Mastery EXAM I Debt
Payments to holders of Ginnie Mae pass-through certificates: I are made monthly II are made semi-annually III represent a payment of both interest and principal IV represent a payment of only interest A I and III B I and IV C II and III D II and IV
The best answer is A. All pass through certificates pass on the monthly mortgage payments received from the pooled mortgages to the certificate holders. Thus, payments are received monthly. These represent a payment of both interest and principal on the underlying mortgages.
When comparing an ETN to a structured product, which statement is TRUE? A ETNs can be traded at any time while structured products cannot B ETNs offer current income while structured products do not C ETN income is taxable at higher rates than income from structured products D ETNs are equity securities that are exchange listed
The best answer is A. An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. They are not an equity security - they are a debt instrument. ETNs are listed on an exchange and trade, so they have minimal liquidity risk. In comparison, a regular structured product is non-negotiable and, if redeemed prior to maturity, imposes an early-redemption penalty. ETNs make no interest or dividend payments. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to other structured debt products.
What constitutes a failed auction for an Auction Rate Security? I Lack of bids II Lack of offers III Clearing rate below bid rate IV Clearing rate above bid rate A I and III B I and IV C II and III D II and IV
The best answer is A. Auction Rate Securities are either preferred stock or bonds that have the dividend rate or interest rate reset at a weekly auction. In order to have a successful auction for anything, there must be bidders (buyers) for the securities offered. A lack of bids (or no bids) will result in no auction, making Choice I correct. The auction is conducted as a "Dutch Auction," where bids are accepted in minimum $25,000 increments to buy the amount of securities offered. The bids are accepted from the lowest interest rate on up to the highest interest rate, and bids are accepted until the total amount offered is sold. The highest interest rate bid that is accepted to complete the sale of the issue is called the "clearing rate" and the entire offering gets this interest rate for the next week. Note that there is usually a maximum interest rate set on bids (otherwise, the issuer could be forced to pay exorbitant interest rates if the only bids received were at excessively high interest rates). If the interest rate bids received are at or below the maximum rate, then the auction is carried out as a Dutch Auction. If the interest rate bids are above the maximum rate (this implies that the issuer's perceived credit quality has deteriorated or that market conditions are excessively volatile and buyers are demanding much higher interest rates), then the auction has "failed" and the sellers (holders) of the securities will carry the positions to the next week, during which they will receive the maximum interest rate on those securities. Then another auction will be attempted. Thus, the risk for the holder of an ARS is not that interest will not be earned; rather it is that the holder may be forced to continue to hold the security when that customer really wants to dispose of the position. This occurs when there is either a lack or bids; or the bids received are at interest rates that are higher than the maximum or clearing rate (which is the same as saying that the clearing rate is below the interest rate bid).
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 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).
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. Which of the following statements are TRUE regarding these T-Notes? I Interest accrues on an actual day month; actual day year basis II Interest accrues on a 30 day month / 360 day basis III The trade will settle in Fed Funds IV The trade will settle in Clearing House Funds A I and III B I and IV C II and III D II and IV
The best answer is A. Government bond accrued interest is computed on an actual month/actual year basis. Trades settle through the Federal Reserve system in "Fed Funds."
The purchaser of a CMO tranche experiences extension risk during periods when interest rates: A rise B fall C are stable D are volatile
The best answer is A. 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.
A corporation has issued $1,000 par, 8 1/2% convertible bonds, callable at 105. The bonds are convertible into common stock at $50 per share. Currently, the bond is trading at 104 while the common stock is trading at $52. The corporation calls the bonds at 105 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 convert the bonds into common and sell the common stock when the common shares are received from the transfer agent D continue to hold the bonds and ignore the call
The best answer is A. If the bonds are tendered at the call price, the owner receives $1,050 per bond. If the bonds are sold at the current market price of 104, the owner receives $1,040 per bond. Converting the bonds into common means that the bonds must be tendered to the transfer agent, who will cancel the bonds and issue 20 shares of stock for each bond tendered. Since each share is now worth $52, this would yield 20 x $52 = $1,040 if those shares are sold right now. The only problem with this is it takes about 30 days for the transfer agent to do this, so the shares cannot be sold "right now." In 30 days, who knows where the share price will be? (Note that if the question gave the answer that the customer should short the stock at $52, tender the bonds, and then when the shares arrive, deliver them to cover the short position, the customer would earn the same $1,040 per bond as in Choice B.) 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!
