issued by commercial banks.

Which of the following money market instruments is issued by corporations? A. Treasury Bill B. Repurchase Agreement C. Commercial Paper D. Prime Banker's Acceptances

The best answer is C. Ginnie Maes are guaranteed by the U.S. Government so there is no risk of default. Ginnie Mae is authorized to raid the U.S. Treasury to make up any payment shortfalls, if required. The holder of a certificate is subject to potential loss of principal if interest rates rise, since the market value of the securities will fall. The holder is also subject to early prepayment risk if interest rates drop and the homeowners prepay their mortgages. Because rates have dropped, these prepayments are now reinvested at lower current market rates.

Which of the following risks are applicable to Ginnie Mae Pass Through Certificates? I Purchasing power risk II Risk of early prepayment of mortgages if interest rates fall III Risk of default if homeowners do not make their mortgage payments IV Risk of loss of principal if interest rates rise A. III only B. I, II, III C. I, II, IV D. I, II, III, IV

The best answer is D. The safest bonds listed are Treasury bonds (backed by the U.S. Government) and General obligation bonds (backed by unlimited municipal taxing power). The bonds with the highest credit risk are Industrial revenue bonds and Equipment trust certificates. Since ETCs are secured by rolling stock, they are safer than Industrial revenue bonds, which are backed by lease payments made by a corporate lessee and the guarantee of that lessee. If the corporate lessee were to default; and then declare bankruptcy, the IRB holders would be left with worthless paper.

Which of the following securities has the lowest level of credit risk? A. Equipment Trust Certificate B. General Obligation Bond C. Industrial Revenue Bond D. Treasury Bond

The best answer is A. One basis point is .01% of interest. 100 basis points equals 1% of interest. 150 basis points equals 1.50%, which is the same as $15.00 per $1,000 face amount on a bond.

150 basis points are equal to: I $15.00 per $1,000 II $150.00 per $1,000 III 1.5% IV 15% A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. A money market instrument is a debt that will mature in 1 year or less (it will turn into "money" within a year). The maximum maturity on Treasury Bills is 1 year. In contrast, Treasury Notes can have a maturity of up to 10 years, and Treasury Bonds and Treasury Strips (zero coupon bonds) have a maximum maturity of 30 years.

Which of the following securities issued by the U.S. Government is considered to be a money market security? A. T-Bill B. T-Note C. T-Bond D. T-Strip

The best answer is A. Each tranche of a CMO, in effect, represents a differing expected maturity, hence each tranche has a different level of market risk. Since each tranche represents a differing maturity, the yield on each will differ, as well.

Which of the following statements regarding collateralized mortgage obligations are TRUE? I Each tranche has a different level of market risk II Each tranche has the same level of market risk III Each tranche has a different yield IV Each tranche has the same yield A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. This question is asking for the following: 8% Coupon 6.00 Basis 105 7.5% Coupon 6.00 Basis ? 7% Coupon 6.00 Basis 101 The difference in price between the 7% and 8% bonds is 4 points. The 7.50% bond is 50% of the way from 7%. 50% x 4 points difference = 2 point price increment from the 7% price. 101 + 2 = 103 price for the 7.5% bond.

A 10 year 8% municipal bond, quoted on a 6.00 basis, is priced at 105. A 10 year 7% municipal bond, quoted on a 6.00 basis, is priced at 101. What is the price of a 10 year, 7.5% municipal bond, quoted on a 6.00 basis? A. 103 B. 104 C. 104.10 D. 105.20

The best answer is B. To make callable issues marketable to the public, investors are protected from calls for a stated period after the bonds' issuance. In this example, the bonds issued in 2017 are first callable in 2027 so the investor has 10 years of "call protection" with this issue.

A 20-year bond is issued in 2017 with the following call schedule: Redemption Date Redemption Price 2027 104 2028 103 2029 102 2030 101 2031 100 and after This issue has how many years of "call protection"? A. 0 B. 10 C. 11 D. 20

The best answer is D. The bond is purchased at 98 and 9/32nds = 98.28125% of $1,000 = $982.8125. The formula for current yield is: Annual Income/ Market Price = Current Yield $35/ $982.8125 = 3.56%

A 5 year $1,000 par 3 1/2% Treasury Note is quoted at 98-4 - 98-9. The note pays interest on Jan 1st and Jul 1st. A customer buys 1 note at the ask price. What is the current yield, disregarding commissions? A. 3.26% B. 3.36% C. 3.46% D. 3.56%

The best answer is C. "5M" means that the customer is buying $5,000 par value of the notes (M is Latin for $1,000). A customer will buy at the ask price, which is 100 and 16/32nds = 100.50% of $5,000 par = $5,025.

A 5 year 2 1/4% Treasury Note is quoted at 100-12 - 100-16. The note pays interest on Jan 1st and Jul 1st. A customer buys 5M of the notes. Approximately how much will the customer pay, disregarding commissions and accrued interest? A. $5,006.00 B. $5,018.75 C. $5,025.00 D. $5,028.75

The best answer is C. "5M" means that the customer is buying $5,000 par value of the notes (M is Latin for $1,000). A customer will buy at the ask price, which is 101 and 8/32nds = 101.25% of $5,000 par = $5,062.50.

A 5 year 3 1/2% Treasury Note is quoted at 101-4 - 101-8. The note pays interest on Jan 1st and Jul 1st. A customer buys 5M of the notes. How much will the customer pay, disregarding commissions and accrued interest? A. $5,056.25 B. $5,070.00 C. $5,062.50 D. $5,090.00

The best answer is D. Government bond accrued interest is computed on an actual month/actual year basis; trades settle through the Federal Reserve system in "Fed Funds;" and trades settle next business day. Because these T-Notes are trading at a premium, the yield to maturity will be lower than the current yield.

A 5 year 3 3/4% Treasury Note is quoted at 101-8 - 101-16. The note pays interest on Jan 1st and Jul 1st. Which of the following statements are TRUE regarding this trade of T-Notes? I Interest accrues on an actual day month; actual day year basis II The yield to maturity will be lower than the current yield III The trade will settle in Fed Funds IV The trade will settle next business day if performed "regular way" A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is C. "C" rated bonds are true "junk" with a high risk of default. This is a totally inappropriate investment for a retiree who needs income.

A 65-year old customer wishes to invest part of his retirement funds with the dual objectives of enhanced income and safety of principal. The customer notices that "C" rated corporate bonds yield significantly more than equivalent maturity Treasury issues and asks you, the registered representative, whether these would be an appropriate investment. The best response is to tell the customer that this is a: A. good idea since corporate bonds are extremely safe investments since they are guaranteed by the issuing corporation B. good idea because the yield spread between corporates and Treasuries guarantees a superior return C. bad idea because "C" rated corporate bonds have a much higher risk of default than Treasury issues D. bad idea because "C" rated corporate bonds are not permitted investment vehicles for retirement fund proceeds

The best answer is B. 100 basis points equals 1 point on a bond = 1% of $1,000 par = $10.00 in interest per year. Since this bond has only 1 year to maturity, a 100 basis point change in quote (1 point) will equal a $10.00 change in price. This quote is being changed by 10 basis points (from 6.85 basis to 6.95 basis), so the approximate price change on this 1 year bond is $1.00.

A 7% general obligation bond matures in 1 year. A municipal dealer quoting the bond has just changed his quote from a 6.85 basis to a 6.95 basis. The approximate dollar change in price per $1,000 bond is: A. $.10 B. $1.00 C. $10.00 D. $100.00

The best answer is B. To be bank qualified, a municipal issue must be a public purpose (not private purpose issue). Any bank that buys the issue can deduct 80% of the interest expense it incurs on deposits used to fund the purchase of the bonds, while the interest income from the municipal issue is not taxable to the bank. This is sometimes termed the 80/20 rule. If an issue is not bank qualified, then none of the interest expense that the bank incurs on deposits used to fund the purchase of the bonds can be deducted, which is logical since the interest income from the bonds is exempt from Federal taxation.

A bank qualified municipal issue is one where: I 80% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted II 100% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted III 80% of the interest income received is not taxable to the bank holding the bonds IV 100% of the interest income received is not taxable to the bank holding the bonds A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The trust indenture of a revenue bond issue includes a "flow of funds" - meaning how revenues will be applied by the issuer. As revenues are collected, they are deposited to a revenue fund, also called a general collection account. The monies are then applied, in sequence, to the operation and maintenance account; sinking fund; debt service reserve fund; reserve maintenance fund; renewal and replacement fund; and finally to the surplus fund.

Regarding the flow of funds set forth in a municipal bond contract, collected monies would FIRST be deposited to the: A. Operations and Maintenance Fund B. Debt Service Reserve Fund C. Revenue Fund D. Reserve Maintenance Fund

The best answer is B. Reinvestment risk occurs when an investor is holding fixed income securities over a long time horizon during a time period when interest rates have been declining. As payments are received from these investments, they must be reinvested to maintain the overall rate of return on that portfolio - and if interest rates have been dropping, these payments are reinvested at lower and lower interest rates, lowering the overall rate of return on the portfolio.

Reinvestment risk occurs in investment time horizons during which market interest rates are: A. rising B. falling C. stable D. volatile

The best answer is B. General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Ad valorem taxes, fines collected for paying taxes late, assessments of additional taxes, as well as fees collected that are not a specified income source for revenue bonds, are all sources of income backing G.O. issues. Highway tolls are pledged to pay the debt service on revenue bonds that are sold to finance the construction of the road. These monies are not available to pay the debt service on G.O. bond issues.

All of the following are sources of income available for general obligation bond debt service EXCEPT: A. ad valorem taxes B. highway tolls C. license fees D. assessments

The best answer is C. The "non-essential" use private purpose revenue bond would have the highest yield because the interest income is subject to the AMT - Alternative Minimum Tax. A public purpose revenue bond would have a lower yield because its interest income is not subject to the AMT. The G.O. bond would have the lowest yield because it is backed by ad valorem taxing power (considered the safest income source) and is not subject to the AMT.

Below is a listing of municipal bonds with the same credit ratings and maturities. Arrange the bonds in order of highest yield to lowest yield: I General Obligation Bond II Public Purpose Revenue Bond III Non-Essential Use Private Purpose Revenue Bond A. I, II, III B. II, III, I C. III, II, I D. III, I, II

The best answer is D. Ranking the yields on these bonds from highest to lowest: Private purpose revenue bond would have the highest yield because its income is Federally taxable via the AMT - Alternative Minimum Tax. Public purpose revenue bond would have a lower yield because its interest income is exempt from Federal tax. A general obligation bond would have a lower yield than a public purpose revenue bond because it has greater safety; as well as being exempt from Federal tax. A Puerto Rico bond would have the lowest yield because its income is exempt from both Federal, State, and Local taxes for all investors, no matter where they live.

Below is a listing of municipal bonds with the same credit ratings and maturities. Which bond has the lowest yield? A. General Obligation Bond B. Public Purpose Revenue Bond C. Non-Essential Use Private Purpose Revenue Bond D. Puerto Rico Bond

The best answer is A. Bonds quoted on a percentage of par basis are term bonds. Municipal bonds quoted in basis points (yield quotes) are serial bonds.

Bonds quoted on a percentage of par basis are generally: A. term bonds B. series bonds C. serial bonds D. short term maturities

The best answer is C. Bonds quoted in basis points (yield quotes) are serial bonds - this is the usual case for municipal bonds. Bonds quoted on a percentage of par basis are term bonds.

Bonds quoted on a yield to maturity basis are generally: A. term bonds B. series bonds C. serial bonds D. short term maturities

The best answer is C. Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing).

Construction Loan Notes are repaid from: A. rents received from the housing project built with the proceeds of the offering B. rent subsidies received from the U.S. Government C. monies received from a permanent take-out financing D. monies received from the issuance of the Construction Loan Note

The best answer is C. The conversion ratio is established when the bond is issued, and is: par value divided by the conversion price. In this case, the conversion price is set at $40 per share, so the conversion ratio is $1,000 par / $40 conversion price = 25:1 (25 shares per bond). If the bond moves to a 10 point premium over par, its new price will be 110, or $1,100 per bond. For the common stock to be valued at parity to the bond, the price per share must be $1,100 / 25 shares per bond = $44 per share parity price.

A convertible debenture is convertible into common at $40 per share. If the market price of the bond rises to a 10 point premium over par, which statements are TRUE? I The conversion ratio is 20:1 II The conversion ratio is 25:1 III The parity price of the stock is $44 IV The parity price of the stock is $50 A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. If the bond is called on Jan 1, 2028, it has 4 years left to maturity. This is the same as 8 - six month periods. For each six month period prior to maturity that the bond is called, 1/8 point is added to the call premium (total equals 1 point). Since the call price is 100 1/2 plus the additional premium of 1 point, the total call price is 101 1/2.

A corporate bond was issued on Jan 1, 2012, that matures on Jan 1, 2032. The trust indenture allows the corporation to call the bond starting in 2017 at a price equaling 100 1/2 plus an additional 1/8 point premium for every 6 month period remaining until maturity. If the bond is called on Jan 1, 2028, the redemption price will be: A. 102 1/2 B. 102 C. 101 1/2 D. 100 1/2

The best answer is C. Income bonds (also known as adjustment bonds) obligate the issuer to pay interest only if the company meets a specified earnings test. If the earnings are not sufficient, no interest payment is legally required. All other bonds obligate the issuer to pay interest, regardless of events.

A corporate bond which obligates the issuer to pay interest ONLY if the company meets a specified earnings test is a(n): A. guaranteed bond B. subordinated bond C. income bond D. collateral trust certificate

The best answer is C. If the bonds are tendered at the call price, the owner receives $1,000 per bond. If the bonds are sold at the current market price, the owner receives $1,020 per bond. Since each bond is convertible into 14 common shares, the short sale of 14 common shares will yield 14 x $75.50 = $1,057. The bonds can then be converted to common to cover the short position. Thus, selling short the common is the best choice. Continuing to hold the bonds does not make sense since interest payments will cease.

A corporation has issued $1,000 par, 8% convertible bonds, callable at par. The bonds are convertible into 14 shares of common stock. Currently, the bond is trading at 102 while the common stock is trading at $75.50. The corporation calls the bonds at par plus accrued interest of $20 per bond. A customer holds 100 bonds, purchased at par. The customer wishes to liquidate the position at the greatest profit. The BEST recommendation is to (ignoring commissions): A. tender the bonds at the call price B. sell the bonds at the current market price C. sell short the common stock and convert the bonds for delivery to cover the short D. continue to hold the bonds

The best answer is C. If the bonds are tendered at the call price, the owner receives $1,000 per bond. If the bonds are sold at the current market price of 100 1/2, the owner receives $1,005 per bond. Since each bond is convertible into 20 common shares, the short sale of 20 common shares will yield 20 x $51 = $1,020. The bonds can then be converted to common to cover the short position. Thus, selling short the common is the best choice. Continuing to hold the bonds does not make sense since interest payments will cease. Also note that the amount of accrued interest to be received is irrelevant to the question. Since the customer already holds the bond, the customer is entitled to the amount of accrued interest due up until the call date, regardless of whether he or she sells the bond or converts!

A corporation has issued $1,000 par, 8% convertible bonds, callable at par. The bonds are convertible into 20 shares of common stock. Currently, the bond is trading at 100 1/2 while the common stock is trading at $51. The corporation calls the bonds at par plus accrued interest of $10 per bond. A customer holds 100 bonds, purchased at par. The customer wishes to liquidate the position at the greatest profit. The BEST recommendation is to (ignoring commissions): A. tender the bonds at the call price B. sell the bonds at the current market price C. sell short the common stock and convert the bonds for delivery to cover the short D. continue to hold the bonds

The best answer is B. Since the common stock is trading at $52 per share, while the parity price is $48 per share ($1,200 current bond price / 25 conversion ratio = $48), the stock is trading at a premium to the parity price. An arbitrage opportunity is present as the common stock is trading above parity. Here, the bond can be bought and converted into common stock at a "cheaper" price than the current market price of the stock. In essence, the common stock can be purchased at $48 per share by purchasing the convertible bond; and the equivalent number of shares can be simultaneously sold short at the current market price of $52. There is a $4 per share profit. The bond is then converted into common shares, and these are delivered to cover the short position.

A corporation has issued $10,000,000 of 8%, 20 year, $1,000 par, convertible debentures, convertible at a ratio of 25:1. The bond is currently trading at 120, while the company's common stock is at $52. Which statements are TRUE? I An arbitrage opportunity exists between the convertible bond and the common stock II An arbitrage opportunity does not exist between the convertible bond and the common stock III The common stock is trading at a discount to the parity price IV The common stock is trading at a premium to the parity price A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The bond is currently priced at $1,200. For the common stock to be trading at "parity," 25 shares (the conversion amount per bond) must be worth the same $1,200. $1,200 divided by 25 shares per bond equals $48 per share parity price.

A corporation has issued $10,000,000 of 8%, 20 year, $1,000 par, convertible debentures, convertible at a ratio of 25:1. The bond is currently trading at 120, while the company's common stock is at 46. The parity price of the common stock is currently: A. $40 B. $46 C. $48 D. $50

The best answer is B. The bonds are convertible into 40 shares of stock. The current market value of the stock is $25.25, so the parity price of the bonds is 40 x $25.25 = $1,010 = 101.

A corporation has issued 10% convertible debentures, convertible into 40 shares of common stock. The current market price of the common stock is $25.25. If the bonds are trading at parity, they are priced at: A. 100 B. 101 C. 106 D. 107

The best answer is C. The bonds are convertible into 5 shares of stock. The current market value of the stock is $205, therefore the parity price of the bonds is 5 x $205 = $1,025 = 102 1/2 per bond.

A corporation has issued 10% convertible debentures, convertible into 5 shares of common stock. The current market price of the common stock is $205. If the bonds are trading at parity, they are priced at: A. 100 B. 101 3/4 C. 102 1/2 D. 105

The best answer is A. The bonds are convertible at $100, based on $1,000 par value. Therefore each bond converts into 10 shares ($1,000 par / $100 conversion price). If the common is trading at $90, the bond must be trading at 10 times this to be at parity. $90 x 10 = $900 parity price of one bond. The parity price of "5M" ($5,000 face amount, "M" is Latin for $1,000) is $900 x 5 = $4,500.

A corporation has issued 10%, $1,000 par convertible debentures, convertible at $100. The common stock is currently trading at $90. If the bond and the common are trading at parity, a customer purchasing 5M of the bonds will pay: A. $4,500 B. $5,000 C. $5,225 D. $5,500

The best answer is B. The conversion price (and hence the conversion ratio) is fixed when the convertible security is issued and does not change. In this case, the bond is issued with a conversion price of $31.25, based upon converting each bond at par. $1,000 par / $31.25 conversion price = 32:1 conversion ratio. Thus, for every bond that is converted, the holder receives 32 shares.

A customer bought a $1,000 par convertible subordinated debenture at par, convertible into common at $31.25 per share. If the bond's market price increases by 20%, the conversion ratio will be: A. 31.25:1 B. 32.00:1 C. 37.50:1 D. 38.40:1

The best answer is D. Regular way trades of corporate bonds and stocks settle 3 business days after trade date.

A customer buys 10 Allied Corporation 8% debentures, M '25, at 90 on Wednesday, April 19th in a regular way trade. The interest payment dates are March 1st and September 1st. The trade settles on: A. Thursday, April 20th B. Friday, April 21st C. Saturday, April 22nd D. Monday, April 24th

The best answer is D. Accrued interest for corporate bonds is calculated on a 30 day month / 360 day year. Interest accrues from the morning of the last interest payment up to but not including settlement date. So, there are 30 days due for March and 23 days due for April (up to but not including settlement date of April 24th) or 53 days total.

A customer buys 10 Allied Corporation 8% debentures, M '28, at 90 on Wednesday, April 19th. The interest payment dates are March 1st and September 1st. The trade settled on Monday, April 24th. How many days of accrued interest will the buyer pay to the seller? A. 23 B. 30 C. 52 D. 53

The best answer is D. Interest accrues on a 30 day month / 360 day year basis for corporate bonds. The bonds were purchased on Monday, Oct 8th. Settlement takes place on Thursday, Oct 11th. Interest accrues up to but does not include settlement date. Thus, 30 days are due for Aug; 30 for Sept; and 10 for Oct; for a total of 70 days.

A customer buys 10 Allied Corporation 8% debentures, M '35, at 90 on Monday, Oct 8th. The interest payment dates are Feb 1st and Aug 1st. The trade settled on Thursday, October 11th. How many days of accrued interest will the buyer pay to the seller? A. 62 B. 63 C. 69 D. 70

The best answer is B. 10M stands for 10 - $1,000 bonds (M is Latin for $1,000) = $10,000 face amount of bonds. The bonds pay 12% interest annually. 12% of $10,000 is $1,200. However, the question asks how much will be received in the next payment. Since bonds pay interest semi-annually, the amount received per payment is $600.

A customer buys 10M of Allied Corporation 12% debentures, M '29, at 90 on Monday, Oct 8th. The interest payment dates are Feb 1 and Aug 1. The trade settled on Thursday, October 11th. The amount of the next interest payment will be: A. $300 B. $600 C. $900 D. $1,200

The best answer is C. The purchase price is 98-8 = 98 and 8/32nds = 98.25% of $5,000 = $4,912.50.

A customer buys 5M of 3 1/4% Treasury Bonds at 98-8. The customer will pay how much for the bonds? A. $4,900.25 B. $4,904.00 C. $4,912.50 D. $5,000.00

The best answer is B. The customer buys the bonds at 96 and 5/32s = 96.15625% of $1,000 = $961.5625 (the fact that $5,000 face amount of bonds were purchased is irrelevant, since the formula is a percentage). The formula for current yield is: Annual Income/ Market Price = Current Yield $37.50 (per $1,000 face amount)/ $961.5625 (per $1,000 face amount) = 3.90%

A customer buys 5M of 3 3/4% Treasury Bonds at 96-5. The current yield of the Treasury Bond is: A. 3.75% B. 3.90% C. 4.05% D. 4.25%

The best answer is C. "5M" means that 5-$1,000 bonds are being purchased (M is Latin for $1,000). Annual interest on the bonds is 6.25% of $5,000 face amount equals $312.50. Since interest is paid twice per year, each payment will be for $156.25.

A customer buys 5M of 6 1/4% Treasury Bonds at 100. How much interest income will the customer receive at each interest payment? A. $31.25 B. $62.50 C. $156.25 D. $312.50

The best answer is B. If a bond is purchased at a premium, there is a premium to be amortized over the life of the bond when computing yield to maturity. If the bond is called prior to maturity, the premium is lost "faster" and the yield to call falls below the yield to maturity. For a premium bond, the nominal yield is always higher than yield to call or yield to maturity (because the purchase price is more than par, the yield must drop below the stated rate of interest).

A customer buys a 10% G.O. bond at 110. The issue is callable in 5 years at par and matures in 10 years. Which statement is TRUE? A. The yield to call is higher than the yield to maturity B. The yield to call is lower than the yield to maturity C. The yield to call is the same as the yield to maturity D. The nominal yield is lower than either the yield to call or yield to maturity

The best answer is C. A declining rate of inflation will lead to lower interest rates. If interest rates drop, then bond prices will rise.

A declining rate of inflation would lead to: I lower bond prices II higher bond prices III lower bond yields IV higher bond yields A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. A declining rate of inflation will lead to lower interest rates. If interest rates drop, then bond prices will rise.

A declining rate of inflation would lead to: A. higher bond prices and higher bond yields B. higher bond prices and lower bond yields C. lower bond prices and lower bond yields D. lower bond prices and higher bond yields

The best answer is B. A declining market rate of interest means that interest rates are dropping. If market interest rates drop, then bond prices will rise, and the yields on those bonds will fall.

A decreasing market rate of interest would lead to: A. higher bond prices and higher bond yields B. higher bond prices and lower bond yields C. lower bond prices and lower bond yields D. lower bond prices and higher bond yields

The best answer is B. If a facility is condemned, it can no longer generate revenues. Though the question is not clear as to why it was condemned, the best choice is that a catastrophe call provision would be activated. This requires the issuer to call in the bonds, repaying the bondholders if a disaster occurs. Of the other choices, sinking fund covenants and defeasance covenants have no bearing. A maintenance covenant requires the issuer to maintain the facility in good repair. This covenant is not "activated" by a condemnation, as is a catastrophe call covenant.

A facility built with a revenue bond issue has been condemned. Which of the protective covenants found in the trust indenture would be activated? A. defeasance covenant B. catastrophe call covenant C. maintenance covenant D. sinking fund covenant

The best answer is A. Treasury Bills are quoted on a yield basis. From the basis quote, the dollar price is computed. A customer who wishes to buy will pay the "Ask" of 4.90. This means that the dollar price will be computed by deducting a discount of 4.90 percent from the minimum par value of $100. This is the discount earned over the life of the instrument.

A government securities dealer quotes a 3 month Treasury Bill at 5.00 Bid - 4.90 Ask. A customer who wishes to buy 1 Treasury Bill will pay: A. a dollar price quoted to a 4.90 basis B. a dollar price quoted to a 5.00 basis C. $4,900 D. $5,000

The best answer is D. All of the bonds listed are discount bonds. As a general rule, the deeper the discount, the more volatile the bond's price movements in response to market interest rate changes. Also, the longer the maturity, the more volatile the bond's price movements in response to market interest rate changes. The 6.25% bond quoted on an 8.50% yield with 4 1/2 years to maturity has both the longest maturity and deepest discount. This bond's price will move the farthest in response to market interest rate changes.

A yield quote change of 5 basis points on municipal bonds with a 6.25% nominal yield will result in the greatest dollar price change for bonds quoted at: A. 8.20% with 3 years to maturity B. 8.30% with 3 1/2 years to maturity C. 8.40% with 4 years to maturity D. 8.50% with 4 1/2 years to maturity

The best answer is D. Quote providers such as Bloomberg and Reuters give dealer to dealer prices (the "wholesale" market) for corporate bonds daily. These are bonds that are trading in the secondary market.

