Debt
Which of the following are considered to be creditors of a corporation? A Convertible Bondholders B Preferred Shareholders C Common Shareholders D Warrant Holders
The best answer is A. 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. Warrant holders have a long term option to buy the stock. Warrants are considered equity-related securities, but they have neither an equity nor creditor stake in the corporation.
A bond issue where every bond has the same issue date, interest rate, and maturity 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 A. A term bond issue is one where every bond has the same issue date, interest rate and maturity. Corporate issues and U.S. Government bond issues are typically term bonds.
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 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.
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 A. Bonds quoted on a percentage of par basis are term bonds. Municipal bonds quoted in basis points (yield quotes) are serial bonds.
1 basis point equals: A .01% B .1% C 1% D 10%
The best answer is A. One basis point equals .01% movement in interest rates.
Which bond will exhibit the greatest price volatility? A 10-year bond; 7% coupon; 8% yield; duration of 7.25 B 8-year bond; 0% coupon; 7% yield; duration of 8.00 C 4-year bond; 4% coupon; 3% yield; duration of 3.74 D 2-year bond; 2% coupon; 1% yield; duration of 1.97
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." An 8-year zero coupon bond will actually be more volatile in price movements than a slightly longer maturity bond (10 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 of the following would be a quote for a U.S. Government bond with a dollar price of $1,012.50? A 101.25 B 101-8 C 101 1/4 D 101 4/16
The best answer is B. U.S. Government bonds are quoted on a percentage of par basis in 32nds. 101-8 = 101 8/32nds = 101.25% of $1,000 par = $1,012.50 per bond. Choice C is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 101 1/4 = 101.25% of $1,000 par = $1,012.50 per bond. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.
Which statements are TRUE regarding market risk for bondholders? I As interest rates rise, the price of long term bonds falls faster than that of short term bonds II As interest rates rise, the price of short term bonds falls faster than that of long term bonds III To avoid market risk, a customer would invest in bonds with long term maturities IV To avoid market risk, a customer would invest in bonds with short term maturities
The best answer is B. Market risk for a bondholder is the risk of rising interest rates forcing the price of a bond to drop. As interest rates rise, the price of a long term bond falls faster than that of a short term bond. To avoid market risk, a bondholder would want to invest in the shortest maturity possible.
The price of which of the following bonds would be MOST affected by rising interest rates? I Low coupon bond II High coupon bond III Short maturity bond IV Long maturity bond A I and III B I and IV C II and III D II and IV
The best answer is B. The deeper the discount on a bond (the same as the lower the coupon rate), the greater the price will move for a given change in interest rates. The longer the maturity, the greater the price will move for a given change in interest rates.
The nominal yield of a bond will: A increase as bond prices fall B remain unchanged as bond prices fluctuate C increase as bond prices rise D decrease as bond prices rise
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.
Which of the following would be a quote for a manufacturing company bond? A 99.50 B 99-16 C 99 1/2 D 99 8/16
The best answer is C. A manufacturing company bond is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 99 1/2 = 99.50% of $1,000 par = $995.00 per bond. Choice B is a U.S. Government bond quote in 32nds. 99-16 = 99 16/32nds = 99.50% of $1,000 par = $995.00 per bond. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.
A bond's yield moves from 5.00% to 6.00%. The yield has increased by: A 1 point B 1 basis point C 100 basis points D 1,000 basis points
The best answer is C. Basis points measure yield change. 1 basis point is .01%, so 100 basis points is 1%. If a bond's yield has moved by 1 point (as in this example), this is the same as a 100 basis point move. Do not mix up basis points with price points. If a bond's price moves from, say, 95 to 96, this is a movement in price from 95% of $1,000 par ($950) to 96% of $1,000 par ($960). Thus, a 1 point price move on a bond is 1% of par value, which is a $10 move.
How are corporate bonds quoted? A Coupon B Yield to Maturity C Whole and Fractional D Decimal
The best answer is C. Corporate bonds are quoted as a percentage of par value, with each "whole" point movement representing 1% of $1,000 par or $10. The minimum price increment is 1/8th of 1%, so it is a fraction of par. Thus, corporate bonds are quoted in whole and fractional points. For example, a corporate bond quoted at 100 1/8 is priced at 100.125% of $1,000 par = $1,001.25.
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 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.
If interest rates rise dramatically, which investment would be LEAST adversely affected? A A discount bond with 5 years to maturity B A 7-year zero coupon bond C A premium bond with 5 years to maturity D A 9-year zero coupon bond
The best answer is C. If market interest rates rise, bond prices fall. Discount bonds fall faster than premium bonds; and long-term bond prices fall faster than short-term bond prices. Zero coupon bonds (which are the deepest discount bonds) with long maturities will fall the fastest of all. The only choice given that is not a discount bond is Choice C - a premium bond. Premium bonds have higher coupon rates, and this higher level of income coming in sooner softens the bond's fall in price as market interest rates rise.
A corporation has issued 10% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 8%. Which of the following are TRUE statements about the outstanding 10% issue? I The current yield will be higher than the nominal yield II The current yield will be lower than the nominal yield III The dollar price of the bond will be at a premium to par IV The dollar price of the bond will be at a discount to par A I and III B I and IV C II and III D II and IV
The best answer is C. The bond was issued with a coupon of 10%. Currently, the yield for a similar issue is 8%. Therefore, interest rates have dropped subsequent to the issuance of the bond; or the credit quality of the bond has improved. When interest rates drop, yields on bonds already trading must also drop. What causes this is a rise in the dollar price of the issue - the bond now trades at a premium.
Which bond will exhibit the greatest price volatility? A 2-year maturity bond with a 1% coupon B 4-year maturity bond with a 2% coupon C 7-year maturity bond with a 0% coupon D 8-year maturity bond with a 6% coupon
The best answer is C. The longer the expiration, the more volatile a bond's price movements, which narrows the Choices to either C or D. The lower the coupon, the more volatile the bond's price movements, with the lowest coupon being "0." A 7-year zero coupon bond will actually be more volatile in price movements than a slightly longer maturity bond (8 years) with a fairly high coupon (6% 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.
The nominal yield of a bond: A increases as bond market prices decline B decreases as bond market prices increase C is unaffected by changes in market interest rates D will vary with the earnings of the issuer
The best answer is C. 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.
In 2021, a customer buys 1 PDQ 10%, $1,000 par debenture, M '36, 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%
The best answer is C. The nominal yield is the stated rate of interest on the bond, based on par value. annual interest/par = nominal yield $100/$1,000 = 10%
When a bond increases in value due to market demand, this is termed: A amortization B accretion C appreciation D accumulation
The best answer is C. When an asset increases in value, this is termed appreciation.