Mandatory redemption provisions of a municipal bond contract may be met by: I making periodic deposits to a segregated account (sinking fund) II advance refunding the issue III making a tender offer for outstanding bonds A I only B I and III C II and III D I, II, III
The best answer is A. Mandatory redemption provisions can only be met by depositing the required funds to the sinking fund. Once these monies are deposited, the issuer must use them to retire bonds as specified in the bond contract. The bonds may be retired by calling in bonds or by purchasing bonds in the open market. The issuer will buy the bonds in the open market if the price is lower than the call price including any premiums. Advance refunding an issue or making a tender offer do not satisfy mandatory redemption provisions.
Which of the following information would be found in a municipal bond resolution? I Any restrictive covenants to which the issuer must adhere II Any call provisions providing for redemption prior to maturity as specified in the contract III The credit rating assigned to the issue by a nationally recognized ratings agencyI V The compensation received by the underwriters for selling the issue to the public A I and II only B III and IV only C I, II, III D I, II, III, IV
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 credit rating is given by the ratings agencies (e.g., Moody's or Standard and Poor's); and is found in their publications. The underwriter's compensation is disclosed to investors in new negotiated municipal bond offerings in the Official Statement (the disclosure document, similar to a prospectus, for new municipal issues).
The yield curve shows the yields of: A different maturities of the same type of security B different types of securities with the same maturity C different risk classes of securities with the same maturity D different maturities of securities with different risk classes
The best answer is A. The yield curve compares the yields of all maturities for the same type of security (e.g., the yields for all maturities of U.S. Government securities; the yields for all maturities of AAA rated corporate securities, etc.)
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 bonds are issued at par in minimum denominations of $100 each, and pay interest semi-annually. At maturity, the bondholder receives par.
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 rate of inflation will lead to lower interest rates. If interest rates drop, then bond prices will rise.
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 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".
The money that a bank has in excess of its reserves is called: A clearing house funds B federal funds C money market funds D available funds
The best answer is B. Any funds that a federal reserve member bank has in excess of its required reserves are called "Federal Funds." These are the funds that the bank has available for lending.
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 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.
5,000,000 10% convertible Subordinated Debentures Convertible at $10.50 per share 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 above parity to the current market price of the bond IV The common stock is trading below parity to the current 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 B. 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.
All of the following statements are true regarding Eurodollar bonds EXCEPT: A U.S. issuers of Eurodollar bonds are not subject to foreign currency risk B Eurodollar bond issues are sold all over the world, including the United States C Non-U.S. issuers of Eurodollar bonds are subject to foreign currency risk D Eurodollar bonds are denominated in U.S. currency only
The best answer is B. Eurodollar bond issues are sold overseas (in Europe), but pay in U.S. Dollars. They are not registered with the SEC and thus, are not sold in the United States. Multinational U.S. issuers tap the Eurodollar bond market if interest rates are lower in this market than those available in the U.S. Foreign issuers may also sell Eurodollar issues. For U.S. issuers, there is no currency exchange risk, since payments are made in U.S. dollars. However, foreign issuers are exposed to currency risk, since they must convert their currency into U.S. dollars to make payments on Eurodollar issues.
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 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.)
In 2022, a customer buys 5 GM 10% debentures, M '42. 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 2031 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 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.
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. 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.
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. 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.
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 B. New issues of municipal notes are available only in "book entry" form. The same is true for new issues of municipal bonds.
A customer buys 10 ABC Corporation 10% debentures, M '45, at 93 on Tuesday, May 10th in a regular way trade. The interest payment dates are March 1st and September 1st. The trade settles on: A Wednesday, May 11th B Thursday, May 12th C Friday, May 13th D Monday, May 16th
The best answer is B. Regular way trades of corporate bonds and stocks settle 2 business days after trade date.
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, 2022. The first payment will be made on January 1, 2023. A bondholder purchases the issue at the offering. The interest starts accruing from: A January 2022 B June 2022 C July 2022 D January 2023
The best answer is B. Since the issue is dated June 1st, 2022, interest starts accruing from this date until the first interest payment is made on January 1st, 2023 (odd first interest payment). From this date forward, regular semi-annual interest payments will be made on January 1st and July 1st.
Reports of corporate bond trades are made to: I TRACE II RTRS III within 10 seconds of execution IV as soon as practicable but no later than 15 minutes after execution A I and III B I and IV C II and III D II and IV
The best answer is B. 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.
All of the following securities are eligible for trading by the Federal Reserve EXCEPT: A Treasury Bills B Bond Anticipation Notes C U.S. Government Bonds D Federal Home Loan Bank Bonds
The best answer is B. The Federal Reserve trading desk can trade securities issued by the U.S. Government, Government Agencies, and prime Banker's Acceptances. Bond Anticipation Notes are municipal issues. They are not eligible for Fed trading.