Dealer offerings of corporate bonds found in Bloomberg are: I retail quotes II wholesale quotes III new issue offerings sold under a prospectus IV secondary market offerings A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Accrued interest on a new issue is calculated from the dated date till settlement date. A new issue is bought from the underwriter. The customer pays the underwriter the price of the bond plus any accrued interest. This interest accrues from the dated date of the issue (the date of legal issuance) until the date the customer settles the purchase with the underwriter.

Accrued interest on a new issue corporate bond is calculated from: A. dated date to settlement date B. dated date to first interest payment C. settlement date to first interest payment D. trade date to settlement date

The best answer is D. Accrued interest on municipal (and corporate) bonds is calculated on a 30 day month/ 360 day year basis.

Accrued interest on municipal issues is calculated on a: I Actual day month II 30 day month III Actual day year IV 360 day year A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. For corporate bonds, the most marketable blocks are 5 bonds up to 100 bonds. Under 5 is an odd lot; over 100 is a large block which is more difficult to trade. The shorter the maturity, the more marketable the bond. The higher the rating, the more marketable the bond. The bond denominations have no effect on marketability.

All of the following affect the marketability of corporate bonds EXCEPT: A. Bond denominations B. Block size C. Maturity D. Bond rating

The best answer is D. Funded debt is a term used to describe corporate bonds that are part of the issuer's "permanent financing". Generally, any corporate debt with a long term maturity is considered to be "funded." Short term debt is not funded, since it must be paid off soon, and is not part of the corporation's long term capital base.

All of the following are considered to be funded debts EXCEPT: A. mortgage bonds with 20 year maturities B. debentures with 10 year maturities C. collateral trust certificates with 15 year maturities D. promissory notes that need to be refinanced with long term debt

The best answer is D. An issuer can retire bonds prior to maturity by calling the issue under the terms established in the bond contract; requesting the bondholders to tender the bonds at a price established by the issuer; or by buying the bonds in the open market. If a bond has a put option, the bondholder has the right to put the bonds back to the issuer at par. This decision is made by the bondholder, not by the issuer.

All of the following are methods that an issuer can use to retire bonds prior to maturity EXCEPT: A. request for tenders B. exercise of call option C. open market purchase D. exercise of put option

The best answer is C. The issue date has no bearing on the calculation of the purchase price of a municipal bond trading in the secondary market. In order to calculate the bond's price, a bond calculator would be used. The calculation requires the coupon rate, yield to maturity, and years to maturity. The trade date is necessary to compute the amount of accrued interest that is due.

All of the following are necessary to calculate the total purchase price of a municipal bond traded on a yield basis in the secondary market EXCEPT: A. coupon rate B. yield to maturity C. issue date D. trade date

The best answer is D. An extraordinary mandatory call is made if the proceeds of the issue were never expended to build the proposed facility, returning the money to the bondholders. An extraordinary optional call is made if homeowners prepay their mortgages faster than expected, so the issuer of housing bonds can retire outstanding debt with the extra payments received. An extraordinary mandatory call is made if a calamity occurs, destroying the facility built with the bond proceeds. If interest rates drop, then the issuer normally has the option of calling in the bonds at pre-set dates and prices. This is an optional call, and is not due to extraordinary events.

All of the following are reasons for a revenue bond issuer to make an extraordinary call EXCEPT: A. the proceeds of the issue were never expended to build the proposed facility B. homeowners have prepaid their mortgages at a faster than expected rate on a housing bond issue C. the facility built with the proceeds of the issue has been destroyed by fire D. interest rates have dropped and the issuer can refund the bonds at lower current rates

The best answer is B. Long term bond prices are more volatile than short term bond prices as interest rates move. Thus, short term bond prices are more stable (move more slowly) as interest rates change compared to long maturities.

During a period when the yield curve has a normal ascending shape, which statement is TRUE? A. Short term bond prices are more volatile than long term bond prices B. Long term bond prices are more volatile than short term bond prices C. Both short term and long term prices are equally volatile D. No relationship exists between long term and short term bond price movements

The best answer is B. Whether the yield curve is ascending (normal), flat or descending, long term bond prices always move faster than short term bond prices, as interest rates change. This is due to the compounding effect on the bond's price that occurs, which increases with longer maturities.

During a period when the yield curve is normal: A. short term bond prices are more volatile than long term bond prices B. long term bond prices are more volatile than short term bond prices C. short term and long term bond prices are equally volatile D. no relationship exists between short term and long term bond price changes

The best answer is B. Bonds with the lowest price volatility will be ones with the highest coupon rate. Bonds with low coupon rates exhibit greater price volatility, with the most volatile bond being a zero-coupon bond. Thus, to minimize price volatility due to interest rate movements ("interest rate risk"), high coupon bonds are more appropriate than low coupon bonds.

During periods when interest rates are rising, which of the following statements are TRUE? I Bonds with low coupon rates exhibit the greatest price volatility II Bonds with high coupon rates exhibit the greatest price volatility III To minimize price volatility, low coupon bonds are appropriate investments IV To minimize price volatility, high coupon bonds are appropriate investments A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Quote providers such as Bloomberg and Reuters give dealer to dealer prices (the "wholesale" market) for corporate bonds daily.

Quotes for corporate bonds found on Bloomberg are: A. wholesale corporate bond prices for broker/dealers B. retail corporate bond prices for public customers C. the dollar amount of new issue corporate bonds traded over the preceding 30 days D. the dollar amount of new issue corporate bonds to be sold over the next 30 days

The best answer is D. Aside from listing dealer offerings of all municipal bonds, Bloomberg also lists dealer offerings of corporate bonds.

Quotes for which of the following are found in Bloomberg? I General obligation bonds II Revenue bonds III Industrial development bonds IV Corporate bonds A. I only B. II and III C. I, II, III D. I, II, III, IV

The best answer is B. Ginnie Mae Pass Through Certificates "pass through" monthly mortgage payments to the certificate holders. Each payment is a combination of both interest and principal paid from the underlying mortgage pool.

Regarding Ginnie Mae Pass Through Certificates: I The certificates pay holders on a monthly basis II The certificates pay holders on a semi-annual basis III Each payment consists of interest only IV Each payment consists of a combination of interest and principal A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Put options are exercisable at the option of the bondholder (not the issuer). Because the put option removes some of the market risk from the bond, this feature is valued by bondholders, who will accept lower yields on bonds having this option.

Regarding bonds with put options, which of the following statements are TRUE? I Exercise of the put is at the option of the bondholder II Exercise of the put is at the option of the issuer III Yields on bonds with put options are lower than similar bonds without this feature IV Yields on bonds with put options are higher than similar bonds without this feature A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Trades of U.S. Government bonds settle in Fed Funds. Regular way settlement of government securities trades takes place the business day following trade date.

Regular way trades of U.S. Government bonds settle: I in Fed Funds II in Clearing House Funds III next business day IV in 3 business days A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. TRACE is FINRA's Trade Reporting and Compliance Engine. It reports trades of corporate, government and agency bonds. Any OTC dealers trading these bonds must report each trade to TRACE "as soon as practicable," but no later than 15 minutes after execution. TRACE disseminates the trade report immediately. RTRS stands for Real Time Reporting System. It reports trades of municipal bonds. The Network A Tape reports trades of NYSE listed equity issues. The Network B Tape reports trades of AMEX and regional listed equity issues. The Network C Tape reports trades of NASDAQ listed equity issues. These are covered in the Trading Markets chapter.

Reports of corporate bond trades are made through: A. TRACE B. RTRS C. Network A Tape D. Network C Tape

The best answer is C. Municipal bonds are generally not sold short because the trading market in each maturity is very thin, making short covering difficult, if not impossible. Short selling (the sale of borrowed securities, with the purchase and replacement of the borrowed securities occurring later) is a strategy that allows the investor to profit in a falling market. Short selling can only be performed with actively traded securities (since ultimately the borrowed securities that were sold must be repurchased and replaced). Common stocks, listed options, and U.S. Government securities are all actively traded; and short selling of these securities is common.

Short sale transactions are typical for which of the following? I Listed options II Common stock III Municipal bonds IV Treasury bonds A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is B. Ginnie Mae buys FHA and VA guaranteed mortgages from banks and assembles them into pools. GNMA then sells undivided interests in these pools as pass-through certificates. The monthly mortgage payments are passed through to the certificate holders. GNMA guarantees the payment of interest and principal on the underlying mortgages and has the direct backing of the U.S. Government. The agencies that have an implied U.S. Government backing are Fannie Mae and Freddie Mac.

The Government National Mortgage Association: A. buys conventional mortgages from financial institutions for repackaging as pass through certificates B. buys FHA and VA guaranteed mortgages from financial institutions for repackaging as pass through certificates C. gives its implied backing to the payment of interest and principal on mortgages purchased from financial institutions D. issues mortgages directly on U.S. Government subsidized housing

The best answer is C. If the purchase price of a bond is higher than par, then the bond is selling for more than par. This is the bond's premium.

The amount by which the purchase price of a municipal bond exceeds the par value of the bond is termed the: A. spread B. discount C. premium D. takedown

The best answer is D. Since the issue is dated June 1st, 2017, interest starts accruing from this date until the first interest payment is made on January 1st, 2018. Thus, the first interest payment will cover 7 months - an odd first interest payment. From this date forward, regular semi-annual interest payments will be made on January 1st and July 1st.

The city of Jacksonville, Florida is issuing $100,000,000 of general obligation bonds paying interest on January 1st and July 1st of each year until maturity. The dated date of the issue is June 1, 2017. The first payment will be made on January 1, 2018. A bondholder purchases the issue at the offering. The first interest payment will cover a period of: A. 1 month B. 5 months C. 6 months D. 7 months

The best answer is A. Each bond is convertible into 40 common shares ($1,000 par / $25 conversion price = 40:1 conversion ratio). Since the bond is now trading at 110 ($1,100 per bond) the parity price of the common is $1,100 / 40 = $27.50. Since the common is currently trading at $27.50, it is trading at parity and it does not make sense to convert. It only makes sense to convert if the common is trading above parity.

The conversion price of a convertible debenture is set at issuance at $25 per share. The common stock is now trading at $27.50 while the bond is trading at 110. In order for the common stock to be trading at parity to the current market price of the bond, the stock price would be: A. $27.50 B. $30.00 C. $32.00 D. $35.50

The best answer is C. If the bond rises 20% from its current price of $1,000 (par), the new price will be 120% x $1,000 = $1,200 per bond. Since each bond is convertible based upon a conversion price of $40 per share, the conversion ratio is $1,000 par / $40 conversion price = 25:1. The new parity price is $1,200 / 25 = $48 per share.

The conversion price of a convertible debenture is set at issuance at $40 per share. The common stock is now trading at 42 while the bond is trading at par. If the bond rises 20% from its current market value, the new parity price of the common stock will be: A. $44 B. $46 C. $48 D. $50

The best answer is C. Since the bond is now trading at 110 ($1,100 per bond) and each bond is convertible into 20 common shares, the parity price of the common is $1,100 / 20 = $55. Since the common is currently trading at $46, it is below parity and it does not make sense to convert. It only makes sense to convert if the common is trading above parity.

The conversion price of a convertible debenture is set at issuance at $50 per share. The common stock is now trading at $46 while the bond is trading at 110. In order for the common stock to be trading at parity to the current market price of the bond, the stock price would be: A. $46.00 B. $50.00 C. $55.00 D. $62.50

The best answer is B. Guaranteed corporate bonds are guaranteed by another corporation (typically a parent company guaranteeing the debt of a wholly owned subsidiary). The guarantor will have the higher credit rating, so the bonds will be able to be issued at a lower interest cost. Such bonds take on the credit rating of the corporate guarantor, who is liable for payment if the issuer defaults. Agencies, such as Federal Deposit Insurance Corp. and Securities Investor Protection Corp. do not guarantee corporate bonds. They protect customer accounts if banks, or securities firms fail, respectively.

The credit rating of a guaranteed corporate bond is based on the credit quality of the: A. corporate issuer B. corporate guarantor C. FDIC D. SIPC

The best answer is B. The current yield is the stated rate of interest on the bond, based on current market value. Current yield=Annual Interest rate/Market value

The current yield on a bond is: A. stated interest rate / bond par value B. stated interest rate / bond market value C. market interest rate / bond par value D. market interest rate / bond market value

The best answer is C. The trust indenture for a revenue bond issue will contain the flow of funds. The flow of funds details the priority of collecting and disbursing pledged revenues.

The flow of funds set forth in a revenue bond Trust Indenture details the: A. dates on which bondholders will be paid interest and principal on the issue B. dates and prices on which the issue can be called by the issuer C. priority of collecting and disbursing pledged revenues D. priority of the bondholder's claim to the assets of the issuer

The best answer is C. The bond counsel examines new municipal issues for legal or tax problems and renders an opinion on the validity, legality and tax exempt status of the issue. Bond counsels do not render economic opinions, which is the same as rendering an opinion on feasibility of an issue.

The municipal bond counsel opines on all of the following EXCEPT: A. validity B. legality C. feasibility D. tax exempt status

The best answer is C. The term "funded debt" refers to CORPORATE debt that is considered part of a company's permanent long term funding. Included is all long term corporate debt. Revenue bonds are issued by municipalities and T-Bonds are issued by the Government. Commercial paper is a short term financing and is an "unfunded" debt.

The term "Funded Debt" refers to which of the following issues? A. Commercial paper with under 270 days to maturity B. Revenue bond with at least 5 years to maturity C. Corporate debt with at least 5 years to maturity D. Treasury bond with at least 5 years to maturity

The best answer is A. The trust indenture is a contract between the issuer and trustee (since the trustee is paid by the issuer) where the trustee acts for the benefit of the bondholders.

The trust indenture is a contract between the: A. issuer and trustee B. trustee and bondholder C. issuer and bondholder D. issuer and transfer agent

The best answer is C. Ad valorem taxes back general obligation bonds. Revenue bonds can be backed by any source of revenue other than ad valorem taxes. These sources include revenue from facility operations, grants, excise taxes, or other non-ad valorem taxes, like sales and income taxes.

Types of funds used to back revenue bond issues include all of the following EXCEPT: A. excise taxes B. lease rentals C. ad valorem taxes D. enterprise activity income

The best answer is D. If interest rates rise, then homeowners will defer moving at the anticipated rate, since they have a "good" deal with their existing mortgage. Thus, the expected mortgage repayment flows from the underlying pass-through certificates slow down, and the expected maturity of the CMO tranches will lengthen. This is extension risk - the risk that the CMO tranche will have a longer than expected life, during which a lower than market rate of return is earned.

Homeowners will extend the anticipated repayment date of mortgages: I when interest rates fall II when interest rates rise III in order to refinance at higher rates IV in order to avoid refinancing at higher rates A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Under the column headed "Sls" are the sales for the day - in this case 12. This means that 12 bonds changed hands. Unlike stock trades, which are listed in lots of 100, the actual number of bonds traded that day is shown. This can be done because trading volume is very small in both corporate and municipal bonds.

How many Con Ed bonds changed hands this day? A. 1.2 B. 12 C. 120 D. 1200

The best answer is B. If Treasury bill yields are dropping at auction, then interest rates are falling and debt prices must be rising.

If Treasury bill yields are dropping at auction, this indicates that: I interest rates are falling II interest rates are rising III Treasury bill prices are falling IV Treasury bill prices are rising A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The basic truths about bond price volatility are: The lower the coupon rate (the same as saying the lower the price of the bond), the greater the bond price volatility; The longer the maturity, the greater the bond price volatility. Thus, the most volatile bonds are deep discount, long maturity bonds.

If a bond is trading at a discount, price volatility is greatest for a bond having: I low interest rates II high interest rates III short term maturities IV long term maturities A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The yield to call will be lower than the yield to maturity if the bond was purchased at a premium (which will be lost faster if the bond is called early). Since the bond is purchased at a premium, both yield to call and yield to maturity must be lower than the nominal yield.

If a callable bond is purchased at a premium, and is then called at par which of the following is TRUE? A. The yield to call is higher than the nominal yield B. The yield to call is lower than the nominal yield C. The yield to call is the same as the nominal yield D. The yield to call moves inversely to the nominal yield

The best answer is A. As a general rule, the longer the maturity on a debt issue, the greater the issue's price volatility in response to interest rate movements. Another general rule is that the lower the price of the issue (which would result from having a lower coupon), the greater the issue's price volatility in response to interest rate movements. As interest rates rise, bonds that are selling at a discount will fall proportionately more than bonds trading at an equivalent premium. This is true since the change in price as a percentage of the bond's cost is greater for a discount bond than for a premium bond.

If interest rates are rising, which statement about discount and premium bonds is TRUE? A. Discount bonds will depreciate faster than premium bonds B. Premium bonds will depreciate faster than discount bonds C. Both bonds will depreciate equally D. The rate of depreciation depends on the credit rating of the issuer

The best answer is C. When constructing a diversified municipal bond portfolio, one is trying to diversify away as much risk as possible. It would be logical to make sure that the portfolio is geographically diversified since having too great a concentration in one state or region is unwise if the local economy goes bad. A mix of credit ratings also helps to diversify the portfolio. Lower credit rated bonds give higher yields and make sense in a large portfolio, as long as the concentration is not too great. A mix of revenue sources also helps diversify away risk. The denominations of the bonds in the portfolio have no bearing on the risks inherent in those bonds.

In order to construct a diversified municipal bond portfolio, which of the following would be considered? I The geographic location of the issuers II The credit rating of each issue III The denominations available of each issue IV The revenue source backing each issue A. I, III B. II, IV C. I, II, IV D. I, II, III, IV

The best answer is A. The interest income from municipal bonds is exempt from Federal income tax; but is subject to State and Local tax. However, if a bond is purchased by a State resident, then the State exempts that issue from taxation as well.

Interest income from municipal bonds purchased by a resident of the issuing State is: A. exempt from Federal, State and Local tax B. exempt from Federal tax and subject to State and Local tax C. subject to Federal tax and exempt from State and Local tax D. subject to Federal, State and Local tax

The best answer is C. Interest income received from bonds issued by territories or possessions such as Puerto Rico, Guam and the Virgin islands, is exempt from Federal, State and Local tax, no matter where the purchaser lives. Interest income from State issues is always exempt from Federal income tax, but is only exempt from State and Local tax if purchased by a resident of that State.

Interest income from which of the following bond issues is SUBJECT to State and Local tax? I Issues of territories purchased by residents of that territory II Issues of territories purchased by non-residents of that territory III Issues of states purchased by residents of that state IV Issues of states purchased by non-residents of that state A. I and II only B. III and IV only C. IV only D. I, II, III, IV

The best answer is B. As a rule, interest income from U.S. Government securities is subject to Federal tax and exempt from State and Local tax. As a general rule, interest income from agency securities is subject to Federal tax and exempt from State and Local tax. However, the interest income from securities issued by the housing agencies that sell pass through certificates is fully taxable. These are: Federal National Mortgage Association ("Fannie Mae") Government National Mortgage Association ("Ginnie Mae") Federal Home Loan Mortgage Corporation ("Freddie Mac") Interest income received from bonds issued by territories or possessions is always triple exempt.

Interest income from which of the following securities is subject to State and Local tax? A. Treasury Bonds B. Federal National Mortgage Association Bonds C. Federal Home Loan Bank Bonds D. Puerto Rico Bonds

The best answer is A. The securities underlying CMOs are GNMA or FNMA mortgage backed pass-through certificates. The interest on these securities is subject to both Federal, State and Local income tax; hence CMOs are taxed in the same manner.

Interest income received from a collateralized mortgage obligation is: A. subject to both Federal and State and Local income tax B. exempt from Federal income tax, but subject to State and Local tax C. subject to Federal income tax, but exempt from State and Local tax D. exempt from both Federal and State and Local income tax

The best answer is B. Issuers call in bonds when interest rates have declined. The issuer can retire the "old" high interest rate debt; and issue new bonds at lower current market rates; reducing its interest cost.

Issuers will call their bonds when interest rates: A. have increased B. have declined C. remain unchanged D. are volatile

The best answer is B. A bond issue is likely to have a mandatory sinking fund if it is perceived as a risky issue, causing prospective purchasers to demand additional safeguards on their investment. Since G.O. bonds are backed by unlimited taxing power of the State, they are perceived as low risk (not needing a sinking fund). Revenue bonds are backed by the facility's revenues and are considered somewhat risky. These are the issues that are likely to have a mandatory sinking fund requirement.

Mandatory sinking funds for municipal issues are: I found in revenue bond issues II not found in revenue bond issues III found in general obligation bond issues IV not found in general obligation bond issues A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Ginnie Mae Pass through certificates are backed by the faith and credit of both GNMA and the U.S. Government.

Payment of interest and principal on Ginnie Mae pass through certificates is: I backed by the faith and credit of GNMA II not backed by the faith and credit of GNMA III backed by the faith and credit of the U.S. Government IV not backed by the faith and credit of the U.S. Government A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Under a gross revenue pledge, all revenues from all sources (including investment income) are pledged to pay the bondholders prior to the payment of operation and maintenance. This water authority collected $8,000,000 in gross revenues - which would be the amount available to pay the bondholders under a gross revenue pledge.

Pitter Patter Water Authority "Flow of Funds" Statement 20XX Water Charges: $6,000,000 Interest on Reserve Funds: $2,000,000 Gross revenues: $8,000,000 Operation and Maint: $4,000,000 Net Revenues: $4,000,000 Debt Service: $2,000,000 Addition to Reserves: $2,000,000 If the bonds were issued under a gross lien revenue pledge, how much in funds were available to pay the bondholders for this year? A. $2,000,000 B. $4,000,000 C. $6,000,000 D. $8,000,000

The best answer is B. New issues of municipal notes are available only in "book entry" form. The same is true for new issues of municipal bonds.

New issues of short term municipal notes and bonds are available in which forms? I Bearer II Book Entry III Registered to Principal and Interest A. I only B. II only C. III only D. I, II, III

The best answer is C. A nominal quote is an approximation of a market price for a bond, given for informational purposes only. The dealer giving such a quote is under no obligation to trade at that price; or even near to that price.

Nominal quotes for municipal bonds are: A. a firm price at which a transaction would take place B. a likely price at which a transaction would take place C. an indication of a price given for informational purposes only D. prohibited to be disseminated to municipal market participants

The best answer is B. Political risk is the risk of investing internationally in countries that have weak political systems. Thus, the bondholder has very little in the way of legal protection. Political risk is an issue for consideration when making investments in 3rd World countries.

Political risk is generally associated with: A. Corporate bond investments B. International bond investments C. Municipal bond investments D. Treasury bond investments

The best answer is A. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower.

Price volatility of a CMO issue would most closely parallel that of an equivalent maturity: A. Treasury bond B. Mortgage backed pass-through certificate C. Treasury STRIP D. Collateral trust certificate

The best answer is C. Mortgage backed pass through certificates are sold in minimum denominations of $25,000 (instead of the typical $1,000 for other bonds and $100 for Treasury issues). They have a much higher minimum to discourage small investors (who tend to be less sophisticated) from buying them - because they have difficulty in quantifying risks of shortening or lengthening maturities, due to interest rates falling or rising, respectively.

The minimum denomination on a mortgage backed pass through certificate is: A. $1,000 B. $10,000 C. $25,000 D. $100,000

The best answer is B. The ratio used to analyze revenue bonds is the Debt Service Coverage Ratio. It is the ratio of Pledged Revenues to Debt Service cost. Almost all revenue bonds have a net revenue pledge, where "net revenues" are pledged to the bondholders (net revenues are gross revenues minus operation and maintenance costs). Thus, the most commonly used ratio to analyze revenue bonds is the ratio of Net Revenues / Debt Service.

The most commonly used measure to evaluate the ability of a revenue bond issuer to pay interest and repay principal is the ratio of: A. Gross Revenues / Debt Service B. Net Revenues / Debt Service C. Overall Net Debt / Population D. Overall Net Debt / Assessed Value

The best answer is A. The Bond Resolution is the contract between the issuer and the bondholder. In the resolution will be found all covenants made by the issuer, including any call provisions. The Official Notice of Sale gives the particulars needed for underwriters to bid on a new issue of bonds; the Daily Bond Buyer is a municipal new issue newspaper; and Moody's Bond Guide gives summary analyses and ratings of municipal bond issues.

The most complete information about a municipal bond's call provisions would be found in the: A. Bond Resolution B. Official Notice of Sale C. Moody's Bond Guide D. Daily Bond Buyer

The best answer is D. The minimum denomination on a Treasury Bill, Treasury Note or Bond is $100 maturity amount. Treasury Stock has no standard par value, since it is common stock of an issuer.

$100 is the minimum denomination for all of the following EXCEPT: A. Treasury Bills B. Treasury Notes C. Treasury Bonds D. Treasury Stock

The best answer is A. Each bond can be converted at $10.50 per share into common stock based on its par value. Therefore, each bond is equivalent to $1,000 par / $10.50 conversion price = 95 shares. The bond is currently trading at $1,050. Based on this price, each share would have to be priced at $1,050 / 95 = $11.05 to be trading at parity. Since the common stock is trading at $10, the stock is below parity and it does not make sense to convert.

(Refer to the exhibit window to answer the following question) After the initial offering, the bonds are trading in the secondary market at 105, while the stock is trading at $10. Which statements are TRUE? I Each bond can be converted into 95 shares II Each bond can be converted into 105 shares III The common stock is trading below the parity price IV The common stock is trading above the parity price A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The bonds of 2030 have a stated interest rate of 8 3/4% x $100,000 principal amount = annual interest of $8,750. These bonds are initially offered at a discount to raise the effective yield of 9.25%.

(Refer to the exhibit window to answer the following question) An individual who buys a $100,000 certificate maturing in 2030 would receive annual interest of: A. $875 B. $925 C. $8,750 D. $9,250

The best answer is C. Each bond can be converted at $10.50 per share into common stock based on its par value. Therefore, each bond is equivalent to $1,000 par / $10.50 conversion price = 95 shares. Since each bond is convertible into 95 shares, the parity price of the common is $1,020 bond price / 95 shares per bond = $10.736 (rounded $10.74) per share parity price.

(Refer to the exhibit window to answer the following question) If the bonds are currently trading at 102 and the common stock is trading at $10, the parity price of the common stock is: A. $9.75 B. $10.00 C. $10.74 D. $11.00

The best answer is B. The certificates maturing in 2017 have a stated interest rate of 8 3/4% but are offered at a price to yield 8.25% so these are priced at a premium (lowering the effective yield indicates the price has been raised).

(Refer to the exhibit window to answer the following question) The certificates maturing in 2017 are offered at: A. par B. premium C. discount D. discount plus interest

The best answer is B. These are equipment trust certificates, which are backed by equipment that has been pledged as collateral - in this case the railroad cars owned by Southwest Railroad.

(Refer to the exhibit window to answer the following question) These securities are backed by: A. the full faith and credit of Southwest Railway Company B. equipment pledged as collateral C. securities pledged as collateral D. real property pledged as collateral

The best answer is C. The total offering of $16,275,000 matures in equal annual installments of $1,085,000 starting in 2017. This is a serial bond offering - it has sequential maturities.

(Refer to the exhibit window to answer the following question) This is a: A. term bond offering B. series bond offering C. serial bond offering D. combined serial and term bond offering

The best answer is C. The spread between the bid and ask is 8/32nds. Remember, government and agency securities are quoted in 32nds (with the exception of T-Bills, quoted on a yield basis). 8/32nds = 1/4th = .25% of $1,000 par = $2.50.

A $1,000 par Treasury Note is quoted at 100-1 - 100-9. The spread is: A. $.025 per $1,000 B. $.25 per $1,000 C. $2.50 per $1,000 D. $25 per $1,000

The best answer is C. The spread between the bid and ask is 2/32nds. Remember, government and agency securities are quoted in 32nds (with the exception of T-Bills, quoted on a yield basis). 2/32nds = .0625% of $1,000 par = $.625.

A $1,000 par Treasury Note is quoted at 101-3 - 101-5. The spread is: A. 2 basis points B. $.0625 per $1,000 C. $.625 per $1,000 D. $6.25 per $1,000

The best answer is B. This question is asking for the following: 8% Coupon 6.00 Basis 105 7.2% Coupon 6.00 Basis ? 7% Coupon 6.00 Basis 101 The difference in price between the 7% and 8% bonds is 4 points. The 7.20% bond is 20% of the way from 7%. 20% x 4 points = .80 point price increment from the 7% price. 101 + .80 = 101.80 price for the 7.20% bond.

A 10 year 8% municipal bond, quoted on a 6.00 basis, is priced at 105. A 10 year 7% municipal bond, quoted on a 6.00 basis, is priced at 101. What is the price of a 10 year, 7.2% municipal bond, quoted on a 6.00 basis? A. 101.25 B. 101.80 C. 102.05 D. 102.20

The best answer is A. A "bank qualified" municipal issue is an issue of $10,000,000 or less that has been designated by the issuer as a "bank qualified issue." To be bank qualified, it must be a public purpose (not private purpose issue). Any bank that buys the issue receives a tax benefit that is not available on all other municipal investments. The bank can deduct 80% of the interest expense it incurs on deposits used to fund the purchase of the bonds, while the interest income from the municipal issue is not taxable to the bank. This is sometimes termed the 80/20 rule. If an issue is not bank qualified, then none of the interest expense that the bank incurs on deposits used to fund the purchase of the bonds can be deducted, which is logical since the interest income from the bonds is exempt from Federal taxation.

A bank qualified municipal issue is one which: A. qualifies for an 80% deduction of its related interest carrying expenses by the bank B. has a qualified legal opinion rendered by a qualified bond counsel C. qualifies for the 80% dividend exclusion under IRS rules D. is eligible for bank trust department investment

The best answer is B. A bond "call premium" is simply the price above par at which the issuer has the right to call in the bonds from the bondholders.

A bond call premium is the amount: A. below par at which the issuer has the right to call bonds B. above par at which the issuer has the right to call bonds C. above par at which a bond is currently trading D. at which the issuer would make money by calling in outstanding bonds

The best answer is A. A municipal bond counsel examines the legal and tax aspects of a proposed bond issue and renders an opinion as to whether the issue is valid and binding on the issuer and also gives an opinion on the tax status of the interest income. A qualified opinion is one where the bond counsel has some reservations about the issue, so instead of giving a "clean" opinion, the counsel renders one that has some "qualifications." If the issuer does not have clear title to project assets, say the land on which the project is to be built, then the counsel would qualify the opinion, stating the reason why. Thus, anyone buying the bonds who reads the opinion knows that this "problem" exists which has potential consequences (such as a person proving that he owns the land and wants the facility moved). Pending litigation is another reason for the bond counsel to qualify an opinion, since an adverse legal ruling can negatively impact the project. The bond counsel's relationship is with the issuer and not the underwriter. The bond counsel has no involvement with the underwriter and the actual sale of the bonds, making Choice III incorrect.

A bond counsel would render a qualified legal opinion in which of the following circumstances? I Liens on certain real properties prevent the issuer from obtaining clear title to those assets II Pending litigation against the issuer may affect future revenues from the project III Underwriters for the issue have not complied with MSRB disclosure requirements in connection with the sale of the issue A. I and II B. II and III C. I and III D. I, II, III

The best answer is C. A BBB rating is the lowest investment grade rating for a bond. The investment grade ratings are AAA, AA, A, and BBB.

A bond is rated BBB by Standard and Poor's. The bond is: A. Highest Quality Investment Grade B. High Quality Investment Grade C. Lowest Quality Investment Grade D. Highest Level Speculative Grade

The best answer is C. Since the bond is purchased at par, there is no premium to be amortized over the life of the bond nor is there a discount to be accreted over the life of the bond. Thus, the nominal yield and the yield to maturity are the same. If the bond is called early at par, again since there is no discount or premium, the nominal yield and the yield to call are the same. The yield to call will be higher than the yield to maturity if there is a substantial call premium or if the bond was purchased at a discount. The yield to call will be lower than the yield to maturity if the bond was purchased at a premium (which will be lost faster if the bond is called early).

A customer buys a 10% G.O. bond at par. The issue is callable in 5 years at par and matures in 10 years. Which statement is TRUE? A. The yield to call is higher than the yield to maturity B. The yield to call is lower than the yield to maturity C. The yield to call is the same as the yield to maturity D. The nominal yield is higher than either the yield to call or yield to maturity

Interest on U.S. Government bonds accrues on an actual day month / actual day year basis. Interest accrues up to but not including settlement. Settlement on U.S. Governments is next business day. Since the last interest payment date covered the period up to January 1st and the bond was purchased on Thursday, February 6th, the trade will settle the next day on February 7th. The buyer must pay the seller: January: 31 days February: 6 days/ 37 days (settlement takes place on Friday the 7th of February)

A customer buys a 4 ½% Treasury Bond, maturing July 1, 2042, at 102-8 on Thursday, February 6th in a regular way trade. The bond pays interest on January 1st and July 1st. How many days of accrued interest are due? A. 37 B. 38 C. 39 D. 40

The best answer is B. The issue is dated Jan 1st, with the first interest payment due Mar 1st (short first interest payment). Interest on a new bond issue accrues from the dated date up to, but not including, the settlement date of the purchase. Since the customer bought the bonds from the underwriter, settling on Jan 31st, he or she must pay 30 days of accrued interest to the underwriter. Remember, interest accrues up to, but not including, settlement date.

A customer buys a new issue municipal bond with a dated date of January 1st, settling on January 31st. The first interest payment is due March 1st. How many days of accrued interest must the customer pay to the underwriter? A. 0 B. 30 C. 31 D. 60

The best answer is C. Interest accrues from the dated date on a new issue up to, but not including the date when the first trade settles. Since settlement is on January 19th, interest accrues through the 18th. Counting from the January 1st dated date through the 18th, 18 days of accrued interest are payable from the buyer of the bond to the seller (the underwriter in this case).

A customer buys a new municipal issue from an underwriter on Wednesday, January 14th, with settlement taking place on Monday, January 19th. The bond is dated January 1st. How many days of accrued interest must be paid by the customer to the underwriter? A. 0 B. 13 C. 18 D. 19

The best answer is B. A "book entry" bond is a fully registered bond where no paper certificate is issued. Instead, the owner simply receives that confirmation that he or she bought the bond. On such bonds, the paying agent mails the semi-annual interest payments to the registered owner. All new issues of U.S. Government bonds, municipal bonds and corporate bonds are book entry. Note that there are still many issues of long term corporate bonds still outstanding that have paper certificates. These bonds have not yet matured. Book entry bonds did not really come to dominate bond issuance until the 1990s, so 30-year bond certificates issued, say in 1995, do not mature until 2025. Also note that no bearer bonds have been sold since 1983, but 40-year bearer bonds still exist (at least until 2023!).

A customer has bought a "book entry" bond which pays interest semi-annually. The customer will receive interest payments: A. from the paying agent once a year B. from the paying agent twice a year C. by clipping coupons once a year D. by clipping coupons twice a year

The best answer is C. As interest rates move, long term maturities will change in price at a faster rate than will short term obligations. This is due to the fact that the "compounding effect" is more acute as maturities lengthen. As interest rates move up, long term maturities fall faster in price than do short term maturities.

A customer has purchased three different bonds, each yielding 9%, with 5 year, 10 year, and 15 year maturities. If prevailing interest rates drop by 20 basis points, which will show the greatest percentage price change? A. 5 year maturity B. 10 year maturity C. 15 year maturity D. The bonds will all move by the same percentage

The best answer is C. In order to compare the tax free municipal yield to the taxable corporate yield, the two must be equalized. 8% (100% - 28%) = 11.1% Since the corporate bond is yielding 11.1%, the equivalent municipal yield is the same.

A customer in the 28% tax bracket is considering the purchase of a municipal bond yielding 8% or a corporate bond yielding 11.1%. Both bonds have similar maturities and credit ratings. Which statement is TRUE? A. The effective yield on the municipal bond is higher B. The effective yield on the corporate bond is higher C. Both effective yields are equivalent D. The coupon rates for each bond are necessary to determine the effective yield

The best answer is C. The conversion price (and hence the conversion ratio) is fixed when the convertible security is issued and does not change. In this case, the bond is issued with a conversion price of $25, based upon converting each bond at par. $1,000 par / $25 conversion price = 40:1 conversion ratio. Thus, for every bond that is converted, the holder receives 40 shares. The only time the conversion price (and hence the conversion ratio) changes is if there is an "anti-dilutive" covenant in the trust indenture. In such a case, if the corporation issues more common shares (diluting the market price of the outstanding common), the conversion price is reduced as well to get the "value" of the conversion feature unchanged relative to the common's market price.

A customer owns a convertible subordinated debenture, convertible into common at $25 per share. The bond is currently trading at par. If the bond's market price increases by 20%, the conversion ratio will be: A. 25:1 B. 32:1 C. 40:1 D. 48:1

The best answer is B. These bonds are quoted at 87 meaning 87% of par value. "3M" means that $3,000 face amount of bonds are being purchased (M is Latin for $1,000). Municipal bonds that are quoted this way are called dollar bonds and are usually term issues. 87% of $3,000 par = $2,610

A customer purchases 3M of Chicago Water Authority 5% revenue bonds maturing in 2039 at 87. The interest payment dates are Mar 15th and Sept 15th. The trade took place on Monday, Apr 14th. How much will the customer pay for the bonds, excluding commissions and accrued interest? A. $870 B. $2,610 C. $3,000 D. $4,350

The best answer is C. Interest accrues on municipal bonds on a 30 day month/ 360 day year basis, with interest accruing up to, but not including settlement date. The trade took place on Tuesday, Feb 1st. Settlement occurs 3 business days after trade date. Therefore, settlement takes place on Friday, Feb 4th. The last interest payment was made on January 1st, so the buyer owes the seller 30 days of interest for January and 3 days for February (up to, but not including the settlement date of February 4th). 33 days interest x $80 x 5 bonds/ 360 = $36.67 Note that "5M" stands for $5,000 face amount of bonds (M is Latin for $1,000).

A customer purchases 5M of New York 8% G.O. bonds, maturing in 2042 at 90. The interest payment dates are Jan 1st and Jul 1st. The trade took place on Tuesday, February 1st. How much accrued interest will the customer be required to pay the seller? A. $16.16 B. $33.33 C. $36.67 D. $66.67

The best answer is C. The bond is currently selling for $900 and the stock is selling at $40. Each bond is equivalent to 25 shares of stock, since the conversion ratio is: par Value of bond/ conversion price = Conversion Ratio $1,000/ $40 = 25:1 Thus, each share can be purchased for the equivalent price of $900 / 25 = $36 per share. Since the current market price of the stock is $40, there is a "bona-fide arbitrage opportunity". Such a situation is rarely found in the marketplace. If it is, the profit must be "locked-in" immediately, otherwise it will disappear as other traders take advantage of the price disparity in the marketplace. To do this, the bond should be purchased immediately at 90 (equivalent to buying 25 shares at $36 each) and the common stock should be sold short (sell borrowed shares) at $40. Once the bond is delivered, it will be converted into 25 common shares, and these are used to replace the borrowed shares that were sold short. Thus, the profit of $4 per share is locked-in. The stock and the bond are currently not trading at parity. To be at parity, the stock must be trading for the $900 current bond market price / 25 shares per bond = $36. Since the stock is trading at $40, it is trading above parity, and a bona-fide arbitrage situation exists.

A customer purchases a convertible bond at 90, convertible into the common stock at $40. The common stock is currently trading at $40. Which statements are TRUE? I There is a bona fide arbitrage opportunity II The conversion ratio is 25:1 III The bond and the stock are trading at parity IV If the bond is purchased and the equivalent number of common shares are sold short, there is an immediate profit A. I and III only B. II and IV only C. I, II, IV D. I, II, III, IV

The best answer is B. If the company issues additional shares, each of the existing shares is worth "less" since the company's earnings are spread over a greater number of shares. Thus, the market price will adjust downward to reflect this. If a company issues 25% more shares (after the dividend, there will be 1.25 times the old number of shares), then the earnings and consequently the share price will drop by a factor of 1/1.25. The bondholder bought the issue based on a conversion price of $50. The market price of the stock is being diluted by the additional shares, reducing or eliminating the value of the bondholder's conversion feature. To protect the bondholder from this occurrence, trust indentures include an anti-dilution covenant. The conversion price of the stock is adjusted downwards by the same factor, so that the convertible bondholder experiences no loss from the issuance of the new shares. Old price/ New factor = New conversion price $50/ 1.25 = $40 per share

A customer purchases a convertible bond at 90, convertible into the common stock at $50. The common stock is currently trading at $45. The company declares a 25% stock dividend. The bond trust indenture includes an anti-dilution clause. After the ex date for the stock dividend, the conversion price for this bond issue will be: A. $36 B. $40 C. $45 D. $50

The best answer is C. The rules on taxation of interest income received, generally, are: Treasury/Agency Issues: Interest is subject to Federal Income tax, but is exempt from State and Local tax Municipal Issues: Interest is exempt from Federal Income tax, and exempt from State and Local tax when purchased by a resident of that state Corporate Issues: Interest is subject to Federal Income tax, and to State and Local tax If the customer buys the Treasury bond yielding 4.5%, 30% of the yield will go to the Federal Government, so the after-tax yield is (.7 x 4.50%) = 3.15%. If the customer buys the Federal Home Loan Bank bond yielding 5%, 30% of the yield will go to the Federal Government, so the after-tax yield is (.7 x 5.00%) = 3.50%. If the customer buys the Corporate bond yielding 6.50%, 30% of the yield will go to the Federal Government and 10% to the State Government, so the after-tax yield is (.6 x 6.50%) = 3.90%. If the customer buys the Municipal bond yielding 4.00%, there is no tax on the income received at either the Federal or State level, so the after-tax yield is 4.00%.

A customer residing in California that is in the 30% Federal tax bracket and the 10% State tax bracket wishes to make a bond investment with a minimum 10-year life. The customer also wants a high level of safety. The following 10-year bonds are available: Yield AAA Corporate Bond 6.50 U.S. Treasury Bond 4.50 AAA Federal Home Loan Bank Bond 5.00 AAA California Bond 4.00 The best recommendation for the customer is the: A. U.S. Treasury bond B. AAA Corporate bond C. AAA California bond D. AAA Federal Home Loan Bank bond

The best answer is A. Short term bonds do not fluctuate much in value as interest rates move since they will be redeemed shortly at par. (The longer the maturity, the greater the price movement in response to market interest rate changes). Short term maturities are also the most liquid.

A customer wishes to maximize liquidity and minimize interest rate risk. The best recommendation is (are): A. short term maturities B. long term maturities C. callable bonds D. non callable bonds

The best answer is A. Municipal dealers are often asked for bond appraisals by customers who wish to sell bonds. Because there is no active trading market for municipal bonds, last trading price information is not available. To get an idea of the value of the bond, the dealer will get prices of similar bonds and then give an estimated price to the customer. This is a likely sale price - not a firm quote.

A customer would ask for a bond appraisal when selling a municipal bond: I because there is little or no active trading market for municipal bonds II because there is an active trading market for municipal bonds III to obtain an indication of the likely market price of the bond IV to obtain a firm bid on the bonds A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The lowest investment grade is BBB. Any securities below this rating are considered to be speculative - and are commonly known as "junk" issues.

A debt issue is commonly referred to as "junk" if its credit rating is BELOW: A. A B. BBB C. B D. CCC

The best answer is B. Mortgage backed pass-through certificates are "paid off" in a shorter time frame than the full life of the underlying mortgages. For example, 30 year mortgages are now typically paid off in 10 years - because people move. This "prepayment speed assumption" is used to "guesstimate" the expected life of a mortgage backed pass-through certificate. Note, however, that the "PSA" can change over time. If interest rates fall rapidly after the mortgage is issued, prepayment rates speed up; if they rise rapidly after issuance, prepayment rates fall. Duration is a measure of bond price volatility. Standard deviation is a measure of the "risk" based on the expected variation of return on investment. The loan to value ratio is a mortgage risk measure.

A mortgage backed security that is backed by an underlying pool of 30 year mortgages has an expected life of 10 years. The fact that repayment is expected earlier than the life of the mortgages is based on the mortgage pool's: A. standard deviation of returns B. prepayment speed assumption C. Macaulay duration D. loan to value ratio

The best answer is B. A municipal workable is a likely price at which a dealer would buy (bid) a bond from a customer. This is not a firm bid; it is an indication of a price at which the dealer would buy from that customer.

A municipal "workable" is a(n): I bid II offer III firm quote IV likely quote A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A municipal "workable quote" is used to get an indication of a likely price at which a dealer will buy specified bonds. The municipal trading market is very thin, so quotes are not readily available for all bonds. Assume that a customer wants to sell certain municipal bonds and wants to know what price he can get. By calling other dealers, you can get a "workable" from each of the dealers giving a likely price at which they would buy. Now you can go back to the customer with a likely price at which the bonds would be bought. If the customer agrees, you can recall the dealer with the best "workable" and sell the bonds.

A municipal "workable" quote is a: A. firm offer B. firm bid C. indication of a likely bid D. indication of a likely offer

The best answer is D. The dealer purchases these bonds at par less 1 1/2 points, so the bonds were purchased at 98.5. Since these 9% coupon bonds were reoffered on an 8.90 basis, they must have been reoffered at a premium price. Since these are long term bonds (30 years), we can approximate the reoffering price by dividing 9% (nominal yield) by the 8.90 reoffering yield. 9.00/8.90 = 1.011. Thus, the bonds were reoffered at an approximate price of 1.011% of par (note, this only works for long term maturities - not short term maturities). The bonds were reoffered at a price that is .026% higher than the cost to the dealer (.985 cost versus 1.011 reoffer price). .026% x $100,000 face amount = $26 gain on the transaction. (Note that "100M" of bonds is $100,000 face amount, where M = $1,000.)

A municipal bond dealer buys 100M of 30 year non-callable 9% General Obligation bonds at par less 1 1/2 points. After holding the bonds in inventory for a week, the dealer reoffers the bonds on an 8.90 basis. The dealer's approximate profit or loss per bond on this transaction is: A. loss of $11 B. loss of $26 C. gain of $10 D. gain of $26

The best answer is D. The dealer purchases these bonds at par less 1 point, so the bonds were purchased at 99. Since these 9% coupon bonds were reoffered on an 8.90 basis, they must have been reoffered at a premium price. Since these are long term bonds (30 years), we can approximate the reoffering price by dividing 9% (nominal yield) by the 8.90 reoffering yield. 9/8.90 = 1.011. Thus, the bonds were reoffered at an approximate price of 1.011% of par (note, this only works for long term maturities - not short term maturities). The bonds were reoffered at a price that is .021% higher than the cost to the dealer (.99 cost versus 1.011 reoffer price). .021% x $100,000 face amount = $21 gain on the transaction. (Note that "100M" of bonds is $100,000 face amount, where M = $1,000. )

A municipal bond dealer buys 100M of 30 year non-callable 9% General Obligation bonds at par less 1 point. After holding the bonds in inventory for a week, the dealer reoffers the bonds on an 8.90 basis. The dealer's approximate profit or loss per bond on this transaction is: A. loss of $12 B. loss of $21 C. gain of $12 D. gain of $21

The best answer is D. The spread is .75 points, which is .75% of $1,000 par, which equals $7.50. $7.50 is the same as 75 basis points, since each basis point equals $.10.

A municipal bond dealer quotes 10 year 3 1/2% Revenue bonds at 97 1/4 - 98. The dealer's spread per $1,000 is: I $ .75 II $7.50 III 7.5 basis points IV 75 basis points A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. The spread is 1.5 points, which is 1 1/2% of $1,000 par, which equals $15. $15 is the same as 150 basis points, since each basis point equals $.10.

A municipal bond dealer quotes 10 year 4% Revenue bonds at 95 1/2 - 97. The dealer's spread per $1,000 is: I $1.50 II $15.00 III 15 basis points IV 150 basis points A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A moral obligation bond is one under which the issuer has the authority, but not the obligation, to apportion the funds necessary to pay the debt service. The state is morally obligated to pay - but not legally obligated to pay.

A municipal bond is issued with a covenant that states "if revenue collections are insufficient, the state legislature has the authority, but not the obligation, to make an annual apportionment of funds necessary to meet debt service requirements." This is a: A. special tax bond B. double barreled bond C. moral obligation bond D. general obligation bond

The best answer is C. All of the issuers in this portfolio reside in New York - so this portfolio is not geographically diversified. The issues have different credit ratings; different maturities; and different issuers; so the portfolio is diversified for these items.

A municipal bond portfolio shows the following: 25M, New York State 5% General Obligation bonds, M '20, rated A1 15M, New York City 8% General Obligation bonds, M '29, rated BBB+ 40M, Syracuse N.Y., 9% Housing Revenue bonds, M '25, rated AA- 20M, New York Port Authority 8% Revenue bonds, M '34, rated AAA This portfolio is diversified as to all of the following EXCEPT: A. issuer B. credit quality C. geography D. maturity

The best answer is B. A bond with a put option allows the holder to put back the bond to the issuer at par value. Thus, this bond, once the put option is exercisable, is always worth at least par. Therefore, if interest rates rise or if market demand falls, this bond's price cannot fall below par (unlike traditional bonds).

A municipal bond that has a put option is protected against depreciation due to: I rising interest rates II falling interest rates III rising demand for the issue IV falling demand for the issue A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Municipal broker's brokers help large institutions buy and sell large blocks of municipal bonds. They take no inventory positions, acting as agent only. Municipal broker's brokers do not deal with the general public.

A municipal broker's broker: A. makes a market in municipal bonds for individual customers B. makes a market in municipal bonds for institutional customers C. acts as agent handling bond trades for individual customers D. acts as agent handling bond trades for institutional customers

The best answer is C. A "GAN" is a municipal "Grant Anticipation Note." A GAN would be issued by a municipality to get immediate access to federal grant monies that are expected to be received months into the future. These grant monies typically are used to support mass transit programs, like buses and subways for cities. Note, in contrast, that a "RAN" - Revenue Anticipation Note - is paid from expected revenues to be received in the future, and that this source of funding is usually federal highway funds.

A municipality would issue a GAN in anticipation of receiving: A. property tax collections B. proceeds from a long term bond sale C. federal transit funding D. federal highway funding

The best answer is C. The selling dealer offering the bonds "firm" means that for a stated time period the price will not be changed. These bonds are offered firm for one-half hour; during this time period that buying dealer can try and find a customer for the bonds before actually purchasing them. The selling dealer also specifies a "five minute recall." This means that during the half hour, the selling dealer can recontact the buying dealer to tell him that he has five minutes to buy the bonds at the offered price or else the quote will be changed.

A municipal dealer offers bonds to another dealer "firm for one-half hour with a five minute recall." This means that the: I selling dealer can change the price at will II selling dealer cannot change the price for one-half hour unless the buying dealer is recontacted III buying dealer can solicit orders for the bonds before actually purchasing them IV buying dealer cannot solicit orders for the bonds before actually purchasing them A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. The selling dealer offering the bonds "firm" means that for a stated time period the price will not be changed. These bonds are offered firm for one-half hour; during this time period the buying dealer can try and round up a customer for the bonds before actually purchasing them. The selling dealer also specifies a "five minute recall." This means that during the half hour, the selling dealer can recontact the buying dealer to tell him that he has five minutes to buy the bonds at the offered price or else the quote will be changed.