A corporation has issued 7% 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 7% 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 B. The bond was issued with a coupon of 7%. Currently, the yield for a similar issue is 8%. Therefore, interest rates have risen subsequent to the issuance of the bond; or the credit quality of the bond has deteriorated. When interest rates rise, yields on bonds already trading must also rise. What causes this is a drop in the dollar price of the issue - the bond now trades at a discount.
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. 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.
In 2022, a customer buys 1 ABC 10%, $1,000 par debenture, M '37, 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 B. The nominal yield is the stated rate of interest on the bond, based on par value. Annual Int/ Par = Nominal Yield
Eurodollars are: A European currencies held on deposit in the branches of domestic banks located in the United States B European currencies held on deposit in offshore branches of United States banks C U.S. dollar deposits held in foreign branches of U.S. banks or foreign banks D U.S. dollar deposits held in domestic branches of foreign banks
The best answer is C. Eurodollars are U.S. dollar deposits held in foreign branches of U.S. banks or foreign banks. Eurodollar deposits are used to finance international trade.
Which of the following agencies issuing mortgage backed pass through certificates is (are) restricted to purchasing conventional mortgages that are not VA or FHA insured? I Fannie Mae II Ginnie Mae III Freddie Mac A I only B II only C III only D I, II, III
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 was partially sold off to the public as a corporation that was listed on the NYSE. Fannie Mae (Federal National Mortgage Association) buys FHA and VA insured mortgages from financial institutions and packages them into pass through certificates. This agency was sold off to the public as a corporation that was listed on the NYSE. Both Fannie and Freddie are now bankrupt due to excessive purchases of bad "sub prime" mortgages and have been placed in government conservatorship. Their shares have been delisted from the NYSE and now trade OTC in the Pink OTC Markets. Ginnie Mae (Government National Mortgage Association) performs the same function as Fannie Mae except that its pass through certificates are guaranteed by the U.S. Government. It remains an agency of the government and cannot be "sold off" as a public company as long as the government continues to guarantee its securities.
General obligation bond analysis would consider all of the following EXCEPT the: A record of tax collections B ratio of total debt per capita C protective covenants in the trust indenture D trend of assessed valuation of property
The best answer is C. G.O. bonds are typically issued without a trust indenture. 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.
In a repurchase agreement, the initiating government securities dealer: I buys securities from another dealer II sells securities to another dealer III agrees to buy back the securities at a later date IV agrees to sell the securities at a later date A I and III B I and IV C II and III D II and IV
The best answer is C. In a repurchase agreement, the initiating government securities dealer "sells" securities to another dealer to obtain cash, with an agreement to buy them back at a later date.
If a corporation reports a loss for a year, it is obligated to make interest payments on which of the following bonds? I Income bonds II Equipment trust certificates III Non-callable bonds IV Non-convertible bonds A I and II only B III and IV only C II, III, IV D I, II, III, IV
The best answer is C. Income bonds, also known as adjustment bonds, pay interest only if the corporation hits a predetermined level of earnings. If the income level is not sufficient, there is no obligation to make the interest payment. On all other corporate bonds - whether they be equipment trust certificates, mortgage bonds, debentures, etc. interest must legally be paid. Conversion and call features have no effect on the obligation to pay.
The primary reason that services such as Moody's and Standard and Poor's provide bond ratings is to: A measure marketability risk of different issues B compare yields of different issues C measure default risk of different issues D compare bond risks to those of equity issues
The best answer is C. Ratings services such as Moody's measure default risk of debt issues. They only rate bonds, so no comparisons can be made with equity issues. They do not measure yields, nor marketability risk.
Trades of all of the following securities will settle in Fed Funds EXCEPT: A Treasury Bills B Treasury Notes C Municipal Bonds D Agency Bonds
The best answer is C. Securities that are eligible to be traded by the Federal Reserve are those backed by the guarantee of the U.S. Government as well as certain agency obligations. Both Treasury Bills and Treasury Notes are eligible securities. Trades in eligible securities settle through the Federal Reserve system, and therefore settle in "Fed Funds." Municipal bond trades and trades in corporate securities are not eligible for trading and settling through the Federal Reserve system; these securities settle in "clearing house" funds.
Which statements are TRUE regarding the Federal Funds rate? I The rate is computed every business day II The rate is lower than the discount rate III The rate is set by the Federal Reserve IV The rate is charged from one Federal Reserve member bank to another member bank A I and III only B II and IV only C I, II and IV D I, II, III, IV
The best answer is C. The Federal Funds rate is the interest rate charged by Federal Reserve member banks for overnight loans to each other. It is computed every day and can change throughout the day. It is lower than the discount rate since the Fed usually pegs the Discount rate at 100 basis points over the Fed Funds rate. The discount rate is charged by the Federal Reserve itself to member banks that wish to borrow reserves directly from the Fed. Federal Reserve actions such as Open Market Operations strongly influence the Federal Funds rate, but the Fed itself does not set this rate.