A municipal dealer offers bonds to another dealer "firm for one-half hour with a five minute recall." This means that the: I selling dealer cannot change the price for one-half hour II selling dealer cannot change the price for the next five minutes III selling dealer has the right to contact the other dealer during the half hour to change the quote if a transaction does not take place in the next five minutes IV buying dealer must call back the selling dealer in five minutes if it wishes to purchase the bonds A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The formula for yield to maturity is: Annual Income + Annual Capital Gains (discount bond)/ Average bond value = Yield to maturity This bond has a coupon rate of 6% = 6% of $1,000 par = $60 of annual income. The bond is purchased at 99% of $1,000 par = $990; and will mature at $1,000 in 2 years, Thus, the $10 capital gain is earned over 2 years for an annual gain of $10 / 2 = $5 per year. The bond is purchased at $990 and matures at $1,000, for an average value of $990 + $1,000 / 2 = $995. The YTM is: $60 + $5/ $995 = 6.53%

A municipal dealer quotes a 2 year, 6% term revenue bond at 99. The yield to maturity is: A. 5.92% B. 6.00% C. 6.53% D. 6.85%

The best answer is C. The formula for yield to maturity is: Annual Income + Annual Capital Gains (discount bond)/ Average bond value = Yield to maturity This bond has a coupon rate of 5% = 5% of $1,000 par = $50 of annual income. The bond is purchased at 94% of $1,000 par = $940; and will mature at $1,000 in 7 years, Thus, the $60 capital gain is earned over 7 years for an annual gain of $60 / 7 = $8.57 per year. The bond is purchased at $940 and matures at $1,000, for an average value of $940 + $1,000 / 2 = $970. The YTM is: $50 + $8.57/ $970 = 6.04%

A municipal dealer quotes a 7 year, 5% term revenue bond at 94. The yield to maturity is: A. 4.78% B. 5.00% C. 6.04% D. 6.78%

The best answer is B. The formula for yield to maturity for a premium bond is: Annual Interest - Annual Capital loss/ (bond cost + redemption price)/ 2 = Yield to Maturity for a premium bond $60 - ($90 premium / 9 years to maturity)/ ($1,090 + $1,000) / 2 = $60 - $10/ $1,045= 4.78%

A municipal dealer quotes a 9 year, 6% term revenue bond at 109. The yield to maturity is: A. 4.58 B. 4.78 C. 5.50 D. 6.00%

The best answer is D. The formula for yield to maturity is: Annual Income + Annual Capital Gains (discount bond)/ Average bond value = Yield to maturity This bond has a coupon rate of 6% = 6% of $1,000 par = $60 of annual income. The bond is purchased at 92% of $1,000 par = $920; and will mature at $1,000 in 9 years, Thus, the $80 capital gain is earned over 9 years for an annual gain of $80 / 9 = $8.88 per year. The bond is purchased at $920 and matures at $1,000, for an average value of $920 + $1,000 / 2 = $960. The YTM is: $60 + $8.88/ $960 = 7.18%

A municipal dealer quotes a 9 year, 6% term revenue bond at 92. The yield to maturity is: A. 6.50% B. 6.92% C. 7.12% D. 7.18%

The best answer is B. A Revenue Anticipation Note (RAN) is issued by a municipality that wishes to borrow short-term against revenues that are expected to be received in the near future. An example would be the City of New York borrowing, via a RAN issue, against a mass transit subsidy payment from the Federal government to be received in the near future.

A municipal note that is issued in anticipation of receiving future revenues is a: A. TAN B. RAN C. TRAN D. BAN

The best answer is A. An "additional bonds test" means that the issuer is prohibited from issuing new bonds against the revenues of a facility, unless the facility's revenues are sufficient. Typically, the debt service on the old bonds is added to that of the new bonds. The revenues of the facility must cover, by an adequate margin, the combined debt service before additional bonds can be sold.

A municipal revenue bond trust indenture includes an "additional bonds test" covenant. This means that: A. an earnings test must be satisfied before additional bonds can be issued against the same revenue source B. additional bonds can only be issued if they have a subordinated lien on pledged revenues C. additional bonds can only be issued after the original issue is called or advance refunded D. additional bond issues having a lien on the same revenue source are prohibited

The best answer is A. When monies are deposited into a sinking fund to retire debt as required under the terms of a bond contract, the issuer has the choice of either calling in bonds at preset dates or buying the bonds in the open market. (The issuer will do whatever is cheaper). The specific bonds to be called are chosen by random lot in a "sinking fund call."

A municipal term bond is issued with a mandatory sinking fund. At the first call date, bonds to be called are selected by: A. random choice B. longest maturity C. highest interest rate D. yield auction

The best answer is B. A municipal variable rate demand note is a municipal bond that gives the holder the right to "put" the bond to the issuer at par, typically at the interest payment dates. The interest rate is reset, usually weekly, to an indexed rate, and thus, will vary. It is called a "note" because the actual maturity is unknown - the holder, in effect, can redeem at par whenever he or she wants. With any variable rate note, the interest rate varies as market rates move; therefore the market price remains at, or very close to, par. Thus, these instruments have almost no market risk.

A municipal variable rate demand note is a municipal: A. note that may be retired prior to maturity on any interest payment date at the demand of the issuer B. bond that gives the holder a tender option feature, usually at par, as of the reset date C. note that requires the issuer to reset the interest rate to the market rate upon demand of the holder D. bond that allows the issuer to vary the repayment date, upon giving written notice to the holders

The best answer is C. A municipal variable rate demand note is a long-term municipal security because it has no stated maturity, but it is issued at short-term (lower) interest rates, because the holder has the right to "put" the bond to the issuer at par at each interest payment date. The interest rate is reset, usually weekly at the interest payment date, to an indexed rate for the next week. Thus, the interest rate will vary. With any variable rate note, the interest rate varies as market rates move; therefore the market price remains at, or very close to, par. Thus, these instruments have almost no market risk.

A municipal variable rate demand note is: I a short term issue II a long term issue III issued at short-term interest rates IV issued at long-term interest rates A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. One mill = .001; 12 mills = .012. Taxes are based on assessed valuation, not fair market value. .012 x $225,000 = $2,700. Another way to think about it is that 1 mill = $1 of tax for each $1,000 of assessed value.

A municipality has a tax rate of 12 mills. A piece of real property in the municipality is assessed at $225,000 and has a fair market value of $250,000. The annual tax liability on the property is: A. $120 B. $300 C. $2,700 D. $3,000

The best answer is A. One mill = .001; 8 mills = .008. Taxes are based on assessed valuation, not fair market value. .008 x $100,000 = $800. Another way to think about it is that 1 mill = $1 of tax for each $1,000 of assessed value.

A municipality has a tax rate of 8 mills. A piece of real property in the municipality is assessed at $100,000 and has a fair market value of $200,000. The annual tax liability on the property is: A. $800 B. $1,600 C. $8,000 D. $16,000

The best answer is C. The Coverage Ratio is: Collected Revenues/ Annual Debt service Requirement = Coverage Ratio $45,000,000/ $20,000,000 = 2.25 : 1 Note that the Annual Debt Service requirement consists of both interest expense for that year as well as scheduled principal repayments for that year.

A municipality has floated a $100,000,000 revenue bond issue. The annual level debt service requirement is $20,000,000. In the first fiscal year, the municipality has collected revenues of $45,000,000. The "Coverage Ratio" is: A. $20,000,000 / $100,000,000 B. $45,000,000 / $100,000,000 C. $45,000,000 / $20,000,000 D. $20,000,000 / $45,000,000

The best answer is D. General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Ad valorem taxes, fines collected for paying taxes late, assessments of additional taxes, as well as fees collected that are not a specified income source for revenue bonds, are all sources of income backing G.O. issues.

A municipality has issued a general obligation bond. Which of the following are sources of income available for debt service? I Ad valorem taxes II License fees III Fines IV Assessments A. I and IV B. II and III C. I, III, IV D. I, II, III, IV

The best answer is A. Voter approval is needed for a municipality to sell general obligation bonds (non-self supporting debt) in an amount that exceeds the municipality's constitutional limit. Revenue bonds and industrial revenue bonds are not subject to debt limits because they are self-supporting and pay their own way from collected revenues. They are not paid from tax collections.

A municipality is at its debt limit and wishes to sell additional bonds. Voter approval is required for the municipality to sell: I General obligation bonds II Revenue bonds III Industrial revenue bonds A. I only B. I and II only C. II and III only D. I, II, III

The best answer is B. Voter approval is needed for a municipality to sell general obligation bonds (non-self supporting debt) in an amount that exceeds the municipality's constitutional limit. It makes no difference if the general obligation bonds are backed by limited or unlimited taxing power. Revenue bonds and industrial revenue bonds are not subject to debt limits because they are self-supporting and pay their own way from collected revenues. They are not paid from tax collections.

A municipality is at its debt limit and wishes to sell additional bonds. Voter approval is required for the municipality to sell: I Limited tax general obligation bonds II Unlimited tax general obligation bonds III Self-supporting revenue bonds IV Self-supporting industrial revenue bonds A. I only B. I and II only C. III and IV only D. I, II, III, IV

The best answer is B. If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract. 103% of $500 = $515.

A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive: A. $500 B. $515 C. $1,000 D. $1,030

The best answer is C. A municipality will defease its debt with securities of the highest credit rating, that provide the highest interest income to the municipality (since this interest income will be used to pay the interest expenses on the municipality's outstanding bonds that have been defeased). Acceptable securities to the bondholders are U.S. Governments, Agencies, and sometimes (rarely) bank certificates of deposit. AAA municipals would not be used because their yield is lower than governments (since the interest is exempt from Federal income tax, while the others are taxable).

A municipality would defease its debt with which of the following? I U.S. Government securities II U.S. Government agency securities III AAA Municipal securities IV Bank certificates of deposit A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is B. Accrued interest on a corporate bond is calculated on a 30-day month / 360-day year basis. All of the other information in the question is irrelevant. Note that if the question asked about how many days of interest will be paid in the first interest payment, then the interest accrual starts on the dated date of September 1st (the date of legal issuance of the bonds) and ends when the first interest payment is made (which would be January 1st for most bond issues, since they use a "standard" January 1st and July 1st for the interest payment dates). In this case, the first interest payment would cover the months of September, October, November and December = 120 days.

A new issue corporate bond has a dated date of September 1st. The bond is assigned by the issuer to the underwriter on August 31st. Accrued interest on the bond will be calculated based on how many days in a year? A. 359 B. 360 C. 364 D. 365

The best answer is D. A pass through certificate is a security which gives the holder an undivided interest in a pool of mortgages. The mortgage payments are "passed through" to the certificate holders.

A pass through certificate is best described as a: A. corporation or trust through which investors pool their money in order to obtain diversification and professional management B. security which is backed by the full faith, credit, and taxing power of the U.S. Government C. security which is backed by real property and/or a lien on real estate D. security which gives the holder an undivided interest in a pool of mortgages

The best answer is B. A gross lien revenue bond is one where the bondholders have claim to the revenues received before any other cash expenses are paid.

A pledge that all revenues received will be used for debt service prior to deductions for any costs or expenses is a: A. net revenue pledge B. gross revenue pledge C. rate covenant D. debt service pledge

The best answer is D. The selling dealer offering the bonds "firm" means that for a stated time period the price will not be changed. These bonds are offered firm for one-half hour; during this time period that buying dealer can try and round up a customer for the bonds before actually purchasing them. The selling dealer also specifies a "five minute recall." This means that during the half hour, the selling dealer can recontact the buying dealer to tell him that he has five minutes to buy the bonds at the offered price or else the quote will be changed.

A selling dealer offering municipal bonds "firm for 1/2 hour with a 5 minute recall" means all of the following EXCEPT: A. prices for bonds that are offered can't be changed for a stated period B. the selling dealer has specified that he can recontact the buying dealer to reinstate a different price within a certain time period C. the buying dealer can try and "round up" a customer for the bonds before the dealer actually purchases the bonds D. the selling dealer has the right to rescind the price at any time

The best answer is A. Commercial paper is simply backed by the issuer's full faith and credit (the promise to pay). The maturities are short, most typically 30 days or less, though legally the maturity can extend to 270 days maximum (9 months). All of the other debts listed are long term (over 1 year) obligations. Income bonds are long term corporate obligations that require the issuer to pay interest only if it has sufficient income. Mortgage bonds are backed by real property owned by the issuing corporation. General obligation bonds are issued by municipalities; they are not issued by corporations.

A short term corporate debt which is backed solely by the full faith and credit of the issuer is: A. commercial paper B. an income bond C. a mortgage bond D. a general obligation bond

The best answer is B. CDOs - Collateralized Debt Obligations - are structured products that invest in CMO tranches (and they can also invest in other debt obligations that provide cash flows). They are used to create tranches with different risk/return characteristics - so a CDO will have higher risk tranches holding lower quality collateral and lower risk tranches holding higher quality collateral. The housing bubble that ended badly in 2008 with a market crash was fueled by massive issuance of sub-prime mortgages to unqualified home buyers, that were then packaged into CDOs and sold to unwitting institutional investors who relied on the credit rating assigned by S&P or Moodys. These credit ratings agencies really did not understand the complex structure of CDOs and how risky their collateral was (sub-prime mortgage loans that were often "no documentation liar loans"). The CDO market collapsed with the housing crash in 2008-2009 and has still not recovered (as of 2017).

A structured product that invests in tranches of private label subprime mortgages is a: A. CMO B. CDO C. CMB D. CAB

The best answer is D. Treasury STRIPS are government bonds that are "stripped" of coupons. They do not provide current income. The discount on the bonds must be accreted annually, with the annual accretion amount being taxable as interest income. As the bond is accreted, its cost basis is adjusted upwards so that at maturity, the bond has an adjusted cost basis of par. Therefore, no taxable capital gain is realized at maturity. This is a zero coupon obligation with a "locked in" rate of return over the life of the bond.

All of the following are true statements about Treasury STRIPS EXCEPT: A. the investor's interest rate is locked in at purchase, eliminating any reinvestment risk B. at maturity, there is no capital gain C. the income is accreted and taxed annually D. these are suitable investments for individuals seeking current income and a high level of safety

The best answer is B. If a bond issued at par is trading at a discount, it indicates that either market interest rates have risen; or that the issuer's rating has deteriorated. As interest rates fall, discount bonds will appreciate at a faster rate than will premium bonds. The change in value of the bond's price is a result of an increased "present value" of the remaining interest payments to be received. This increase in the "value" of the remaining interest payments is a larger percentage of a discount bond's price than of a premium bond's price. Thus, as interest rates drop, discount bond prices rise faster than premium bond prices. Similarly, as interest rates rise, discount bond prices fall faster than premium bond prices. If the bond is trading at a discount and is then called, then the issuer will have to pay par for the bonds. Why not, instead of paying par, purchase the bonds at the current market price? It would be better to pay the discount than the full market value. Furthermore, a bond trading at a discount indicates that market interest rates have risen - why would an issuer call in such an issue, when it has a bargain interest rate? The only bonds that are likely to be called are those trading at premiums - meaning that market interest rates have fallen. The issuer can call in the premium bonds at a price close to par, and refund at lower current market interest rates.

All of the following are true statements about discount bonds EXCEPT: A. bond trading at a discount can indicate that the issuer's rating has deteriorated B. bonds trading at a discount are more likely to be called than bonds trading at a premium C. discount bonds will appreciate more rapidly as interest rates fall than will similar premium bonds D. a bond trading at a discount can indicate that interest rates have risen

The best answer is A. T-Bills are registered in the owner's name in book entry form; no bearer securities can currently be issued in the U.S. to individual residents. T-Bills are original issue discount obligations and are not callable, since they are short term obligations.

All of the following are true statements regarding Treasury Bills EXCEPT: A. T-Bills are issued in bearer form in the United States B. T-Bills are registered in the owner's name in book entry form C. T-Bills are issued at a discount D. T-Bills are non-callable

The best answer is A. Treasury Bills are original issue discount obligations of the U.S. Government which mature in 52 weeks or less. They are not callable (as a rule, short term obligations are never callable - why would the issuer bother calling in obligations that will mature in the near future?)

All of the following are true statements regarding Treasury Bills EXCEPT: A. Treasury Bills are callable at any time at par B. Treasury Bills trade at a discount to par C. Payment is backed by the full faith and credit of the U.S. Government D. The maturity is 52 weeks or less

The best answer is B. When convertible bonds are issued, it is normal for the conversion price to be at a premium to the current market price. Thus, for the conversion feature to be worth something, the stock's price must move up in the market. Due to the value of the conversion feature (or rather, the potential value if the stock price goes up), convertible bonds are saleable at lower yields than bonds without the conversion feature. When the stock price is at a discount to the conversion price, the conversion feature is worthless. The bond is valued based on interest rate movements. On the other hand, when the stock price is at a premium to the conversion price, the conversion feature now has intrinsic value. For every dollar that the stock now moves, the bond will move as well, since the securities are "equivalent."

All of the following are true statements regarding convertible bond issues EXCEPT: A. at the time of issuance, the conversion price is set at a premium to the stock's current market price B. the yield on convertible issues is higher than the yield for similar non-convertible issues C. when the stock price is at a premium to the conversion price, bond price movements are usually caused by those of the stock D. when the stock price is at a discount to the conversion price, bond price movements are usually caused by interest rate changes

The best answer is A. An issuer is least likely to call bonds which have low interest rates (low financing cost to the issuer) and high call premiums (expensive for the issuer to call in these bonds).

All of the following callable municipal bonds are trading at a 5% basis. Which is LEAST likely to be called? A. 3 3/4% coupon rate callable at 103 in 2017 B. 4 1/2% coupon rate callable at 103 in 2017 C. 5% coupon rate callable at 100 in 2017 D. 6 3/4% coupon rate callable at 100 in 2017

The best answer is D. FDIC - Federal Deposit Insurance Corporation - insures bank deposits for up to $250,000 per account. AMBAC (American Municipal Bond Assurance Corporation), MBIA (Municipal Bond Insurance Association) and FGIC (Financial Guaranty Insurance Corporation) all insure municipal bonds.

All of the following insure municipal bonds EXCEPT: A. AMBAC B. FGIC C. MBIA D. FDIC

The best answer is C. The Federal Reserve Bank does not issue bonds. Fannie Mae (FNMA) and Freddie Mac (FHLMC) issue mortgage-backed pass through certificates. The Federal Home Loan Banks (FHLB) issues short term and long term bonds.

All of the following issue agency securities EXCEPT: A. FNMA B. FHLMC C. FRB D. FHLB

The best answer is A. Best's is a rating agency for insurers. Moody's, Standard and Poor's and Fitch's are the bond rating agencies, listed in order of market share.

All of the following rate bonds for credit risk EXCEPT: A. Best's B. Fitch's C. Moody's D. Standard and Poor's

The best answer is D. CMOs have a lower level of market risk (risk of price volatility due to movements in market interest rates) than do mortgage backed pass-through certificates. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower. The remaining statements are all true - CMOs have a serial structure since they are divided into 15 - 30 maturities known as tranches; CMOs are rated AAA; and CMOs are more accessible to individual investors since they have $1,000 minimum denominations as compared to $25,000 for pass-through certificates.

All of the following statements are true about CMOs EXCEPT: A. CMO issues have a serial structure B. CMO issues are rated AAA C. CMO issues are more accessible to individual investors than regular pass-through certificates D. CMO issues have the same market risk as regular pass-through certificates

The best answer is D. Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a "Planned Amortization Class." Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments that are made earlier than the PAC maturity are made to the Companion classes before being applied to the PAC (this would occur if interest rates drop); while principal repayments made later than anticipated are applied to the PAC maturity before payments are made to the Companion class (this would occur if interest rates rise). Thus, the PAC class is given a more certain maturity date and hence lower prepayment risk; while the Companion classes have a higher level of prepayment risk if interest rates drop; and they have a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.

All of the following statements are true about PAC tranches EXCEPT: A. If prepayment rates slow down, the PAC tranche will receive its sinking fund payment prior to its companion tranches B. If prepayment rates rise, the PAC tranche will receive its sinking fund payment after its companion tranches C. PAC tranche holders have lower prepayment risk than companion tranche holders D. PAC tranche holders have higher extension risk than companion tranche holders

The best answer is C. Treasury Receipts represent an undivided interest in a portfolio of U.S. Government securities held by a trustee. The portfolio is assembled by a broker-dealer, who sells "receipts" representing ownership of the interest. Each receipt is, essentially, a zero-coupon obligation, that is purchased at a discount, and which is redeemable at par at a pre-set date. Thus, there is no reinvestment risk, since semi-annual interest payments are not received. The implicit rate of return is locked-in when the security is purchased, and the customer will earn that rate of return if the security is held to maturity. Like all original issue discount obligations, the Internal Revenue Code requires that the discount be accreted over the life of the receipt. The annual accretion is taxable, since the underlying securities are U.S. Governments. At maturity, the receipt will have an adjusted cost basis of par, and will be redeemed at par, for no capital gain or loss. Broker-dealers that issue the Receipts make a market in the units. If a customer wishes to sell prior to maturity, the broker will buy back the Receipt at its current market value (which will vary, depending on interest rate movements). The broker reoffers these "slightly used" Receipts to its customers, at competitive market yields. There are no new T-Receipt issues coming to market. Once the Treasury started issuing STRIPS in 1986, there was no need for the "middleman" anymore. However, T-Receipts still trade until they all mature.

All of the following statements are true about Treasury Receipts EXCEPT the: A. investor "locks in" a rate of return that is free from reinvestment risk if the Receipt is held to maturity B. underlying bonds are held by a trustee for the beneficial owners C. interest income on the Receipts is exempt from Federal income tax if the Receipt is held to maturity D. Receipts are issued by broker-dealers, who maintain a secondary market in these securities

The best answer is D. Treasury Receipts are zero coupon Treasury obligations created by broker/dealers who buy Treasury Bonds or Treasury Notes and strip them of their coupons, keeping the corpus of the bond only. The bonds are put into a trust, and "units" of the trust are sold to investors. Treasury Receipts are purchased at a discount and mature at par. The discount earned over the life of the bond is the "interest income." Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, this market evaporated. However, 30 year T-Receipts will trade until they all mature.

All of the following statements are true about Treasury Receipts EXCEPT: A. the full faith and credit of the U.S. Government backs the securities underlying the issue B. they are "packaged" by broker-dealers C. the interest coupons are sold off separately from the principal portion of the obligation D. the securities are purchased at par

The best answer is A. Corporate "funded debt" represents long term debt financing of a corporation with at least 5 years to maturity. Since commercial paper has a maximum maturity of 270 days, it is not a funded debt. Commercial paper is quoted on a yield basis; matures at a pre-set date and price; and is an unsecured promissory note of the issuer.

All of the following statements are true about commercial paper EXCEPT commercial paper: A. is a funded debt of the issuer B. matures on a pre-set date and at a pre-set price C. is quoted on a yield basis D. is an unsecured promissory note

The best answer is D. FNMA is a publicly traded company. Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets. Unlike GNMA, whose securities are directly U.S. Government guaranteed; FNMA only carries an "implicit" U.S. Government backing, so its credit rating is lower than that of GNMA. Interest received by the holder of a mortgage backed pass through security is fully taxable by both federal, state, and local government. Certificates are issued in minimum $25,000 denominations. For most investors this is too much money to invest, so they buy shares of a mutual fund that invests in these instruments instead.

All of the following statements are true about the Federal National Mortgage Association Pass-Through Certificates EXCEPT: A. FNMA is a publicly traded company B. interest payments are subject to state and local tax C. certificates are issued in minimum units of $25,000 D. the credit rating is considered the highest of any agency security

The best answer is A. Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing). CLNs allow an issuer to reduce its interest cost, since the interest rate that must be paid on short term notes is lower than that for long term bond issues. CLNs typically have a maturity of 2 to 3 years, to coincide with the projected construction period of the building. Accrued interest on all municipal short term notes is computed in a manner similar to other money market instruments - an actual day month / actual day year basis. Please note that this is not true for long term municipal bonds, which accrue interest on a 30 day month / 360 day year. The first statement is false. When the long term financing is completed, the proceeds are used to retire the CLNs. The proceeds of the long term bond issue are not added to the original debt outstanding.

All of the following statements are true regarding Construction Loan Notes ("CLNs") EXCEPT: A. When the facility is completed, the permanent financing is added to the outstanding balance ("basis") of the CLNs B. Accrued interest on CLNs is computed on an actual day month / actual day year basis C. The maturity of CLNs is generally 2 to 3 years D. The use of CLNs allows the municipal issuer to reduce its interest cost when constructing a new facility

The best answer is D. GNMA securities are guaranteed by the U.S. Government. Dealers typically quote agency securities, including Ginnie Maes, on a basis point differential to equivalent maturing U.S. Governments. Reinvestment risk is greater for Ginnie Maes than for U.S. Governments. If the mortgages backing a Ginnie Mae Pass Through Certificate are prepaid (if interest rates have dropped), the certificate holder receives payments that are a return of principal, and that, when reinvested at lower current rates, produce a lower return (this is reinvestment risk). There is little reinvestment risk with U.S. Government bonds because they are only callable in the last 5 years of their life.

All of the following statements are true regarding Government National Mortgage Association pass-through certificates EXCEPT: A. GNMA securities are guaranteed by the U.S. Government B. Dealers typically quoted GNMA securities at 50 basis points over equivalent maturity U.S. Government Bonds C. Credit risk for GNMAs is the same as for equivalent maturity U.S. Government Bonds D. Reinvestment risk for GNMAs is the same as for equivalent maturity U.S. Government Bonds

The best answer is C. If a bond has a put option at par, the holder can always exercise the put and "put" the bond back to the issuer, receiving 100% of par for that bond. Thus, as market interest rates rise, this bond's price will not fall, because it must always be worth par. Thus, such a bond is not susceptible to market risk. The yield on such a bond with a 5% coupon rate cannot rise above this level, because the price will not fall below par. However, the yield can drop below this level, because if interest rates fall, the bond's price will go to a premium and the put option would be worthless.

All of the following statements are true regarding a 5% municipal bond purchased at par that has a put option at par EXCEPT the: A. investor's yield cannot rise above 5% StatusB B. put would be exercised if interest rates rise C. put option will not affect the market risk of the security D. investor can exercise the put at his or her discretion

The best answer is C. Zero coupon bonds do not offer a current return; instead, the holder earns the discount on the bond over its life. This "earning" of the discount is taxed annually as interest income to the bondholder even though no physical payment is made. Zero coupon bonds are usually invested in IRAs and retirement plans since these vehicles are tax deferred, thus avoiding paying tax on interest income that isn't actually received. With bonds that make interest payments, the holder is subject to "reinvestment risk" on the interest payments. Rates may fall, causing the bondholder to reinvest the interest payments at lower rates. This risk is not present in zero coupon bonds since no interest payments are made.

All of the following statements are true regarding corporate zero coupon bonds EXCEPT: A. zero coupon bonds do not offer investors a current return B. zero coupon bonds are usually suitable investments for Individual retirement Accounts and Self Employed Retirement Plans C. the interest income on such obligations is not taxable until maturity D. the rate of return for zero coupon bonds is not subject to reinvestment risk associated with interest paying issues

The best answer is B. Mortgage bonds are term issues; all of the bonds are issued at the same date and mature on the same date. A serial structure is not required since real property is not a depreciating asset (as is the case with rolling stock pledged as collateral for equipment trust certificates). At maturity, it is common for mortgage bond issuers to sell a "refunding" bond issue. A new mortgage bond issue is floated, with the proceeds used to retire the maturing debt. In essence, the issuer is rolling over the debt. Mortgage bonds originated in the 1890s as a means of financing the growth of utility companies. As a means of lowering the interest cost to the issuer, bondholders were given a lien on all real property of the utility. In theory, if the issuer defaulted, the bondholders could sell that real property to repay the outstanding debt balance. Historically, mortgage bond defaults have been very low, because we need to keep our lights on!

All of the following statements are true regarding mortgage bonds EXCEPT: A. Mortgage bonds are issued in term maturities B. Default of mortgage bonds is common during recessionary periods C. Mortgage bonds are commonly issued by utilities D. Mortgage bonds are secured by real property

The best answer is C. A "derivative" product is one whose value is "derived" via a "formula" from an underlying investment. Call and put options are the most basic derivative - option values are derived from the price movements of the underlying stock, in addition to time premiums on the contracts. Collateralized mortgage obligation values are derived from the underlying mortgage backed pass-through certificates held in trust by recutting the cash flows and applying them to the CMO tranches. Again, these are derived via a formula. Treasury STRIPS are not a derivative, because the value of the coupons "stripped" from the Treasury bonds is a direct correlation to the interest payments received from the underlying U.S. Government securities.

All of the following would be considered examples of derivative products EXCEPT: A. PAC tranche B. TAC tranche C. Treasury STRIP D. Companion tranche

The best answer is D. The bond resolution (or bond contract) is the contract between the issuer and the bondholder. It spells out the nature of the obligation; the issuer's duties to the bondholders; and any restrictive covenants to which the issuer must adhere. Any costs that the issuer incurs to sell the bonds has no bearing on the bond contract, since the bondholder is not involved in these expenses - they are solely the responsibility of the issuer.

All of the following would be found in a municipal bond resolution EXCEPT: A. the issuer's duties to the bondholders B. the nature of the obligation C. any restrictive covenants to which the issuer must adhere D. any costs to be paid by the issuer in connection with issuing the bonds

The best answer is A. If interest rates decline, it is likely that issuers will call in outstanding bonds and refund the issues at the lower current interest rates. An investor who expects interest rates to drop should avoid callable issues (choice III) or issues with adjustable interest rates (since each year as interest rates drop, the rate on the bond is dropped). Non callable bonds are fine, as are bonds with put options. The put option will only be used if interest rates rise, decreasing the value of the bond. Then, the bondholder would exercise the option and "put" the bonds to the issuer at par.

An investor expects that interest rates will decline over the next 5 years. Which of the following are appropriate investments? I Non-callable 5 year bonds II 10 year bonds puttable at par in 5 years III 10 year bonds callable at par in 5 years IV Adjustable rate (reset) bonds, with an annual reset period A. I and II B. III and IV C. I, II, III D. I, III, IV

The best answer is B. The primary risk associated with holding long term U.S. Government obligations is "purchasing power" risk. This is the risk that inflation reduces the value of future interest payments and the principal repayment yet to be received in the future.

An investor in 30 year Treasury Bonds would be most concerned with: A. credit risk B. purchasing power risk C. marketability risk D. call risk

The best answer is D. The formula for the equivalent taxable yield is: 8% = 8% = 11.11% (100% - 28%) .72

An investor in the 28% tax bracket buys a 6% municipal bond quoted on an 8.00 basis. To calculate the equivalent taxable yield: A. multiply 6% by 72% B. divide 6% by 72% C. multiply 8% by 72% D. divide 8% by 72%

The best answer is C. An investor seeking call protection does not want the bonds to be called away. Most likely to be called are bonds with low call premiums and high interest rates. After calling the bonds, the issuer can refund the issue at lower rates, given that interest rates have fallen.

An investor is seeking a bond issue offering call protection. An issue having which features would NOT be an appropriate investment? I Low stated interest rates II High stated interest rates III Low stated call premiums IV High stated call premiums A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Mortgage bonds pay interest semi-annually and are backed by a mortgage on real property - so these bonds are secure. Convertible bonds pay lower interest rates because of the value of the conversion feature and are not as suitable for a person seeking a high level of current income. Income bonds are unsuitable since they pay only if the company has sufficient earnings. Common stock is unsuitable since the dividend decision is discretionary on the part of the Board of Directors.

An investor seeking a high level of income and a moderate level of risk would buy: A. common stock B. mortgage bonds C. income bonds D. convertible bonds

The best answer is A. In the bond contract or bond resolution, the issuer may have the right to call in the entire issue at preset dates and prices (a normal call schedule, usually with at least 10 years of call protection given to the bondholder). The issuer has the option of calling in the bonds at those dates and prices; and will only do so if it is advantageous to the issuer (meaning that interest rates have dropped since the bonds were issued).

An issuer decides to call in an outstanding bond issue under the terms detailed in the bond resolution because interest rates have dropped substantially after issuance. This type of call is a(n): A. optional call B. extraordinary optional call C. mandatory call D. extraordinary mandatory call

The best answer is B. The bonds which are most likely to be called are bonds with high nominal yields, which is the same as the coupon rate. After calling the bonds, the issuer can refund the issue at lower current market rates (given that interest rates have fallen after issuance). Bonds with low coupon rates are not going to be called since the interest cost to the issuer is low. Bonds with high call premiums would be expensive for the issuer to retire and long call protection periods prevent the issuer from calling the bond during the protection period.

An issuer would MOST likely call bonds with: A. low coupon rates B. high nominal yields C. high call premiums D. long call protection period

The best answer is B. The only debt that can be overlapping is G.O. debt - not revenue bonds. An overlapping debt is one shared by taxpayers in differing political subdivisions. For example, a school district may encompass 5 different towns. A portion of the school district debt overlaps each town. G.O. bond issues are usually structured as serial bonds under a level debt service arrangement to match yearly payments to expected tax revenues.

An overlapping municipal debt is usually: I General Obligation II Revenue III Term IV Serial A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. In a corporate liquidation, secured bondholders are paid first; then unpaid wages and taxes; then debenture holders; then subordinated bondholders; then preferred stockholders; and finally, common stockholders.

Arrange the following in priority of claim in a corporate liquidation: I Unpaid Wages II Secured Bondholders III Subordinated Bondholders IV Debenture Bondholders A. I, II, III, IV B. IV, III, II, I C. I, II, IV, III D. II, I, IV, III

The best answer is B. The general rule is the lower the price of the bond, the faster that bond's price will move as market interest rates change. Deep discount bonds have a lower price than small discount bonds, hence their prices move faster. Small premium bonds have a lower price than large premium bonds, hence their prices move faster as well.

As interest rates rise, which of the following statements are TRUE? I Bonds trading at large discounts fall faster in price than bonds trading at small discounts. II Bonds trading at small discounts fall faster in price than bonds trading at large discounts. III Bonds trading at large premiums fall faster in price than bonds trading at small premiums. IV Bonds trading at small premiums fall faster in price than bonds trading at large premiums. A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Monies to meet debt service requirements are deposited to the sinking fund. The bondholders are paid their annual debt service requirements from this fund. The Debt Service Reserve fund is used for "extra" deposits above and beyond the annual requirement.

As stated in the flow of funds found in a revenue bond issue's trust indenture, monies to meet debt service requirements are deposited to the: A. Revenue Fund B. Debt Service Reserve Fund C. Sinking Fund D. Surplus Fund

The best answer is D. Companion classes are "split off" from the Planned Amortization Class (PAC) and act as buffers absorbing prepayment and extension risk prior to this risk being applied to the PAC tranche. The PAC, which is relieved of these risks, is given the most certain repayment date. The Companion, which absorbs these risks first, has the least certain repayment date. A Targeted Amortization Class (TAC) is like a PAC, but is only buffered for prepayment risk by the Companion; it is not buffered for extension risk. Thus, a TAC has the same level of prepayment risk as the PAC; but the TAC has a higher level of extension risk than the PAC.

CMO Targeted Amortization Classes (TACs) have: A. lower prepayment risk, but the same extension risk as a Planned Amortization Class B. higher prepayment risk, but the same extension risk as a Planned Amortization Class C. the same level of prepayment risk but a lower level of extension risk than a Planned Amortization Class D. the same level of prepayment risk but a higher level of extension risk than a Planned Amortization Class

The best answer is B. CMO investors have almost no default risk (the same thing as credit risk), since the underlying mortgages are usually implicitly backed by the U.S. Government. CMO tranch holders are subject to extension risk - the risk that the expected life of the tranch becomes much longer due to a rise in interest rates causing homeowners to keep their existing mortgages longer than expected. CMO tranch holders are subject to prepayment risk - the risk that the expected life of the tranch becomes much shorter due to a decline in interest rates causing homeowners to refinance and prepay their existing mortgages earlier than expected. The purchaser of a CMO tranch is subject to interest rate risk - if interest rates go higher, then the value of the tranch will decline. Finally, CMO tranch holders are subject to reinvestment risk, since monthly payments must be reinvested at the same interest rate to maintain the same rate of return on the investment. The only securities that do not have reinvestment risk are zero-coupon obligations.

CMO investors are subject to which of the following risks? I Default risk II Credit risk III Prepayment risk IV Reinvestment risk A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is B. CMOs are available in $1,000 denominations unlike the underlying pass-through certificates which are available only in $25,000 denominations. CMOs are quoted in 32nds, similar to the underlying pass-through certificates. Often CMO tranches are quoted on a "yield spread" basis to equivalent maturing Treasury issues.

CMOs are: I available in $1,000 denominations II available in $25,000 denominations III quoted in 1/8ths IV quoted in 1/32nds A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. A CMO divides the cash flow from a pool of underlying mortgages into a number of tranches, each with a different maturity. All of the tranches are issued on the same date; but the maturities extend over a sequence of years. This is a serial structure.

Collateralized mortgage obligation issues have: A. term structures B. serial structures C. series structures D. combined serial and series structures

The best answer is B. Corporate bonds are usually term bonds - all bonds of an issue having the same interest rate and maturity. Term bonds are quoted on a percentage of par basis in 1/8ths, which is the same as a "dollar" quote.

Corporate bonds are quoted on what basis? A. Yield to maturity B. Dollar price C. Discount yield D. Nominal yield

The best answer is D. Debentures are backed solely by the full faith and credit of the issuer. Debentures are usually issued by "Blue Chip" organizations with high credit ratings or lower credit rated companies in the form of high yield or "junk" bonds.

Corporate debentures are backed by: A. real estate B. equipment C. portfolio of marketable securities D. full faith and credit

The best answer is A. When an investment is made outside the U.S. that is denominated in a foreign currency, the investor assumes exchange rate risk. This is the risk that the foreign currency weakens against the U.S. dollar (which is the same as the U.S. dollar strengthening). For example, assume that an investment is made in $100,000 of bonds denominated in Japanese Yen when the Yen is trading at 100 to the U.S. dollar. Thus, $100,000 x 100 Yen per U.S. dollar = 1,000,000 Yen being spent. Also assume that each bond costs 10,000 Yen, so 100 bonds are purchased at $100 each. Now assume that the bonds do not move in price, but the Yen weakens to 200 Yen to the U.S. dollar (each U.S. dollar now "buys" 200 Yen instead of 100 Yen). This means that 100 bonds are still priced at 10,000 Yen each in Japan. However, because each U.S. dollar is worth 200 Yen, the bonds are now worth 10,000 Yen / 200 Yen per U.S. dollar = $50 each. Thus, the bonds are now worth 1/2 of what was paid for them, solely due to the movement in currency exchange rates.

Exchange rate risk exists when making an investment in a: A. foreign security when the U.S. dollar strengthens B. foreign security when the U.S. dollar weakens C. U.S. security when the U.S. dollar strengthens D. U.S. security when the U.S. dollar weakens

The best answer is A. When bonds are trading at a discount, the stated (nominal) yield will be lowest. The current yield will be higher, since it is based on the discounted market price - not par value. The yield to maturity will be the next highest, since it includes the portion of the discount earned annually as part of the annual return in addition to the interest received.

For bonds trading at a discount, rank the yield measures from lowest to highest? I Nominal II Current III Basis A. I, II, III B. III, II, I C. II, I, III D. I, III, II

The best answer is A. When bonds are trading at a discount, the stated (nominal) yield will be lowest. The current yield will be higher, since it is based on the discounted market price - not par value. The yield to maturity will be the next highest, since it includes the portion of the discount earned annually as part of the annual return in addition to the interest received. Finally, yield to call will be highest, since the discount would be earned over a shorter period of time, increasing the annual yield on the security.

For bonds trading at a discount, rank the yield measures from lowest to highest? I Nominal II Current III Basis IV Yield to Call Basis A. I, II, III, IV B. IV, III, II, I C. II, I, III, IV D. I, III, II, IV

The best answer is C. The bond is convertible into common at a 12.5:1 ratio, based on the par value of the bond. The conversion price formula is: Par value of a bond/ Conversion ratio= conversion price $1,000 par/ 12.5 = $80 conversion price

Ford Motor Company has issued 8% convertible debentures, convertible at a 12.5:1 ratio. Currently the debenture is trading at 90. The stock is trading at $72. What is the conversion price of the stock? A. $72 B. $75 C. $80 D. $90

The best answer is C. The bond is convertible into common at a 25:1 ratio, based on the par value of the bond. The conversion price formula is: Par value of a bond/ Conversion ratio= conversion price $1,000 par/ 25 = $40 conversion price

Ford Motor Company has issued 8% convertible debentures, convertible at a 25:1 ratio. Currently the debenture is trading at 110. The stock is trading at 38. What is the conversion price of the stock? A. 25 B. 38 C. 40 D. 44

The best answer is C. Level debt service means that the issuer pays a constant yearly amount to service both the interest and principal repayment of a serial bond issue. Similar to a mortgage amortization schedule, part of the payment goes to principal repayment with the rest going to interest. In the early years, most of the payment is interest. In the later years, most of the payment is principal, since a majority of the bonds have been retired.

From an issuer's standpoint, level debt service serial bonds have: A. constant interest cost in the later years B. constant principal repayment in the later years C. declining interest payments equally offset by rising principal repayments D. declining principal repayments equally offset by rising interest payments

The best answer is C. G.O. bonds are typically issued without a trust indenture - revenue bonds have trust indentures. The specific protections of an indenture are not needed since the municipality's taxing power is unconditionally pledged to pay off the bonds. Trust indentures are found in revenue bond issues, where only the revenues are pledged to pay off the debt, and purchasers of the bonds demand additional protections that are spelled out in the trust indenture, such as rate, insurance, and maintenance covenants. To assess whether taxes are likely to be sufficient to pay off the debt, G.O. bond analysis includes evaluation of the tax collection record; trend of assessed valuation of property in the area; and debt to population ratios.

General obligation bond analysis would consider which of the following? I Protective covenants in the trust indenture II Trend of assessed valuation of property III Ratio of overall debt per capita IV Record of tax collections A. I and III only B. II and IV only C. II, III, IV D. I, II, III, IV

The best answer is B. The nominal yield is the stated rate of interest on the bond, based on par value. Annual interest rate/par= nominal yield $100/$1,000=10%

In 2017, a customer buys 1 ABC 10%, $1,000 par debenture, M '32, at 100. The interest payment dates are Jan 1st and Jul 1st. The nominal yield on the bond is: A. 5.00% B. 10.00% C. 12.00% D. 15.00%

The best answer is A. The formula for yield to maturity for a premium bond is: Annual Interest - Annual Capital loss/ (bond cost + redemption price)/ 2 = Yield to Maturity for a premium bond $80 - ($100 premium / 15 years to maturity)/ ($1,100 + $1,000) / 2 = $80 - $6.67/ $1,050= 6.98%

In 2017, a customer buys 1 GE 8%, $1,000 par debenture, M '32, at 110. The interest payment dates are Jan 1st and Jul 1st. The yield to maturity on the bond is: A. 6.98% B. 7.58% C. 8.00% D. 8.24%

The best answer is C. The nominal yield is the stated rate of interest on the bond, based on par value. Annual interest rate/par= nominal yield $100/$1,000=10%

In 2017, a customer buys 1 PDQ 10%, $1,000 par debenture, M '32, at 115. The interest payment dates are Jan 1st and Jul 1st. The nominal yield on the bond is: A. 8.37% B. 8.69% C. 10.00% D. 10.23%

If the bonds are called prior to maturity, the yield to call will be higher than the yield to maturity since the discount will be earned faster and the bondholder will receive the call premium. Assume that the bonds are called in 2019. Yield to call uses the same formula as YTM computed to the call date. The Yield to Call will be: $100 + $90 ($150 discount + $30 premium/2 years to call)/ ($850 + $1,030) / 2 = $190/ $940 = 20.21% Note for the exam that you do not have to compute yield to call; but you must know that yield to call will be higher than yield to maturity if the bond is trading at a discount; and yield to call will be lower than yield to maturity if the bond is trading at a premium.

In 2017, a customer buys 5 GE 10% debentures, M '27, at 85. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2019 at 103. If the bonds are called prior to maturity, which statement is TRUE? A. The yield to call will be higher than the yield to maturity B. The yield to call will be lower than the yield to maturity C. The yield to call will be the same as the yield to maturity D. The yield to call will depend on the current market price of the bond at the time of the call

The best answer is D. The formula for yield to maturity for a discount bond is: Annual Income + Annual Capital Gains (discount bond)/ Average bond cost + Redemption price/2 = Yield to maturity for a discount bond $100 + ($150 discount / 10 years to maturity)/($850 + $1,000) / 2 =$100 + $15/$925= 12.43%

In 2017, a customer buys 5 GE 10% debentures, M '27, at 85. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2022 at 103. The yield to maturity on the bonds is: A. 10.00% B. 10.81% C. 11.76% D. 12.43%

The best answer is B. The formula for current yield is: Current yield=Annual Interest rate/Market value $100/$900= 11.11%

In 2017, a customer buys 5 GE 10% debentures, M '37 at 90. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2022 at 107. The current yield on the bonds is: A. 10.00% B. 11.11% C. 11.76% D. 12.43%

The best answer is B. If the bond's current yield (11.76%) is higher than the coupon yield (10%), the bond is trading at a discount. In order for the yield to rise above the stated fixed coupon rate, the price of the bond must drop in the market.

In 2017, a customer buys 5 GE 10% debentures, M '37. The interest payment dates are Feb 1st and Aug 1st. The current yield on the bonds is 11.76%. The bonds are callable as of 2027 at 103. The bond is trading: A. at a premium B. at a discount C. at par D. in the money

The best answer is A. Interest received from corporate bonds is taxable at the Federal, State and Local levels.

Interest earned on corporate bonds is: A. subject to Federal tax and subject to State and Local tax B. subject to Federal tax and exempt from State and Local tax C. exempt from Federal tax and subject to State and Local tax D. exempt from Federal tax and exempt from State and Local tax

The best answer is B. A municipal "covenant of defeasance" allows the issuer to "advance refund" the bond issue under the terms specified in the bond contract. An issuer will take advantage of this covenant if interest rates have dropped and the issue is not currently callable. To advance refund the issue, the issuer buys enough U.S. Government securities to meet the debt service requirements on the issue and places then in escrow with a trustee. The maturity on the U.S. Governments matches the maturity (or first call date) of the outstanding bonds. The interest payments received from the U.S. Governments are used to meet the debt service requirements. When the U.S. Governments mature, the proceeds are used to retire the issuer's debt. By advance refunding, the issuer removes the existing debt as its own liability, freeing it to issue new debt at lower current interest rates.

In a municipal bond contract, a "covenant of defeasance" would allow the issuer to: A. redeem the issue in part or full at predetermined date(s) and prices B. advance refund the issue under the terms specified in the bond contract C. omit interest or principal repayments if coverage ratios decline below specified limits D. reset interest rates periodically at predetermined dates based upon recognized interest rate indices

The best answer is D. In a period of rising interest rates, bond prices will be falling. Therefore, a dealer would lower his quoted prices in Bloomberg. If the dealer has depreciated bonds that he wishes to sell, he can place "Requests for Bids" for those bonds in Bloomberg. The dealer may bid (buy) bonds that he has previously sold short to take gains due to falling prices. To hedge existing long positions against falling prices, the dealer would buy put options. If prices fall, the dealer can "put" the bond at the contract price. Put options are used to hedge existing long positions from falling prices.

In a period of rising interest rates, a bond dealer would engage in which of the following activities? I Lower prices in interdealer quote publications such as Bloomberg for municipal bonds II Place "request for bids" in services such as Bloomberg on depreciated positions where the dealer has no current interest III Bid for bonds to cover previously established short positions IV Buy put options on debt instruments to hedge existing long positions A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. The bond counsel renders an opinion as to the legality, validity, and tax exempt status of a new municipal issue. To do this, he examines municipal statutes, state laws, judicial edicts, and tax regulations. Municipal securities, as well as Government and Agency securities, are exempt from the provisions of the Securities Acts (with the exception of these Acts' broadly written anti-fraud provisions). Thus, these would not be examined by the bond counsel in connection with rendering a legal opinion.

In order to render an opinion on a new municipal bond issue, the bond counsel will examine all of the following EXCEPT: A. Municipal statutes B. State constitution and amendments C. Tax code and interpretive regulations D. Securities Act of 1933

The best answer is D. Ad valorem taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales and income taxes).

Income sources backing a special tax bond issue could be all of the following EXCEPT: A. Excise taxes B. Sales taxes C. Income taxes D. Ad Valorem taxes

The best answer is A. Industrial development bonds are backed by the rental revenues paid by the corporate lessee as well as by the guarantee of the corporate lessee. These bonds, therefore, take on the credit rating of the corporation leasing the facility.

Industrial development bonds: I are backed by rental revenues paid by the corporate lessee II are backed by the municipality's ad valorem taxes III take on the credit rating of the corporate lessee IV take on the credit rating of the municipal lessor A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. The Daily Bond Buyer gives information about the municipal primary market (new issues) - it is a newspaper for brokers and banks that want to buy new issue municipal bonds from issuers. Munifacts is a newswire service run by the Bond Buyer that mainly announces new issue offerings by syndicates, but also includes some general news items that can affect the secondary market. Bloomberg posts dealer offerings of bonds in the secondary market. EMMA is the MSRB's retail oriented website for municipal investors (EMMA stands for Electronic Municipal Market Access). It includes "RTRS" - the Real Time Reporting System, which reports municipal bond trades occurring in the secondary market.

Information about the municipal secondary market can be obtained from all of the following EXCEPT: A. Daily Bond Buyer B. Bloomberg C. Munifacts D. EMMA

The best answer is B. The interest income from direct issues of the U.S. Government and most agency obligations is subject to federal income tax but is exempt from state and local tax. An exception is the interest income received from mortgage backed passthrough certificates (issued by GNMA, FNMA, FHLMC). This interest income is subject to both federal income tax and state and local tax. The logic behind this tax treatment is that the mortgage interest paid by the homeowners was fully deductible from both federal, state, and local taxes. When this interest is received by the certificate holder, both the federal and state government want to recapture this interest income and tax it.

Interest received from which of the following securities is exempt from state and local tax? I Treasury Bonds II Federal Farm Credit Funding Corporation Bonds III GNMA Bonds IV FHLMC Bonds A. I only B. I and II C. III and IV D. I, II, III, IV

The best answer is C. Only municipal issues are exempt from Federal income tax on interest income. Corporate and U.S. Government debt interest income is subject to Federal income tax.

Issuers of Federal tax exempt commercial paper include: I Corporations II Federal Government III Municipal Governments A. I only B. II only C. III only D. I, II, III

The best answer is A. Level debt service means that the issuer pays the same amount each year, with the funds being used to pay both interest and a portion of principal on the issue. The balance of the level payment is used to pay off bonds for that year. Thus, each year, the principal repayment amount increases; and the interest amount decreases. The total of the two remains the same. This is essentially the same idea as a mortgage amortization schedule.

Level debt service is best described as: A. debt service remains the same amount each year B. debt service decreases as the years progress C. principal repayments decrease as the years progress D. principal repayments stay the same as the years progress

The best answer is C. Most corporate bond and municipal bond trades take place dealer-to-dealer in the OTC market. The municipal market is quite illiquid and the corporate bond market is not very active either. Such illiquid markets are better handled by dealers that will buy bonds into inventory when there are no other buyers; or sell bonds out of inventory to customers when there are no other sellers. There is no corporate bond trading on the NYSE floor (NYSE bond trading, which is very limited, is now handled by a matching computer).

Most corporate bond trades are executed: I on exchange floors II over-the-counter III by bond dealers IV by specialists (DMMs) A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Municipal bonds are traded in the over-the-counter market - with bank dealers, other brokers, as well as with municipal broker's brokers. They are not traded on national stock exchanges.

Municipal bond traders execute transactions in all of the following ways EXCEPT: A. on the floor of recognized exchanges B. with bank dealers in the over-the-counter market C. with brokerage wire houses in the over-the-counter market D. with municipal broker's brokers

The best answer is D. It makes no sense to place "federally tax exempt" municipal bonds into a "tax deferred vehicle" such as an IRA or Keogh account. Since the account is tax deferred, one would place securities earning the highest "before tax" return, such as corporates or governments into the account.

Municipal bonds would be an appropriate investment for which of the following? I Individuals II Individual Retirement Accounts III Bank Holding Companies IV Casualty Companies A. II, III, IV B. I, II, III C. I, II, IV D. I, III, IV

The best answer is D. Municipal term bonds are generally quoted on a dollar price basis (so-called "dollar bonds"). Serial bonds and short term municipal notes are quoted on a yield basis.