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 C. The U.S. Government issues Treasury Bonds (and Treasury Bills and Notes) in book entry form, in minimum denominations of $100.
A municipal dealer who wishes to buy bonds has received a quote which is "out firm for 1/2 hour with a 5 minute recall." This means that the: I buying dealer can buy the bonds at the stated price during the next half hour II selling dealer can call during the next half hour and demand a purchase decision be made in the next 5 minutes III buying dealer is free to sell the bonds before actually making the purchase IV buying dealer can renegotiate the price during the next half hour, but the deal can be canceled by giving 5 minutes' notice A I and III B II and IV C I, II, III D I, II, IV
The best answer is C. The buying dealer has been given a firm quote, good for 1/2 hour. During this time, the buying dealer is free to sell the bonds before making the actual purchase, since he has been guaranteed a firm price. The "5 minute recall" means that the selling dealer can call at any time during the 1/2 hour and demand that a decision to buy be made within 5 minutes, or the quote is invalid.
Interest income received from a GNMA Pass-Through Certificate is: A taxed the same as for Treasury obligations B taxed the same as for Municipal obligations C taxed the same as for corporate obligations D exempt from all taxes
The best answer is C. Unlike Treasury obligations and regular agency debt, where interest income is subject to federal income tax, but is exempt from state and local tax, interest income from mortgage backed securities is subject to both federal and state income tax. This is the law because the interest payments made on the underlying mortgages are deductible to the homeowner making the mortgage payments at both the federal and state level, therefore the recipient of these payments should be taxed at both the federal and state level. Note that interest income from corporate bonds is also taxable at both the federal and state level, so interest income from mortgage backed pass through securities is taxed in the same manner.
Which of the following statements are TRUE regarding corporate zero coupon bonds? I The rate of return for zero coupon bonds is subject to reinvestment risk II The rate of return for zero coupon bonds is not subject to reinvestment risk III The interest income from such obligations is taxable annually IV The interest income from such obligations is not taxable until maturity A I and III B I and IV C II and III D II and IV
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. 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.
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 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.
Which of the following is a double barreled bond? A Turnpike revenue bond backed by collected tolls and rents from food and service station concessionaires B School bond issue backed by full faith and credit and unlimited ad valorem taxing power C Airport authority bond based by landing fees and terminal lease fees D Convention center bond backed by user fees and unlimited ad valorem taxing power
The best answer is D. A double barreled bond is a revenue bond that is additionally backed by the municipality's ad valorem taxing power. They are issued when the projected net revenues available for debt service are not sufficient for the issue to get a top credit rating. To get a top rating, the issuer can additionally back the bond with its property taxing power (ad valorem taxes), reducing the interest rate on the issue. Of course, if the project's revenues turn out to be insufficient, the municipality is on the hook to make the debt service payments from property tax collections.
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 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.
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 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.
All of the following statements are true regarding municipal bonds that have been called EXCEPT: A interest ceases to accrue on the bonds B the call price sets a ceiling on the market price of the bonds C the holder may redeem the bonds at anytime D the bonds will continue to trade "and interest"
The best answer is D. If a bond issue is called, interest ceases to accrue as of the date specified in the call. Thus, the bond will now trade "flat" - that is, without accrued interest. The call price will set a ceiling on the market price of the bond. Meaning, the market price of the bond will never go above the call price; if it did and the bonds were called, investors would suffer a loss. The bond can be tendered anytime thereafter, at which point the bondholder will be paid par value plus any specified call premium. The call price would not set the floor on the market price of the bonds as the market could go below the call price (which could occur if market interest rates started to rise).
Non-interest bearing securities are quoted based on: A 1/8ths B 1/16ths C 1/32nds D yield basis
The best answer is D. Securities that don't make periodic interest payments, such as Treasury Bills, are quoted on a yield basis.
Bonds sls High Low Last Chg Coleco 11s22f 44 21 1/4 18 20 -2
The best answer is D. The Coleco bonds closed this day at 20, down 2 from the preceding trading day. Therefore, yesterday the bonds closed 2 points higher at 22.
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 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.
A customer buys 5M of 3 1/4% Treasury Bonds at 99-31. The current yield of the Treasury Bond is: A 3.25% B 3.50% C 3.75% D 4.00%
The customer buys the bonds at 99 and 31/32s = 99.96875% of $1,000 = $999.6875 (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