Municipal term bonds are generally quoted on a: A. yield to call basis B. yield to maturity basis C. current yield basis D. dollar price basis

The best answer is B. Municipal variable rate demand notes are issued by a municipality. The interest rate is reset to the market rate weekly; and at the reset date, the holder can "put" the bonds back to the issuer at par. Here, the minimum value of the bond is par - because of the put feature. Because the price of the bond cannot go below par, these bonds are not subject to market risk and the yield cannot go above the stated rate. However, if interest rates fall, the price can go above par (by a small amount) and the yield can fall below the stated rate until the next reset date.

Municipal variable rate demand notes: I have a market value which will never go below par II have a market value which will never go above par III have a yield which will never fall below the stated rate IV have a yield which will never rise above the stated rate A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Municipal variable rate demand notes are issued by a municipality. The interest rate is reset to the market rate weekly; and at the reset date, the holder can "put" the bonds back to the issuer at par. Here, the minimum value of the bond is par - because of the put feature. Because the price of the bond cannot go below par, these bonds are not subject to market risk. However, if interest rates fall, the price can go above par (by a small amount) until the next reset date.

Municipal variable rate demand notes: I have a minimum value which will never go below par II have a maximum value which will never go above par III are subject to market risk IV are not subject to market risk A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Variable rate bonds, also known as reset bonds, have a rate of interest that is reset periodically, usually weekly, based upon a recognized interest rate index that usually consists of Treasury Issues. At the reset date, the note is puttable back to the issuer at par (payable on demand of the holder, hence the term "demand note"). This was the first attempt by municipal issuers to sell long term bonds (because there is no stated maturity) at short-term interest rates (which are usually lower).

Municipal variable rate demand notes: I have an interest rate that is fixed throughout the life of the bond II have an interest rate that is reset periodically III are considered short term municipal notes IV are considered long term municipal notes A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Municipalities issue TANs (Tax Anticipation Notes) to "pull forward" funds that will be collected as taxes in later months. For example, if taxes are due on April 15th, and it is now January 15th, and the municipality wishes to get funds at this time, it can issue 3 month TANs. When the taxes are actually collected, the proceeds are used to retire the TAN issue. RANs (Revenue Anticipation Notes) are issued to "pull forward" revenues that are expected to be received by the municipality in the coming months. For example, the City of New York will receive a $200,000,000 payment from the Federal government on July 1st to support mass transit. It is now April 1st. The city can issue 3-month RANs and borrow against the upcoming revenue to be received from the Federal Government. A TRAN is a combination Tax and Revenue Anticipation Note. A BAN is a Bond Anticipation Note - a short term note that will be retired by a later long term bond sale. A CLN is a Construction Loan Note - a 2-3 year IOU used to start a major building project. The short term financing is "taken-out" (retired) from the proceeds of a later long term bond sale.

Municipalities will issue which of the following to "pull forward" funds that will be collected as taxes in later months? A. BAN B. RAN C. TAN D. CLN

The best answer is C. Municipal commercial paper is not very popular. Most municipalities finance short term needs through BANs (Bond Anticipation Notes), TANs (Tax Anticipation Notes), RANs (Revenue Anticipation Notes) and TRANs (Tax and Revenue Anticipation Notes). However, commercial paper could be used by a municipality to finance short-term cash shortages caused by slow tax collections or unforeseen extraordinary expenses (these could also be financed by tax anticipation notes). Also, commercial paper could be used for an interim construction loan, because when a building is under construction, the long term financing may not yet be in place (of course, the municipality could also finance the construction through a CLN - construction loan note). Commercial paper cannot be used for long term financing such as a bond refunding. Remember, commercial paper is a short term promissory obligation - not long term.

Municipalities would issue tax exempt commercial paper for which of the following reasons? I To smooth out collections of funds that are normally subject to seasonal fluctuations II To meet a temporary cash shortage due to unforeseen extraordinary expenses III To refund an outstanding bond issue IV To provide construction period financing that will be permanently financed by a future bond sale A. I only B. III only C. I, II, IV D. I, II, III, IV

The best answer is C. Net Overall Debt of a municipality is used as the numerator in Debt Per Capita ratios and Debt to Assessed Value ratios. These ratios measure the relative size of the municipality's debt level. Net Overall Debt is: Net Direct Debt + Overlapping Debt.

Net Direct Debt and Overlapping Debt equals: A. Debt per Capita B. Debt to Assessed Valuation C. Net Overall Debt D. Overlapping Debt

The best answer is B. Private CMOs (Collateralized Mortgage Obligations) are also called "private label" CMOs. Instead of being backed by mortgages guaranteed by Fannie, Freddie or Ginnie, they are backed by "private label" mortgages - meaning mortgages that do not qualify for sale to these agencies (either because the dollar amount of the mortgage is above their purchase limit or they do not meet Fannie, Freddie or Ginnie's underwriting standards). Whereas CMOs backed by Fannie, Freddie or Ginnie mortgage-backed securities are rated AAA, the rating of "private label" CMOs is dependent on the credit quality of the underlying mortgages.

Private CMOs are: A. rated AAA because the underlying mortgages are government backed B. assigned credit ratings by independent credit agencies based on their structure, issuer, and collateral C. not rated by independent credit agencies because they are private placements that cannot be traded in the market D. not rated by independent credit agencies because of the uncertainty surrounding the quality of the mortgage loans collateralizing the issue

The best answer is A. The trust indenture of a bond spells out all of the protective and restrictive covenants made to the bondholders. The trustee ensures that the corporation adheres to the covenants.

Promises made by corporate issuers to bondholders, as well as any restrictions placed on the issuer are found in the: A. indenture B. legal opinion C. prospectus D. underwriting agreement

The best answer is D. Revenue bonds may be called if interest rates fall, allowing the issuer to refinance at the new lower rates; or can be called under extraordinary mandatory calls such as a calamity call if a disaster occurs destroying the facility; and can be called under extraordinary optional calls such as parts of a mortgage revenue bond issue being called if homeowners prepay their mortgages. Statutory debt limits do not apply to revenue bonds because they are self-supporting debts - they only apply to non-self supporting general obligation bonds.

Revenue bonds may be called for all the following reasons EXCEPT: A. the facility has been destroyed by fire B. homeowners have prepaid their mortgages C. interest rates have fallen D. the issuer has reached a statutory debt limit

The best answer is C. Revenue bonds may be called if interest rates fall, allowing the issuer to refinance at the new lower rates; or can be called under extraordinary mandatory calls such as a calamity call if a disaster occurs destroying the facility; and can be called under extraordinary optional calls such as parts of a mortgage revenue bond issue being called if homeowners prepay their mortgages. Statutory debt limits do not apply to revenue bonds because they are self-supporting debts - they only apply to non-self supporting general obligation bonds.

Revenue bonds may be called for which of the following reasons? I Homeowners have prepaid their mortgages II Interest rates have fallen III The issuer has reached a statutory debt limit IV The facility has been destroyed by fire A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is B. A special assessment bond is one which is used to fund an improvement that benefits only a segment of the population; and only those people are charged taxes to pay for that improvement. Such taxes cannot exceed the value of the benefit received. This makes them totally different from general tax collections, such as ad valorem taxes, which have no such "tie-in".

Special assessment bond issues are paid from: A. taxes levied upon all taxable property within the municipality, without limitation as to rate or amount B. taxes levied upon all taxable property within a particular locality, not to exceed the benefit derived from the improvement C. revenues pledged from the operation of a facility built with the proceeds of the issue D. excise taxes placed upon the sale of either alcohol, tobacco, or fuel

The best answer is D. Special tax bonds are backed by taxes other than an ad valorem tax, such as liquor taxes, gasoline taxes, cigarette taxes or sales taxes. They are considered to be a non-self supporting debt since they are paid from tax collections. Self supporting debts are revenue bond issues that pay their own way from collected revenues.

Special tax bonds are: I backed by ad valorem taxes II backed by sales or excise taxes III a self supporting debt IV a non-self supporting debt A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Standard and Poor's Bond Guide is published on the web, and gives capsule summaries of every outstanding corporate issue, including recent price, rating, and yield. Reports of corporate bond trades are made through TRACE (FINRA's Trade Reporting and Compliance Engine). Dealer offerings of corporate bonds are found on Bloomberg and Reuters, as well as each bond dealer's web site. The Bond Guide does not include corporate new issue information.

Standard and Poor's Bond Guide: A. reports completed corporate bond trades on a real-time basis B. lists dealer offerings of corporate bonds in the secondary market C. gives capsule summaries of every outstanding corporate issue, including recent price, rating, and yield D. gives the details of each corporate new issue that is coming to market

The best answer is B. A bank is allowed to deduct 80% of any interest expense that it must pay on monies borrowed to buy bank qualified municipal bonds. (The bank "borrows" the monies from its depositors and pays them interest on their deposits). If an individual were to buy municipal bonds, the interest expense on monies used to buy the bonds is non-deductible.

The interest expense on monies used to buy bank qualified municipal bonds is: A. 20% deductible for bank investors B. 80% deductible for bank investors C. 20% deductible for individual investors D. 80% deductible for individual investors

The best answer is C. The interest income derived from "non-essential use" private purpose revenue bonds is included in the alternative minimum tax computation. Industrial Revenue Bonds fall into this category. Public purpose bonds, such as G.O.'s, and public facility revenue issues are not subject to the alternative minimum tax (AMT).

The interest income earned on which of the following municipal bonds would be included in the alternative minimum tax computation? A. School District Bond B. Turnpike Revenue Bond C. Industrial Revenue Bond D. Water District Revenue Bond

The best answer is A. The interest income earned from Industrial revenue bond issues that were issued prior to 1986 was generally tax exempt. The Tax Reform Act of 1986 made this "private use" interest income taxable. An issue arises regarding older "tax free" industrial revenue bond issues. Essentially, the lease payments made by the corporation are used to fund the interest payments made on the outstanding debt. These lease payments are tax deductible to the corporate lessee. If the corporation were to buy the outstanding bond issue, it would receive interest payments on the bonds that are tax free. Effectively, the corporation has taken a tax deduction for the lease payments; and has converted these payments into tax free interest income. The IRS does not allow this. If the purchaser of the bonds is a "substantial user" of the facility being leased, then the interest income received becomes taxable to the corporate lessee. This is only fair, since the lease payments used to fund the payment of that interest income were tax deductible to the corporation.

The interest income received from older Industrial Revenue bonds may be taxable to the holder at regular income tax rates if the holder: A. is a "substantial user" of the facility built with the proceeds of the issue B. receives more than $10,000 per year in interest income from the bonds C. has purchased the bonds in a margin account and has borrowed against the position D. is an officer of the issuer

The best answer is B. The School District bonds have a coupon of 5.20% and were scheduled to mature in 2027. However, the issuer has pre-refunded (P/R) the bonds by escrowing U.S. government securities to retire the bonds prior to maturity (at the call date of 6/15/17). At that time, the bondholder will receive 102 (call premium of 2 points). The bonds are currently being offered at a price to yield 3.50%, so they are trading at a premium (coupon is 5.20%).

The listing of current municipal bond offerings shows the following: Cook County School District Bond P/R @ 102 5.20 6/15/17 M'27 3.50 The bonds are offered at (a): A. par B. premium C. discount D. parity

The best answer is D. Treasury Bills are issued in initial 4 week (1 month); 13 week (3 month); 26 week (6 month); and 52 week (12 month) maturities.

The longest initial maturity available for new issues of Treasury Bills is: A. 4 weeks B. 8 weeks C. 26 weeks D. 52 weeks

The best answer is C. The interest rate placed on a TIPS (Treasury Inflation Protection Security) is less than the rate on an equivalent maturity Treasury Bond. For example, a 30 year Treasury Bond might have a coupon rate of 4%; but a 30 year TIPS has a coupon rate of 2.75%. The "difference" between the two is the current market expectation for the inflation rate (1.25% in this example). The coupon rate on the TIPS approximates the "real interest rate" - the rate earned after factoring out inflation. If 30 year T-Bonds have a nominal yield of 4%; and the inflation rate is expected to be 1.25%; then the "real" interest rate is 2.75%. The reason why the TIPS sells at a lower coupon rate is that, every year, the principal amount is adjusted upwards by that year's inflation rate. So there are really 2 components of return on a TIPS - the lower coupon rate (the "real" interest rate) plus an adjustment equal to that year's inflation rate.

The nominal interest rate on a TIPS approximates the: A. discount rate B. federal funds rate C. real interest rate D. expected interest rate

The best answer is B. The nominal yield is the stated rate of interest as a percentage of par value. It does not change as bond prices move. However, the current yield and yield to maturity will be affected by changes in bond prices.

The nominal yield of a bond will: I increase as bond prices fall II decrease as bond prices rise III remain unchanged as bond prices fall IV remain unchanged as bond prices rise A. I and II B. III and IV C. I and IV D. II and III

The best answer is A. The nominal yield is the stated rate of interest on the bond, based on par value. Annual interest rate/par= nominal yield

The nominal yield on a bond is: A. stated interest rate / bond par value B. stated interest rate / bond market value C. market interest rate / bond par value D. market interest rate / bond market value

The best answer is B. The physical securities which are held in trust against the issuance of Treasury Receipts are either Treasury Notes or Treasury Bonds. Treasury Bills cannot be used because their maturities are too short; Series EE bonds (savings bonds) cannot be used because they are non-marketable.

The physical securities which are the underlying collateral for Treasury Receipts are: A. Treasury Bills B. Treasury Notes C. Series EE Bonds D. Treasury Stock

The best answer is B. With a fixed rate note, as interest rates rise or fall, the note's value must decrease or increase proportionately, so that the note gives a yield that approximates the current level of interest rates. Variable rate notes periodically adjust the rate of interest paid to holders, usually based upon an index of government securities. The interest rate on the notes will fluctuate up or down, depending upon market interest rates. Thus, the note always gives a yield that approximates current interest rate levels so the market price of these securities will remain fairly constant. These notes avoid "interest rate risk," also known as market risk, since a rise in interest rates will not devalue these securities. However, they still may have marketability risk (the risk that the securities cannot be easily sold); and can have credit risk.

The principal advantage of purchasing a variable rate municipal note is: A. The interest rate can be expected to remain fairly stable B. The market value can be expected to remain fairly stable C. The marketability risk can be expected to be lower D. The credit risk can be expected to be lower

The best answer is D. Build America Bonds (BABs) were issued by municipalities in 2009 and 2010. They are taxable municipal bonds that get a 35% Federal interest rate subsidy and the bond proceeds must be used for capital improvements (this is part of the economic stimulus program after the 2008-2009 "great recession"). These bonds were meant to create jobs and make to it easier for municipalities to access the debt market for needed capital projects. The proceeds of BABs cannot be used to prerefund existing issues (that does not create jobs).

The proceeds of a "Build America Bond" may be used for all of the following EXCEPT: A. public buildings B. transportation infrastructure C. water and sewer projects D. prerefunding outstanding issues

The best answer is D. Public schools do not produce revenue and thus are not funded by revenue bond issues. Rather, school bond issues are general obligations of the issuer. Special tax bonds pledge collected "special taxes," such as excise taxes, to pay for the financing of a project. For example, a road improvement district bond issue could be financed by a special gasoline tax. A moral obligation bond is only issued in times of municipal distress, when the municipality does not have enough taxing power or revenue generating ability to sell a normal bond issue. To bail out the local municipal issuer, the state can morally obligate itself to pay if the municipal issuer cannot.

The type of municipal bond issue that would be used to finance the construction of public schools would be a: A. revenue bond B. special tax bond C. moral obligation bond D. general obligation bond

The best answer is A. There are two Yield to Maturity formulas, one for a discount bond and one for a premium bond: Annual Interest rate + Annual Capital gain/ (bond cost + Redemption Price) / 2 = Yield to maturity for discount bond Since both the Annual Interest and Annual Capital Gain are fixed, as the cost of the bond falls, the Yield to Maturity must rise. Annual Interest rate + Annual Capital loss/ (bond cost + Redemption Price) / 2 = Yield to maturity for premium bond Since both the Annual Interest and Annual Capital Gain are fixed, as the cost of the bond rises, the Yield to Maturity must fall.

The yield to maturity of a bond will: I increase as bond prices fall II decrease as bond prices rise III remain unchanged as bond prices fall IV remain unchanged as bond prices rise A. I and II B. III and IV C. I and IV D. II and III

The best answer is A. Municipalities issue BANs (Bond Anticipation Notes) to "pull forward" funds that will be collected from a later permanent bond sale. For example, a municipality expects to float a 20 year bond issue in 6 months. It can get the funds today by issuing 6 month BANs now. When the bond issue is floated, the proceeds are used to pay off the BANs. Municipalities issue TANs (Tax Anticipation Notes) to "pull forward" funds that will be collected as taxes in later months. For example, if taxes are due on April 15th, and it is now January 15th, and the municipality wishes to get funds at this time, it can issue 3 month TANs. When the taxes are actually collected, the proceeds are used to retire the TAN issue. RANs (Revenue Anticipation Notes) are issued to "pull forward" revenues that are expected to be received by the municipality in the coming months. For example, the City of New York will receive a $200,000,000 payment from the Federal government on July 1st to support mass transit. It is now April 1st. The city can issue 3-month RANs and borrow against the upcoming revenue to be received from the Federal Government. A TRAN is a combination Tax and Revenue Anticipation Note.

To obtain short term funds in anticipation of a subsequent long term debt financing, a municipality will issue a: A. BAN B. TAN C. RAN D. TRAN

The best answer is D. Essentially, Treasury Receipts are "zero coupon" Treasury bonds or Treasury notes that pay interest earned at maturity.

Treasury Receipts pay interest: A. quarterly B. semi annually C. annually D. at maturity

The best answer is C. Long term government and agency securities, like T-Notes and T-STRIPS, are quoted in 32nds, T-Bills are quoted on a discount yield basis.

Treasury STRIPS are quoted by dealers: A. as a percentage of par in minimum increments of $.10 B. as a percentage of par in minimum increments of 1/8ths C. as a percentage of par in minimum increments of 1/32nds D. on a yield to maturity basis

The best answer is A. Treasury bonds are issued at par in minimum denominations of $100 each, and pay interest semi-annually. At maturity, the bondholder receives par.

Treasury bonds: I are issued in minimum $100 denominations II are issued in minimum $10,000 denominations III mature at par IV mature at par plus accrued interest A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Treasury notes are issued at par in minimum denominations of $100 each, and pay interest semi-annually. At maturity, the bondholder receives par.

Treasury notes: I are issued in minimum $100 denominations II are issued in minimum $10,000 denominations III mature at par IV mature at par plus accrued interest A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Municipal secondary market joint accounts are formed by municipal firms to purchase, and subsequently resell, large blocks of bonds. Any quotes disseminated for those bonds must appear as one quote (they are actually grouped and bracketed in Bloomberg to show that they represent a single source for the quote). It cannot appear that there are multiple markets for the bonds when in fact there is only one (the joint account).

Under MSRB rules, municipal securities traders that participate in secondary market joint accounts: A. can only act as agent in the transactions and cannot carry positions overnight B. cannot disseminate quotes severally for the securities; any quote can only indicate that one market exists for the securities C. cannot place orders to buy bonds for an accumulation account sponsored by a dealer participating in the joint account D. cannot effect customer transactions and can only deal with other municipal broker-dealers

The best answer is B. When a revenue bond is issued under a "Net Revenue Pledge," there is usually a rate covenant that accompanies the pledge. In a Net Revenue Pledge, the issuer pledges its "net revenues" (gross revenues net of operation and maintenance costs) to the bondholders. A rate covenant is a promise to set rates for the use of a facility at a sufficient level to cover both of these items - operation and maintenance, as well as required debt service payments. There is no requirement to cover "optional" sinking fund deposits or reserve fund deposits.

Under a municipal revenue bond rate covenant, charges for the use of a facility must be set at a level sufficient to cover: I Operation and maintenance of the facility II Debt service and mandatory deposits to the debt service reserve fund III Optional sinking fund deposits IV Deposits to the reserve maintenance fund A. I only B. I and II C. III and IV D. II and III

The best answer is D. Revenue bond rate covenants usually require that rates be set at a level sufficient to cover operation and maintenance of the facility, as well as debt service costs. There is no requirement to cover "optional" sinking fund deposits or reserve fund deposits.

Under a municipal revenue bond rate covenant, rates must be set to cover all of the following EXCEPT: A. operation of the facility B. debt service C. maintenance of the facility D. optional sinking fund deposits

The best answer is C. The normal order for the "flow of funds" under a net revenue pledge is to apply revenues first to operation and maintenance; then to debt service; followed by debt service reserve; and last to the operation and maintenance reserve. If there are still funds left over after these payments are made, the excess goes into the surplus fund.

Under the flow of funds for a net revenue pledge revenue bond, which of the following is paid first out of the collected revenues? A. debt service B. debt service reserve C. operation and maintenance D. operations and maintenance reserve

The best answer is D. Net revenues are defined as gross revenues less operation and maintenance costs. Under a net revenue pledge, once operation and maintenance are covered, the net revenues that remain are first used to pay debt service.

Under the flow of funds in a revenue bond trust indenture, net revenue is defined as gross revenue minus: A. sinking fund expenses B. debt service reserve expenses C. debt service expenses D. operation and maintenance expenses

The best answer is B. Under a net revenue pledge, only the net revenues (after operations and maintenance are paid) are pledged to bondholders. This water authority has $4,000,000 of net revenues, which would be the amount pledged to the bondholders under a net revenue pledge.

Wet and Wild Water Authority "Flow of Funds" Statement 20XX Water Charges: $9,000,000 Interest on Reserve Funds: $1,000,000 Gross revenues: $10,000,000 Operation and Maint: $6,000,000 Net Revenues: $4,000,000 Debt Service: $2,000,000 Addition to Reserves: $2,000,000 If the bonds were issued under a net revenue pledge, how much in funds were available to pay the bondholders for this year? A. $2,000,000 B. $4,000,000 C. $9,000,000 D. $10,000,000

The best answer is B. If a company wishes to buy outstanding securities directly from the holders of those securities, it can make a "tender offer" for the securities. Any security holders who tender get a price that is higher than the current market price, but these tender offers are usually conditioned on a minimum percentage of the shares (or bonds) being tendered. If the minimum is not met, then the tender offer is canceled. An LBO (Leverage Buy Out) is where an undervalued publicly held company is "bought out" and taken private. The funds to do this are raised by selling bonds, so this is the "leverage" used to complete the buy out. A reverse merger is a way for a privately held company to go public by purchasing an existing publicly held company. A reorganization is a restructuring of a financially troubled company in an attempt to remake the company into viable entity. (Note that reverse mergers and reorganizations are not "test" items other than being wrong answers to a question.)

When a corporation is making a limited time offer to buy its own securities or the securities of another company at a price that is above the current market price, this is known as a: A. leveraged buy out B. tender offer C. reverse merger D. reorganization

The best answer is A. When a municipality "defeases" its debt, it terminates the lien that the bondholders have on pledged revenues, and substitutes another acceptable form of collateral in the form of escrowed U.S. Government or Agency securities. The interest received from the escrowed government securities is the new revenue source for the issue. When the governments mature, the proceeds are used to pay off the bondholders. Thus, the outstanding debt is not retired until maturity, or a call date.

When a municipal issuer defeases its debt in accordance with the terms of the bond contract, it: I terminates the lien that existing bondholders have on pledged revenues II substitutes another source of revenue acceptable to the bondholders III returns the principal amount to the bondholders at the time of the defeasance A. I and II B. I and III C. II and III D. I, II, III

The best answer is C. The bonds most likely to be refunded are those with the highest interest rates (to be replaced by lower interest rate bonds) and low call premiums (so it will not be too expensive to the issuer to call in the debt for refunding). In a refunding, an issuer refinances an outstanding debt by issuing new bonds. The proceeds of the new issue are used to retire the old debt; or are placed in escrow to "pre-refund" an older issue that cannot be immediately repaid because the first call date or maturity date is years in the future. This is either done to reduce interest cost or to remove an onerous restrictive covenant.

When an issuer refinances an outstanding debt issue, the bonds which are MOST likely to be refunded by the issuer are bonds with the: I lowest interest rates II highest interest rates III lowest call premiums IV highest call premiums A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. As a general rule, the deeper the discount, the more volatile the bond's price movements in response to market interest rate changes. The deepest discount bond that can be purchased is a "zero coupon" bond. Such a bond has the most volatile price movements. Also, the longer the maturity, the more volatile the bond's price movements in response to market interest rate changes.

When bonds are trading at a large discount, which of the following statements are TRUE? I The deeper the discount, the more volatile the bond's price movement in response to interest rate changes II The deeper the discount, the less volatile the bond's price movement in response to interest rate changes III Discount bonds with long maturities are more volatile than ones with short maturities IV Discount bonds with short maturities are more volatile than ones with long maturities A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Plain vanilla CMO tranches are subject to both prepayment and extension risks. PACs protect against extension risk, by shifting this risk to an associated Companion tranche. Thus, PACs have lower extension risk than plain vanilla CMO tranches.

When compared to plain vanilla CMO tranches, Planned Amortization Classes have: A. higher extension risk B. lower extension risk C. the same level of extension risk D. no extension risk

The best answer is A. A Targeted Amortization Class (TAC) is a variant of a PAC. A PAC offers protection against both prepayment risk (prepayments go to the Companion class first) and extension risk (later than expected payments are applied to the PAC before payments are made to the Companion class). A TAC bond protects against prepayment risk; but does not offer the same degree of protection against extension risk. A TAC bond is designed to pay a "target" amount of principal each month. If prepayments increase, they are made to the Companion class first. However, if prepayment rates slow, the TAC absorbs the available cash flow, and goes in arrears for the balance. Thus, average life of the TAC is extended until the arrears is paid. Therefore, both PACs and TACs provide "call protection" against prepayments during period of falling interest rates. TACs do not offer the same degree of protection against "extension risk" as do PACs during periods of rising interest rates - hence their prices will be more volatile during such periods.

When comparing a CMO Planned Amortization Class (PAC) to a CMO Targeted Amortization Class (TAC), all of the following statements are true EXCEPT: A. Both PACs and TACs offer the same degree of protection against extension risk B. PACs differ from TACs in that TACs do not offer protection against a decrease in prepayment speeds C. PACs are similar to TACs in that both provide call protection against increasing prepayment speeds D. TAC pricing will be more volatile compared to PAC pricing during periods of rising interest rates

The best answer is B. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the expected life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the expected maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the expected life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the expected maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower.

When comparing the effect of changing interest rates on prices of a CMO issues versus the prices of regular bond issues, which of the following statements are TRUE? I When interest rates rise, mortgage backed pass through certificates fall in price faster than regular bonds of the same maturity II When interest rates rise, mortgage backed pass through certificates fall in price slower than regular bonds of the same maturity III When interest rates fall, mortgage backed pass through certificates rise in price faster than regular bonds of the same maturity IV When interest rates fall, mortgage backed pass through certificates rise in price slower than regular bonds of the same maturity A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. A Capital Appreciation Bond (CAB) is a municipal zero coupon bond with a "legal" twist to it. A conventional zero coupon G.O. bond is counted against an issuer's debt limit at par value because the discount is treated as "principal." If a new issue discount bond is legally crafted as a CAB, then the principal counted against the issuer's debt limit is the discounted principal amount and the discount earned is considered to be interest income. The bond is purchased at the discounted price and then par is returned at maturity, with the 2 components of that par payment being the return of the discounted purchase price (the "principal" amount) and the accreted interest income.

When does an investor receive payment of interest and principal on a Capital Appreciation Bond (CAB)? I Interest is paid semi-annually II Interest is paid at maturity III Principal is paid semi-annually IV Principal is paid at maturity A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. An issuer will call its debt when interest rates have fallen sufficiently. The issuer must pay call premiums to the bondholders to "call in" the debt. In order for the call to make economic sense, the issuer must be able to issue new bonds at a lower interest rate to cover the cost of the call premiums and the costs associated with calling the old debt and issuing new debt. The issuer will call the outstanding high interest rate bonds and issue new bonds with lower interest rates - thus reducing the issuer's interest cost.

When interest rates have fallen, an issuer will: I call the outstanding low interest rate bonds II call the outstanding high interest rate bonds III issue new bonds with lower interest rates IV issue new bonds with higher interest rates A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. One basis point = .01%. The difference between 5.45 and 5.46 = .01%, or one basis point. In this case, the difference between 5.45 and 5.55 = .10%, or 10 basis points.

When quoting bonds on a yield basis, the difference between a bond priced at a yield of 5.45 and a bond priced at a yield of 5.55 is: A. 1 Basis Point B. 10 Basis Points C. 100 Basis Points D. 1,000 Basis Points

The best answer is C. When short term rates are higher than long term rates, this is an inverted or descending yield curve. If the Federal Reserve sharply tightens credit, the effect is felt mainly on short term rates, which can then rise above long term rates.

When short term interest rates are higher than long term interest rates, the yield curve is said to be: A. flat B. normal C. inverted D. bell shaped

The best answer is A. When short term rates are the same as long term rates, this is a flat yield curve. If the Federal Reserve tightens credit to a limited extent, the effect is felt mainly on short term rates, which can then rise to the same level as long term rates.

When short term interest rates are the same as long term interest rates, the yield curve is said to be: A. flat B. normal C. inverted D. bell shaped

The best answer is C. Bondholders are creditors of a company. Convertible bondholders are creditors of a company as long as they keep their bonds and do not convert to common shares. Common and preferred shareholders have an equity position.

Which of the following are considered to be creditors of a corporation? I Common Shareholders II Preferred Shareholders III Convertible Bondholders IV Non-convertible bondholders A. I and II B. III only C. III and IV D. I, II, IV

The best answer is D. When the price of a bond increases, yield to maturity drops. Similarly, because the bond is more expensive, yield to call will also fall.

When the price of a bond increases, which of the following statements regarding yields are TRUE? I Yield to call increases II Yield to call decreases III Yield to maturity increases IV Yield to maturity decreases A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Companion classes are "split off" from the Planned Amortization Class (PAC) and act as buffers absorbing prepayment and extension risk prior to this risk being applied to the PAC tranche. The PAC, which is relieved of these risks, is given the most certain repayment date. The Companion, which absorbs these risks first, has the least certain repayment date. A Targeted Amortization Class (TAC) is like a PAC, but is only buffered for prepayment risk by the Companion; it is not buffered for extension risk.

Which CMO tranche has the least certain repayment date? A. Planned Amortization Class B. Plain Vanilla C. Companion Class D. Targeted Amortization Class

The best answer is B. A floating rate CMO tranche has an interest rate that varies, tied to the movements of a recognized interest rate index, like LIBOR. Therefore, an interest rates move up, the interest rate paid on the tranche goes up as well; and when interest rates drop, the interest rate paid on the tranche goes down as well. There is usually a cap on how high the rate can go and a floor on how low the rate can drop. Because the interest rate moves with the market, the price stays close to par - as is the case with any variable rate security.

Which CMO tranche is LEAST susceptible to interest rate risk? A. Z-tranche B. Floating rate tranche C. PAC tranche D. TAC tranche

The best answer is C. Companion tranches are the "shock absorber" tranches, that absorb prepayment risk out of a TAC (Targeted Amortization Class) tranche; or both prepayment risk and extension risk out of a PAC (Planned Amortization Class) tranche. Because the companion absorbs both of these risks, it has the greatest risk and trades at the highest yield. Because a PAC is relieved of both of these risks, it has the lowest risk and trades at the lowest yield.

Which CMO tranche will be offered at the lowest yield? A. Plain vanilla B. Targeted amortization class C. Planned amortization class D. Companion

The best answer is A. Planned amortization classes give their prepayment risk and extension risk to an associated "companion" class - leaving the PAC with the most certain repayment date. TACs are like a "one-sided" PAC - they protect against prepayment risk, but not against extension risk. Plain vanilla CMO tranches are subject to both risks, while zero-tranches are like "wild cards" - whatever is left over is what you get!

Which Collateralized Mortgage Obligation tranche has the MOST certain repayment date? A. Planned Amortization Class B. Targeted Amortization Class C. Plain Vanilla Tranche D. Zero Tranche

The best answer is B. The longer the expiration, the more volatile a bond's price movements, which narrows the Choices to either A or B. The lower the coupon, the more volatile the bond's price movements, with the lowest coupon being "0." A 9-year zero coupon bond will actually be more volatile in price movements than a slightly longer maturity bond (11 years) with a fairly high coupon (7% in this case). The higher coupon means that more of the bond's value is represented by the interest stream than comes in early and this stabilizes the bond's price as market interest rates move. Duration is a concept that is tested as a "basic" idea on Series 7. It represents the amount of time that it will take for an investor to recoup his or her purchase price. The longer the duration, the longer it will take for an investor to get his or her money back and longer term bonds are more volatile. So the higher the duration number, the greater the bond volatility, and duration is often used as a measure of bond price volatility.

Which bond will exhibit the greatest price volatility? A. 11-year bond; 7% coupon; 8% yield; duration of 7.71 B. 9-year bond; 0% coupon; 7% yield; duration of 9.00 C. 5-year bond; 4% coupon; 3.50% yield; duration of 4.59 D. 3-year bond; 2% coupon; 1.50% yield; duration of 2.93

The best answer is B. Liquidity risk is the risk that a security can only be sold by incurring large transaction costs. The easiest securities to sell (meaning the most readily marketable) are those with high credit ratings and short term maturities.

Which characteristics make a security least subject to liquidity risk? I Short term maturity II Long term maturity III Low credit rating IV High credit rating A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Liquidity risk is the risk that a security can only be sold by incurring large transaction costs. The easiest securities to sell (meaning the most readily marketable) are those with high credit ratings and short term maturities. The least marketable securities (meaning the hardest to sell) are those with low credit ratings and long term maturities.

Which characteristics make a security most subject to liquidity risk? I Short term maturity II Long term maturity III Low credit rating IV High credit rating A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. Treasury STRIPS are zero-coupon Treasury obligations - these have the highest level of purchasing power risk. In contrast, 6 month Treasury bills have a low level of purchasing power risk. Since they will mature at par in the near future, their value cannot fall very far below this if interest rates rise.

Which investment gives the LEAST protection against purchasing power risk? A. 6 month Treasury Bill B. 10 year Treasury Note C. 10 year Treasury "TIPS" D. 10 year Treasury "STRIPS"

The best answer is C. Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. Since all of the choices have the same maturity, this is not a factor. "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher total payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. STRIPS are zero-coupon Treasury obligations - these have the highest level of purchasing power risk.

Which investment gives the greatest protection against purchasing power risk? A. 10 year Double Barreled Bonds B. 10 year Guaranteed Bonds C. 10 year TIPS D. 10 year STRIPS

The best answer is B. Moody's rates municipal anticipation notes under the "MIG" (Moody's Investment Grade) ratings scale, with MIG 1 and MIG 2 being investment grades; and the non-investment grades being MIG 3 and SG ("Speculative Grade").

Which of the following Moody's MIG ratings are considered investment grade? I MIG 1 II MIG 2 III MIG 3 IV SG A. I only B. I and II C. II and III D. I, II, III, IV

The best answer is A. If a municipality wishes to raise its debt limit, the voters must approve via a public referendum. In effect, the voters are approving an increase in their taxes when they approve such a measure.

Which of the following actions must be taken if a municipality wishes to raise its debt limit? A. Public referendum B. Court order C. Judicial edict D. Tax assessment

The best answer is C. A quote offered out "firm" means that the selling dealer will not change the price for the time period specified. During this time period, the buying dealer has control over the bonds and can sell the bonds before actually purchasing them.

Which of the following are TRUE regarding municipal bonds offered out "firm" by one dealer to another? I The buying dealer is able to renegotiate the price II The buying dealer can sell the bonds before actually purchasing them III The selling dealer will not change the price for a specified time period IV The buying dealer has control over the bonds for a specified time period A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is C. As interest rates fall, discount bonds will appreciate at a faster rate than will premium bonds. The change in value of the bond's price is a result of an increased "present value" of the remaining interest payments to be received. This increase in the "value" of the remaining interest payments is a larger percentage of a discount bond's price than of a premium bond's price. Thus, as interest rates drop, discount bond prices rise faster than premium bond prices. Similarly, as interest rates rise, discount bond prices fall faster than premium bond prices. If a bond is trading at a discount, it can indicate that interest rates have risen after the issuance of the bond. One reason why bonds trade at a discount is because the interest rate that the bond is paying is less than the "market" rate of interest. A bond may be trading at a discount because the issuer's credit rating has slipped, forcing prices down and subsequently, yields up. Bonds trading at a premium are most likely to be called. An issuer calls debt when interest rates have fallen so it can refund at a lower interest cost.

Which of the following are TRUE statements about discount bonds? I Discount bonds will appreciate more rapidly as interest rates fall than will similar premium bonds II A bond trading at a discount can indicate that market interest rates have risen III A bond trading at a discount can indicate that the issuer's credit rating has deteriorated IV Bonds trading at a discount are more likely to be called than bonds trading at a premium A. I and IV only B. II and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Fannie Mae was "spun off" by the government as a public company listed on the NYSE (so was Freddie Mac). Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets. Ginnie Mae obligations trade at lower yields than Fannie Mae obligations since Ginnie Maes are directly backed by the U.S. Government whereas Fannie Maes are only implicitly backed. Ginnie Mae is still a government (not a private) agency and cannot be spun off because of the guarantee of the U.S. Government that its securities carry. All other Agencies have the indirect backing of the U.S. Government.

Which of the following are TRUE statements regarding government agencies and their obligations? I Fannie Mae is a publicly traded company II Ginnie Mae obligations trade at lower yields than Fannie Mae obligations III Federal agency obligations have the direct backing of the U.S. Government IV Ginnie Mae securities are directly backed by the U.S. Government A. I only B. II and IV only C. I, II, IV D. I, II, III, IV

The best answer is C. In order to issue revenue bonds, a feasibility study must be prepared and it must show adequate net revenues ("earnings") to service the debt before the bonds can be floated. A revenue bond can be double barreled to improve its safety by additionally backing the issue with the ad valorem taxing power of the issuer. Yields on revenue bonds are higher than that of comparable G.O. bonds because of generally higher risk. Revenue bonds are suitable for investors willing to take on low, medium or high risk. To evaluate credit risk on these issues, look at Moody's or Standard and Poor's ratings.

Which of the following are TRUE statements regarding revenue bonds? I Yields for revenue bond issues are generally higher than yields for comparable G.O. issues II Revenue bonds are only suitable for investors willing to assume a high level of risk III The bonds may be double barreled with backing by ad valorem taxes IV Issuance of the bonds is dependent on earnings requirements A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

The best answer is C. The dated date has no bearing on the calculation of the purchase price of a municipal bond. It is the date of issuance of the bonds, from which time interest will be paid. The other items are necessary to calculate the purchase price in a municipal bond transaction. To find the price, one must use the coupon rate, yield to maturity, and years to maturity. The settlement date is necessary to compute the amount of accrued interest that is due.

Which of the following are necessary to calculate the total purchase price for a bond quoted on a yield basis in a municipal bond transaction? I Yield to maturity II Coupon rate III Settlement date IV Dated date A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Market discount bonds are simply bonds trading at a discount in the secondary market because either interest rates have risen; or the credit quality of that issue has deteriorated. These bonds are meeting their interest payments and trade with accrued interest. Defaulted bonds trade flat; zero coupon bonds trade flat (since no interest payments are made); and adjustment (income) bonds trade flat since interest is only paid if the issuer earns enough income to service the debt. Otherwise, the issuer is not obligated to pay.

Which of the following bonds trade "flat"? I Defaulted bonds II Market discount bonds III Adjustment (income) bonds IV Zero coupon bonds A. I only B. II and IV C. I, III, IV D. I, II, III, IV

The best answer is C. A secured bondholder has a lien on a specific asset of the company - such as equipment (an equipment trust certificate), real property (a mortgage bond) or securities given as collateral (a collateral trust certificate). A debenture is a promise to pay without any liens on corporate assets.

Which of the following corporate bonds are secured? I Collateral trust certificate II Subordinated debenture III Second mortgage bond IV Equipment trust certificate A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

The best answer is B. The Federal Reserve designates a dealer as a "primary" dealer - meaning one entitled to trade with the Federal Reserve trading desk. There are about 20 primary dealers (such as Cantor Fitzgerald, Nomura Securities, Citibank, Goldman Sachs, Royal Bank of Scotland, etc.) The rest of the government dealers are termed "secondary" dealers. They do not enjoy a special relationship with the Federal Reserve.

Which of the following designates "primary" U.S. Government securities dealers? A. Securities and Exchange Commission B. Federal Reserve C. Office of the Comptroller of Currency D. Congress

The best answer is C. Treasury "STRIPS" are bonds which have been stripped of coupons - essentially they are zero coupon Treasury obligations. The rate of return on the bonds is "locked in" at purchase since the discount represents the compounded yield to be earned over the life of the bond. Because no interest payments are received, the bond is not subject to reinvestment risk - the risk that interest rates will drop and the interest payments will be reinvested at lower rates.

Which of the following investments gives a rate of return that cannot be affected by "reinvestment risk"? A. Treasury Notes B. Treasury Stock C. Treasury Strips D. Treasury Bonds

The best answer is A. Treasury Notes are government obligations maturing between 1 year and 10 years which pay interest semi-annually.

Which of the following investments is issued with a stated coupon rate and with a maximum maturity of 10 years? A. Treasury Notes B. Treasury Stock C. Treasury Strips D. Treasury Bonds

The best answer is D. The books and records covenant is the promise to maintain proper recordkeeping of accounts.

Which of the following is a promise by the issuer to maintain proper recordkeeping of accounts? A. Defeasance covenant B. Maintenance covenant C. Segregation of funds covenant D. Books and records covenant

The best answer is D. The basic truths about bond price movements caused by changes in market interest rates are: 1. The longer the maturity, the greater the price will move for a given change in interest rates. 2. The deeper the discount on the bond (caused by the coupon being lower than the market rate of interest), the greater the price will move for a given change in interest rates. Choice D is both a very long maturity, and a relatively low coupon compared to current interest rates (the basis is the fairest representation of current market rates for that type of issue), so it would be trading at the deepest discount. While Choice A has an even lower coupon, its very short maturity would reduce the bond's potential price drop as market interest rates rise. This is true because the essential truth is that this short maturity bond must be worth par at redemption in just a few years, so its price cannot drop very much below this level.

Which of the following municipal bonds should be trading at the lowest dollar price? A. 4.80 coupon; 7.10 basis; M '20 B. 6.80 coupon; 8.30 basis; M '30 C. 7.20 coupon; 6.50 basis; M '35 D. 6.00 coupon; 8.60 basis; M '40

The best answer is A. Bonds that are not making interest payments trade flat (without accrued interest). In this category are defaulted bonds and zero-coupon bonds. Moral obligation bonds and general obligation bonds trade with accrued interest - these make interest payments twice per year (unless they default!)

Which of the following municipal bonds will trade "flat" ? I Defaulted bonds II Zero-coupon bonds III Moral obligation Bonds IV General obligation bonds A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is B. Commercial paper is rated P1, P2, P3, NP (highest to lowest) by Moody's. P stands for prime. NP means "not prime" and is the lowest rating. The "ABC" ratings are used for long term corporate and municipal bonds. The MIG ratings are used for municipal short term notes.

Which of the following ratings applies to commercial paper? A. MIG 1 B. P3 C. Bb D. A+

The best answer is C. Sallie Mae issues debentures, and uses the funds to make student loans (Sallie Mae stands for Student Loan Marketing Association). Only mortgage backed pass-through certificates are used as the backing for CMOs - and Ginnie Mae (Government National Mortgage Assn.), Fannie Mae (Federal National Mortgage Assn.), and Freddie Mac (Federal Home Loan Mortgage Corp.) all issue pass-throughs.

Which of the following securities would be used as "collateral" for a collateralized mortgage obligation? I "Ginnie Maes" II "Fannie Maes" III "Sallie Maes" IV "Freddie Macs" A. I only B. II and III C. I, II, IV D. I, II, III, IV

The best answer is B. Fannie Mae performs the same functions as Ginnie Mae except that its pass through certificates are not guaranteed by the U.S. Government; and it has been "sold off" as a public company. Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets.

Which of the following statements are TRUE about the Federal National Mortgage Association (FNMA)? I FNMA is a publicly traded corporation II FNMA is owned by the U.S. Government III FNMA pass through certificates are guaranteed by the U.S. Government IV FNMA pass through certificates are not guaranteed by the U.S. Government A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Federal Farm Credit Banks Funding Corporation does not issue pass-through certificates. Interest received gets the same tax treatment as Treasury issues. Interest on Federal Farm Credit issues is subject to federal income tax but exempt from state and local tax.

Which of the following statements are TRUE about the taxation of interest on securities issued by the Federal Farm Credit Banks Funding Corporation? I Interest is exempt from state and local taxes II Interest is subject to state and local taxes III Interest is exempt from Federal tax IV Interest is subject to Federal tax A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. "Plain vanilla" CMOs are relatively simple - as payments are received from the underlying mortgages, interest is paid pro-rata to all tranches; but principal repayments are paid sequentially to the first, then second, then third tranche, etc. Thus, the earlier tranches are retired first. A newer version of a CMO has a more sophisticated scheme for allocating cash flows. Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a "Planned Amortization Class." Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments made earlier than that required to retire the PAC at its maturity are applied to the Companion class; while principal repayments made later than expected are applied to the PAC maturity before payments are made to the Companion class. Thus, the PAC class is given a more certain maturity date; while the Companion class has a higher level of prepayment risk if interest rates fall; and a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.

Which of the following statements are TRUE regarding CMO "Planned Amortization Classes" (PAC tranches)? I PAC tranches reduce prepayment risk to holders of that tranche II PAC tranches increase prepayment risk to holders of that tranche III Principal repayments made earlier than expected are applied to the PAC prior to being applied to the Companion tranche IV Principal repayments made later than expected are applied to the PAC prior to being applied to the Companion tranche A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Most CMOs make payments to holders monthly; though there are some issues that pay quarterly or semi-annually. CMOs are subject to a lower degree of prepayment risk than the underlying pass-through certificates. During periods of falling interest rates, prepayments of mortgages in a pool are applied pro-rata to all holders of pass-through certificates. CMOs divide the cash flows into "tranches" of varying maturities; and apply prepayments sequentially to the tranches in order of maturity. Thus, prepayments are applied to earlier tranches first, so the actual date of repayment of the tranche is known with more certainty. CMOs receive the same credit rating (AAA or AA) as the underlying mortgage backed pass-through certificates held in trust. CMOs are available in $1,000 denominations, as opposed to pass-through certificates that are $25,000 denominations. This makes CMOs more accessible to small investors.

Which of the following statements are TRUE regarding CMOs? I CMOs make payments to holders monthly II CMOs receive the same credit rating as the underlying pass-through securities held in trust III CMOs are subject to a lower level of prepayment risk than the underlying pass-through certificates IV CMOs are available in $1,000 denominations A. II, III, IV B. I, II, IV C. I, III, IV D. I, II, III, IV

The best answer is A. When interest rates rise, homeowners do not refinance their mortgages, and the prepayment rate will be lower than expected. Thus, the average life of pass-through certificates that represent ownership of that mortgage pool will lengthen; as will the average life of CMO tranches which are derived from those certificates (though not to the same extent). Thus, when interest rates rise, prepayment risk is decreased. On the other hand, extension risk is increased. Extension risk is the risk that the maturity will be longer than expected - during which longer period, the holder receives a lower than market rate of interest. When interest rates fall, homeowners do refinance their mortgages, and the prepayment rate will be higher than expected. Thus, the average life of pass-through certificates that represent ownership of that mortgage pool will shorten; as will the average life of CMO tranches which are derived from those certificates (though not to the same extent). Thus, when interest rates fall, prepayment risk is increased. On the other hand, extension risk is decreased.

Which of the following statements are TRUE regarding CMOs? I When interest rates rise, maturities will lengthen II When interest rates fall, maturities will shorten III When interest rates rise, holders are subject to prepayment risk IV When interest rates fall, holders are subject to extension risk A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is B. GNMA certificates are quoted on a percentage of par basis in 32nds. Accrued interest on "agency" securities is computed on a 30 day month / 360 day year basis. (Do not confuse this with the accrued interest on U.S. Government obligations, which is computed on an actual day month / actual day year basis).

Which of the following statements are TRUE regarding GNMA "Pass Through" Certificates? I The certificates are quoted on a percentage of par basis II The certificates are quoted on a yield basis III Accrued interest on the certificates is computed on an actual day month / actual day year basis IV Accrued interest on the certificates is computed on a 30 day month / 360 day year basis A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Marketability risk is the risk that a security will be difficult to sell. The easiest securities to trade are "round lots" of actively traded issues. For example, a round lot of stock is 100 shares; a round lot of bonds is 5 bonds. Large blocks are more difficult to market; and it is more difficult to sell thinly traded securities than actively traded securities.

Which of the following will increase the marketability risk of a bond? I Active trading in that security II Inactive trading in that security III Round lot size transaction amount IV Large block size transaction amount A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. If a bond has a put option at par, the holder can always exercise the put and "put" the bond back to the issuer, receiving 100% of par for that bond. Thus, as market interest rates rise, this bond's price will not fall, because it must always be worth par. Thus, such a bond is not susceptible to market risk. The yield on such a bond with a 5% coupon rate cannot rise above this level, because the price will not fall below par. However, the yield can drop below this level, because if interest rates fall, the bond's price will go to a premium and the put option would be worthless.

Which of the following statements are TRUE regarding a 5% municipal bond purchased at par that has a put option at par? I The yield on the bond can fall below 5% II The put would be exercised if interest rates rise III The holder can receive 100% of par for the bond if he or she exercises the put option IV The investor can exercise the put at his or her discretion A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is A. In an advance refunding, the issuer floats a new bond issue and uses the proceeds to "retire" outstanding bonds that have not yet matured. These funds are deposited to an escrow account and are used to buy U.S. Government securities. The escrowed Government securities become the pledged revenue source backing the refunded bonds. These bonds no longer have claim to the original revenue source. Since there is a new source of backing for the bonds (and an extremely safe one!), the credit rating on the pre-refunded bonds increases, as does their marketability. The refunded bonds no longer have any claim to the original pledged revenues - and thus have been "defeased" - that is, removed as a liability of the issuer. Municipal securities are not used for escrow in a prerefunding because they earn a lower rate of interest (since they are Federally tax-free) than Governments.

Which of the following statements are TRUE regarding a municipal bond issue that is advance refunded? I The marketability of the advance refunded bonds will increase II The issuer redeems an old bond issue by advancing funds from the U.S. Government for this purpose III The funds to pay debt service requirements are deposited to an escrow account and used to buy U.S. Government securities IV The funds to pay debt service requirements are deposited to an escrow account and used to buy Municipal securities A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. When convertible bonds are issued, it is normal for the conversion price to be set at a premium to the current market price. Assume that a convertible bond is issued with a conversion price of $40 when the market price of the common is $30. Thus, the market price must rise to the conversion price before the conversion feature has any value. If the market price rises above the conversion price, then the conversion feature has "intrinsic value." For example, if the conversion price is set at $40 and the market price rises to $50 per share, there is $10 per share of "intrinsic value." Once the stock's market price moves above the conversion price, for every dollar that the stock price now moves, the bond will move by an equivalent amount as well. The securities are termed "equivalent." For the conversion feature to be worth something, the stock's price must move up in the market after issuance. Due to the value of the conversion feature (or rather, the potential value if the stock price goes up), convertible bonds are saleable at lower yields than bonds without the conversion feature.

Which of the following statements are TRUE regarding convertible bond issues? I At the time of issuance, the conversion price is set at a premium to the stock's current market price II When the stock price is at a premium to the conversion price, the conversion feature has intrinsic value. III For the conversion feature to have value, the stock's price must move up in the market after issuance IV Convertible bonds usually have lower yields than bonds without the conversion feature A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

The best answer is C. Corporations issue income bonds (also known as adjustment bonds) in times of corporate distress. These bonds obligate the issuer to pay only if the issuer has sufficient income. Municipalities issue revenue bonds, which pledge the revenues from a facility (such as a bridge or tunnel) to pay for the debt service on the bond issue.

Which of the following statements are TRUE regarding debt obligations? I Corporations issue revenue bonds II Municipalities issue revenue bonds III Corporations issue income bonds IV Municipalities issue income bonds A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. If interest rates drop, it is more likely that an issuer will call its bonds. As interest rates drop, bond prices in the market will rise. The price will not rise by as much for a callable issue as that for a non-callable issue. The reason: why would someone pay a premium for an issue that is likely to be called off the market? The price for a puttable bond sets a floor under the market price of the bond during periods of rising interest rates. The price will never drop much below par once the option is exercisable, because if it did, customers would buy as many of the bonds as possible and "put" them to the issuer at par for a capital gain.

Which of the following statements are TRUE regarding the effect of market interest rate movements on callable and puttable bond prices? I When interest rates fall, the call price tends to set a ceiling on the market price of the bond II When interest rates fall, the call price tends to set a floor on the market price of the bond III When interest rates rise, the put price tends to set a ceiling on the market price of the bond IV When interest rates rise, the put price tends to set a floor on the market price of the bond A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. The government obligation trading market is the deepest and most active market in the world. Trading is performed by both the primary and secondary dealers, and by the Federal Reserve trading desk. While long term government and agency securities are quoted in 32nds, T-Bills are quoted on a discount yield basis. The market is unregulated - these are exempt securities under the Securities laws, however the Federal Reserve does exert influence over the primary dealers.

Which of the following statements are TRUE regarding the trading of government and agency bonds? I The trading market is very active, with narrow spreads II Trading is confined to the primary dealers III All government and agency securities are quoted in 32nds IV The market is regulated by the Securities and Exchange Commission A. I only B. I, II C. II, III D. I, II, III, IV

The best answer is B. Credit risk is the risk that a bond will default. To evaluate this risk for a revenue bond issue, one would examine coverage ratios; the effect of competing facilities; and the management of the facility. Legislative actions have no bearing on credit risk. Potential effects of adverse legislative actions would be evaluated as legislative risk.

Which of the following would NOT be considered when evaluating the credit risk of a municipal revenue bond? A. Coverage ratios B. Legislative actions C. Competing facilities D. Management experience

The best answer is C. The government obligation trading market is the deepest and most active market in the world. Trading is performed by both the primary and secondary dealers, and by the Federal Reserve trading desk. While long term government and agency securities are quoted in 32nds, T-Bills are quoted on a discount yield basis. The market is unregulated - these are exempt securities under the Securities laws, however the Federal Reserve does exert influence over the primary dealers. Trading of Government and agency obligations does not take place on the New York Stock Exchange. Almost the entire debt market (Treasuries, Corporates, Municipals) takes place over-the-counter.

Which of the following statements are TRUE regarding the trading of government and agency bonds? I Trading is performed by primary and secondary dealers II Trading is performed by the Federal Reserve III The trading market is active IV Trading takes place on the New York Stock Exchange A. I and III only B. II and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Interest payments on CMOs are made pro-rata to all tranches, but principal repayments that are made earlier than the PAC maturity are made to the Companion classes before being applied to the PAC (this would occur if interest rates drop); while principal repayments made later than anticipated are applied to the PAC maturity before payments are made to the Companion class (this would occur if interest rates rise). Thus, the PAC is given a more certain repayment date; while the CMO is given the least certain repayment date.

Which of the following statements are TRUE when comparing CMO PAC tranches to Companion tranches? I Principal repayments made earlier than expected are applied to the PAC before being applied to the Companion class II Principal repayments made earlier than expected are applied to the Companion class before being applied to the PAC III Principal repayments made later than expected are applied to the PAC before being applied to the Companion class IV Principal repayments made later than expected are applied to the Companion class before being applied to the PAC A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Both bonds and preferred stock are "Senior" securities over common. Payments to bondholders are a legal obligation of the issuer. They are not a discretionary decision on the part of the Board of Directors, as is the decision to pay a dividend to preferred and common shareholders.

Which of the following statements are TRUE when comparing bonds and preferred stock? I Payments to bondholders are subject to approval of the Board of Directors II Payments to preferred stockholders are subject to approval of the Board of Directors III Bonds are considered senior securities over common stock in a corporate dissolution IV Preferred stock is considered to be a senior security over common stock in a corporate dissolution A. I and III only B. II and IV only C. II, III, IV D. I, II, III, IV

The best answer is C. Municipal broker's brokers act as agents for institutional clients, helping to buy or sell large blocks of municipal bonds. However, they do not trade for their own accounts, nor do they take inventory positions.

Which of the following statements best describe the activities of a municipal securities broker's broker? I Municipal broker's brokers assist institutions that wish to buy blocks of municipal bonds II Municipal broker's brokers assist institutions that wish to sell blocks of municipal bonds III Municipal broker's brokers act as agents for their clients IV Municipal broker's brokers trade for their own accounts A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Freddie Mac - Federal Home Loan Mortgage Corporation - buys conventional mortgages from financial institutions and packages them into pass through certificates. This agency has been partially sold off to the public as a corporation that was listed on the NYSE. Freddie is now bankrupt due to excessive purchases of bad "sub prime" mortgages and has been placed in government conservatorship. Its shares have been delisted from the NYSE and now trade OTC in the Pink OTC Markets. Freddie Mac buys conventional mortgages from financial institutions and packages them into pass through certificates. These pass through certificates are not guaranteed by the U.S. Government (unlike GNMA pass through certificates).

Which of the following statements describe Freddie Mac? I Freddie Mac buys conventional mortgages from financial institutions II Freddie Mac is an issuer of mortgage backed pass-through certificates III Freddie Mac is a corporation that is publicly traded IV Freddie Mac debt issues are directly guaranteed by the U.S. Government A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Original issue discount obligations (i.e. T-Bills) trade "flat" - without accrued interest. Every day the issue is held, its value increases towards the redemption price of par. This increase in value is the interest income earned on the obligation. Obligations issued at par make periodic interest payments. They trade "and interest" - with accrued interest. These include Treasury Notes, Treasury Bonds, and Municipal Bonds.

Which of the following trade "and interest" ? I Treasury Bills II Treasury Notes III Treasury Bonds IV Municipal Bonds A. I only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is C. Corporate and municipal bond trades settle in clearing house funds. These are funds payable at a registered clearing house, which are usually not good funds for three business days. These trades are settled through NSCC - the National Securities Clearing Corporation. U.S. Government and agency bond trades settle in Federal Funds, which are good funds the business day of the funds transfer (next business day for regular way settlement of government securities). Ginnie Mae Pass-Through certificates are U.S. Government guaranteed, so trades settle in Fed Funds. These trades are settled through GSCC - the Government Securities Clearing Corporation.

Which of the following trades settle in "Fed" funds? I General Obligation Bonds II U.S. Government Bonds III Agency Bonds A. I only B. I and II C. II and III D. I, II, III

The best answer is A. Corporate and municipal bond trades settle in clearing house funds. These are funds payable at a registered clearing house, which are usually not good funds for three business days. These trades are settled through NSCC - the National Securities Clearing Corporation. U.S. Government and agency bond trades settle in Federal Funds, which are good funds the business day of the funds transfer (next business day for regular way settlement of government securities). Ginnie Mae Pass-Through certificates are U.S. Government guaranteed, so trades settle in Fed Funds. These trades are settled through GSCC - the Government Securities Clearing Corporation.

Which of the following trades settle in "clearing house" funds? I General Obligation Bonds II U.S. Government Bonds III Agency Bonds IV GNMA Pass-Through Certificates A. I only B. I and II C. II and IV D. III and IV

The best answer is C. Pension funds and retirement accounts are the large purchasers of STRIPS. These zero-coupon bonds are purchased at a deep discount and are held to maturity to fund future retirement liabilities. There is little credit risk, because the U.S. Treasury is a top credit. There is no current income because they don't pay until maturity. They have a huge amount of purchasing power risk as a long-term zero coupon obligation, but this is not an issue if they are held to maturity. Retirement plan managers like STRIPS because they don't have to worry about reinvestment risk - there are no semi-annual interest payments to reinvest! It is an investment that can be "tucked away" for 20 or 30 years, with no further work or worry on the part of the retirement fund manager.

Which of the following would NOT purchase STRIPS? I Pension fund II Money market fund III Individual seeking current income IV Individual wishing to avoid reinvestment risk A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. U.S. Government bonds are quoted on a percentage of par basis in 32nds. 105-20 = 105 20/32nds = 105.625% of $1,000 par = $1,056.25 per bond. Choice C is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 105 5/8 = 105.625% of $1,000 par = $1,056.25 per bond. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.

Which of the following would be a quote for a U.S. Government bond? A. 105.625 B. 105-20 C. 105 5/8 D. 105 10/16

The best answer is C. An airline bond is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 105 5/8 = 105.625% of $1,000 par = $1,056.25 per bond. Choice B is a U.S. Government bond quote in 32nds. 105-20 = 105 20/32nds = 105.625% of $1,000 par = $1,056.25 per bond. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.

Which of the following would be a quote for an airline bond? A. 105.625 B. 105-20 C. 105 5/8 D. 105 10/16

The best answer is C. Credit risk is the risk that the bond will default. To evaluate this risk for a revenue bond issue, one would examine coverage ratios; the effect of competing facilities; and the management of the facility. Collection ratios are only used to analyze G.O. bonds. The collection ratio shows the percentage of property taxes assessed that are actually collected by the municipality.

Which of the following would be considered when evaluating the credit risk of a municipal revenue bond? I Management experience II The effect of competing facilities III Coverage ratios IV Collection ratios A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Net Bonded Debt of a municipal issuer includes all bonded debt except for self supporting revenue bonds. This is the debt that must be serviced from tax collections. Self supporting revenue bonds pay their own way and are not paid from tax collections. Non-self supporting revenue bonds (for example, a double barreled revenue bond that is payable from revenues and taxing power if necessary) are included in Net Bonded Debt. Also note that partially self supporting general obligation bonds are GO bonds issued on behalf of an enterprise system, such as a health care facility, where debt service is paid by revenues of the system and a GO pledge - another double-barreled bond. Moody's and Standard & Poor's include partially self supporting general obligation bonds in net bonded debt. Note, however, if the general obligation bond is fully self supporting it would be excluded from net bonded debt.

Which of the following would be included in the Net Bonded Debt of a municipal issuer? I Partially self supporting general obligation bonds II Non-self supporting general obligation bonds III Self supporting revenue bonds IV Non-self supporting revenue bonds A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is D. An ascending yield curve is a normal curve - short term yields are normally lower than long term yields. Choice D describes an ascending curve. If there is an increase in demand for long term bonds, then long term bond prices rise and their yields fall. This can cause their yields to fall below short term rates - an inverted yield curve - making Choice A wrong. If the Federal Reserve is pursuing a tight money policy, this will raise short term rates (the Fed exerts its influence at the short end of the yield curve). Again, this can cause the curve to invert - making Choice C wrong. Finally, a "laddered" bond portfolio is one that has maturities staggered at roughly even intervals - say 5, 10, 15, 20, 25 and 30 years out. Thus, every 5 years, bonds are maturing and if rates have been rising, the proceeds are reinvested at higher current rates. This gives some protection to the value of the portfolio in a period of rising interest rates. Because purchases are being made at even intervals across the yield curve, laddering should not distort the shape of the yield curve - making Choice B wrong.

Which of the following would cause the yield curve to be ascending? A. An increase in demand for long term bonds from investors B. An increase in the laddering of bond portfolios by investors C. The Federal Reserve pursuing a tight monetary policy D. Short term yields declining at the same time as long term yields are increasing

The best answer is C. A bond trades flat (without accrued interest) when the issuer has defaulted on the interest payments, or if the issue is an income bond or a zero coupon bond. Therefore, a current bondholder receives no interest on bonds that trade flat. When such a bond is traded, no accrued interest is paid from buyer to seller - so the trade is being done at a "flat" amount without any accrued interest added to the price.

Which statement BEST describes a bond which is trading "flat"? The bond is trading: A. at par B. with accrued interest C. without accrued interest D. at a fixed dollar price

The best answer is C. CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.

Which statement is FALSE about CMBs? A. CMBs are used to smooth out cash flow B. CMBs are sold at a discount to par C. CMBs are sold at a regular weekly auction D. CMBs are direct obligations of the U.S. government

The best answer is A. A PO is a Principal Only tranche. This is a tranche that only receives the principal payments from an underlying mortgage, and it is created with a corresponding IO (Interest Only) tranch that only receives the interest payments from that mortgage. The principal portion of a fixed rate mortgage makes smaller payments in the early years, and larger payments in the later years. Because of this payment structure, it is most similar to a long-term bond, which pays principal at the end of its life. These are issued at a deep discount to face. Its price moves just like a conventional long term deep discount bond. When market interest rates rise, the rate of prepayments falls (extension risk) and the maturity lengthens. Because the principal is being paid back at a later date, the price falls. Conversely, when market interest rates fall, the rate of prepayments rises (prepayment risk) and the maturity shortens. Because the principal is being paid back at an earlier date, the price rises.

Which statement is TRUE about PO tranches? A. When interest rates rise, the price of the tranche falls B. When interest rates rise, the price of the tranche rises C. When interest rates rise, the interest rate on the tranche falls D. When interest rates rise, the interest rate on the tranche rises

The best answer is C. A Targeted Amortization Class (TAC) is a variant of a PAC. A PAC offers protection against both prepayment risk (prepayments go to the Companion class first) and extension risk (later than expected payments are applied to the PAC before payments are made to the Companion class). A TAC bond protects against prepayment risk; but does not offer the same degree of protection against extension risk. A TAC bond is designed to pay a "target" amount of principal each month. If prepayments increase, they are made to the Companion class first. However, if prepayment rates slow, the TAC absorbs the available cash flow, and goes in arrears for the balance. Thus, average life of the TAC is extended until the arrears is paid. Therefore, both PACs and TACs provide "call protection" against prepayments during period of falling interest rates. TACs do not offer the same degree of protection against "extension risk" as do PACs during periods of rising interest rates - hence their prices will be more volatile during such periods.

Which statement is TRUE about a Targeted Amortization Class (TAC)? A. A TAC is a variant of a PAC that has a higher degree of prepayment risk B. A TAC is a variant of a PAC that has a lower degree of prepayment risk C. A TAC is a variant of a PAC that has a higher degree of extension risk D. A TAC is a variant of a PAC that has a lower degree of extension risk

The best answer is A. Long term bond prices are more volatile than short term bond prices as interest rates move. Thus, short term bond prices are more stable (move more slowly) as interest rates change compared to long maturities.

Which statement is TRUE about bond price changes that result from interest rate movements? A. Short term bond prices move slower than long term bond prices B. Long term bond prices move slower than short term bond prices C. Both short term and long term prices move at equivalent rates D. No relationship exists between short term and long term bond price movements

The best answer is C. A municipal dealer can trade without physically having the position. If a dealer is requesting bids (that is, the dealer wishes to sell bonds), the dealer must simply intend to deliver those bonds by settlement. There is no requirement that the dealer must have the bonds, or must have purchased the bonds, prior to soliciting bids. There is also no requirement that the dealer accept the first bid received. The dealer will accept the highest bid received (if the bid amount is acceptable).

Which statement is TRUE regarding a municipal trader that requests bids for bonds in the marketplace? A. The dealer must be long the bonds in inventory before any bids can be accepted B. The dealer must have effected a purchase transaction in the bonds before the bids can be requested C. The dealer must intend to deliver the bonds by settlement date if a bid is accepted D. The dealer must accept the first bid that is made for the bonds

The best answer is B. If the principal amount of a Treasury Inflation Protection Security is adjusted upwards due to inflation, the adjustment amount is taxable in that year as ordinary interest income. Conversely, if the principal amount of a Treasury Inflation Protection Security is adjusted downwards due to deflation, the adjustment is tax deductible in that year against ordinary interest income. (TIPS are usually purchased in tax qualified retirement plans that are tax-deferred. This avoids having to pay tax each year on the upwards principal adjustment.)

Which statement is TRUE regarding the tax treatment of the annual adjustment to the principal amount of a Treasury Inflation Protection Security? A. An annual upward adjustment due to inflation is taxable in that year; an annual downward adjustment due to deflation is not tax deductible in that year. B. An annual upward adjustment due to inflation is taxable in that year; an annual downward adjustment due to deflation is tax deductible in that year. C. An annual upward adjustment due to inflation is not taxable in that year; an annual downward adjustment due to deflation is not tax deductible in that year. D. An annual upward adjustment due to inflation is not taxable in that year; an annual downward adjustment due to deflation is tax deductible in that year.

The best answer is D. All of the statements are true. Bloomberg is published electronically every day, and lists dealer offerings of municipal bonds in the secondary market. All quotes are "firm;" nominal (approximate) quotes cannot be given unless it is clearly stated that the quote is nominal. Quotes can be for any amount (any "size") of bonds; it is not required that they be for round lots only. The MSRB requires that all quotes that are disseminated be "bona fide." This means that, at the time that the quote was placed, the firm giving the quote is willing to trade at that price for the size quoted. However, all quotes are subject to prior sale or change in price.

Which statements are TRUE about Bloomberg? I Bloomberg is published daily II Bloomberg lists dealer offerings of municipal bonds in the secondary market III Bloomberg shows quotes for any size IV Bloomberg quotes are subject to prior sale or change in price A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is B. Treasury Notes are government obligations maturing between 1 year and 10 years which pay interest semi-annually. Treasury STRIPS are notes or bonds "stripped" of coupons, meaning all that is left is the principal repayment portion of the note or bond (sometimes called the "corpus" or body). STRIPS are zero coupon original issue discount obligations that do not have a stated interest rate. The accretion of the discount over the bond's life represents the interest earned.

Which statements are TRUE when comparing Treasury Notes to Treasury STRIPS? I Treasury Notes pay interest semi-annually II Treasury Notes pay interest at maturity III Treasury STRIPS pay interest semi-annually IV Treasury STRIPS pay interest at maturity A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. An IO is an Interest Only tranche. This is a tranche that only receives the interest payments from an underlying mortgage, and it is created with a corresponding PO (Principal Only) tranche that only receives the principal payments from that mortgage. The interest portion of a fixed rate mortgage makes larger payments in the early years, and smaller payments in the later years. These are issued at a discount to face and each interest payment made brings the "notional principal" of the bond closer to par. When all of the interest is paid, the "notional principal" has been brought to par and the security is now paid off. The price movements of IOs are counterintuitive! Unlike regular bonds, where when interest rates rise, prices fall, with an IO, when interest rates rise, prices rise! This occurs because when market interest rates rise, the rate of prepayments falls (extension risk) and the maturity lengthens. Because interest will now be paid for a longer than expected period, the price rises. Conversely, when interest rates fall (prepayment risk) the principal is being paid back at an earlier than expected date, so less interest is being received and the price falls (if interest rates fall drastically, the holder might get less interest back than what was originally invested).

Which statements are TRUE about IO tranches? I Payments are larger in the early years II Payments are smaller in the early years III Payments are larger in the later years IV Payments are smaller in the later years A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A PO is a Principal Only tranche. This is a tranche that only receives the principal payments from an underlying mortgage, and it is created with a corresponding IO (Interest Only) tranche that only receives the interest payments from that mortgage. The principal portion of a fixed rate mortgage makes smaller payments in the early years, and larger payments in the later years. Because of this payment structure, it is most similar to a long-term bond, which pays principal at the end of its life. These are issued at a deep discount to face. Its price moves just like a conventional long term deep discount bond. When market interest rates rise, the rate of prepayments falls (extension risk) and the maturity lenghtens. Because the principal is being paid back at a later date, the price falls. Conversely, when market interest rates fall, the rate of prepayments rises (prepayment risk) and the maturity shortens. Because the principal is being paid back at an earlier date, the price rises.

Which statements are TRUE about PO tranches? I Payments are larger in the early years II Payments are smaller in the early years III Payments are larger in the later years IV Payments are smaller in the later years A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. As municipalities reached their debt limits with G.O. bond issuance, they found it harder and harder to get voter approval to raise limits to sell additional G.O. bonds (think of Proposition 13 in California that capped property taxes to almost no increase unless the property was sold). To get around this, the COP - Certificate of Participation - was invented and COP issuance is now greater than G.O. bond issuance in many states. A COP is issued by a state entity where lease revenues are pledged to back the issue. The lease payments are received from a project such as a university dormitory, prison, municipal office building, municipal transit system, etc. The "difference" is that the lease payment is made based on the governing body making an annual appropriation from tax collections, and it is not "legally" obligated to do so, hence it is not really a bond. Rather, it is a security that gives the holder a share of "revenue" if the appropriation is made (which it will be, otherwise that issuer's credit rating would be trashed). COP issuance has increased greatly over the years because they are easier to issue than G.O. debt (no pesky debt limits or voter approval to deal with) - but they are sold at a slightly higher yield, because they have more credit risk.

Which statements are TRUE about a Certificate of Participation (COP)? I COPs are considered to be a general obligation of the issuer II COPs are considered to be backed by a revenue pledge III Payments to security holders are contingent on the governing body making an annual appropriation from budgeted funds IV Payments to security holders are not contingent on the governing body making an annual appropriation from budgeted funds A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The most common maturity for commercial paper is 30 days. The maximum maturity is 270 days.

Which statements are TRUE about commercial paper? I The most common maturity is 30 days II The most common maturity is 270 days III The maximum maturity is 30 days IV The maximum maturity is 270 days A. I and III B. I and IV StatusC C. II and III StatusD D. II and IV

The best answer is C. Homeowners will prepay mortgages when interest rates fall, so they can refinance at more attractive lower current rates. They tend not to prepay mortgages when interest rates rise, since there is no benefit to a refinancing. The main reason for prepayments when interest rates have risen is that the homeowner has moved, and the house was sold.

Which statements are TRUE about prepayment experience on collateralized mortgage obligations? I When interest rates rise, prepayment rates rise II When interest rates rise, prepayment rates fall III When interest rates fall, prepayment rates rise IV When interest rates fall, prepayment rates fall A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. In periods of deflation, the principal amount is adjusted downwards. Even though the interest rate is fixed, the holder receives a lower interest payment, due to the decreased principal amount. In this case, when the bond matures, the holder receives par - not the decreased principal amount.

Which statements are TRUE regarding Treasury Inflation Protection securities? I In periods of deflation, the amount of each interest payment will decline II In periods of deflation, the amount of each interest payment is unchanged III In periods of deflation, the principal amount received at maturity will decline below par IV In periods of deflation, the principal amount received at maturity is unchanged at par A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. A Z-tranch is a "zero" tranche that receives no payments, either interest or principal, until all other tranches before it are paid off. It acts like a long-term zero coupon bond.

Which statements are TRUE regarding Z-tranches? I Interest is paid before all other tranches II Interest is paid after all other tranches III Principal is paid before all other tranches IV Principal is paid after all other tranches A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The actual dollar price of a bond is computed by taking the yearly income stream and principal repayment at maturity and discounting it back to today's "present value" based on the current market interest rate. Most of the value of the bond comes not from the yearly interest payments, but rather from the final payment when the principal ($1,000 par) is being returned. From a present value standpoint, if a bond has a long maturity, the present value of the final principal payment is greatly affected by interest rate movements, since many years of compounding are applied to get the present value of the last $1,000 payment. On the other hand, if the bond has a short maturity, the present value of the final $1,000 principal payment is not affected much at all by market interest rate movements, because the basic truth is that the bond will be redeemed shortly at par, so the value of the payment cannot vary much from par.

Which statements are TRUE? I Most of the value of a bond is established by the present value of the first payment II Most of the value of a bond is established by the present value of the last payment III The longer the maturity of a bond, the greater the bond's price volatility IV The shorter the maturity of a bond, the greater the bond's price volatility A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The purchase on Wednesday, October 12th will settle on Monday, October 17th - 3 business days after trade date. Accrued interest on corporate bonds is based on a 30 day month / 360 day year. And interest starts accruing from the morning of the last interest payment, up to, but not including, settlement. So, 30 days are due for July, 30 days for August, 30 days for September, and 16 days for October (up to but not including settlement) = 106 days total.

XYZ Debentures Issue Date: 8-1-XX Payment Dates: J 1 & J 1 Maturity Date: 7-1-XX Some years after issuance, a customer buys 10 debentures in a regular way trade on Wednesday, October 12th. The customer will owe the seller: A. 103 days of accrued interest B. 105 days of accrued interest C. 106 days of accrued interest D. 107 days of accrued interest

The best answer is D. All of the statements are true regarding yield curve analysis. The curve shows market expectations for interest rates. Because it shows all the rates for all maturities, investors can compare rates against differing maturities. The yield curve is an average for securities of a given risk class. An investor can compare the yield on a specific security to the curve for the risk class to evaluate the attractiveness of that investment. If there is a great demand for a specific maturity, the price will be pushed up and the yield lowered. One can pick this out in a yield curve since the curve would drop for that specific maturity.

Yield curve analysis is useful for an investor in debt securities because: I the curve shows market expectations for interest rates II investors can compare rates of return relative to changing maturities III the yield of a specific security can be compared to the market expectation for similar securities IV the curve can show relative demand for differing maturities by comparing the change in yield to the change in maturity A. I, II only B. II, III only C. I, III, IV D. I, II, III, IV

The best answer is B. If Treasury bill yields are dropping at auction, then interest rates are falling and debt prices must be rising.

Yields on 3 month Treasury bills have declined to 1.84% from 2.21% at the prior week's Treasury auction. This indicates that: A. Treasury bill prices are falling B. market interest rates are falling C. demand for Treasury bills is weakening D. the Federal Reserve may have to loosen credit

The best answer is C. Zero-coupon bonds do not make semi-annual interest payments, therefore they trade "flat" - that is, without accrued interest. The term "and interest" means trading with accrued interest.

Zero-coupon bonds trade: A. and interest B. with accrued interest C. flat D. at par