Series 65 Unit 1 Cont. Fixed Income (Debt Securities)

A bond, preferred stock, or debenture exchangeable at the option of the holder (for common stock of the issuing corporation) is a: A) convertible security. B) synthetic security. C) nondilutive stock. D) collateral-backed equity security.

Answer: A A bond, preferred stock, or debenture exchangeable at the option of the holder for common stock of the issuing corporation is a convertible security.

Which of the following are NOT considered money market instruments? I. American depositary receipts. II. Commercial paper. III. Corporate bonds. IV. Jumbo (negotiable) certificates of deposit. A) I and III. B) I and II. C) II and IV. D) III and IV.

Answer: A A money market instrument is a high-quality, short-term debt security with maturity of 1 year or less. American Depositary Receipts (ADRs) are equity, and corporate bonds are long-term debt instruments.

A client has indicated that his primary objective is maximizing current income regardless of the risk. Which of the following mutual funds would probably be most suitable for achieving that goal? A) DEF High Yield Bond Fund. B) ABC Growth and Income Fund. C) GHI Index Fund. D) JKL Municipal Bond Fund.

Answer: A High yield (junk) bonds, although carrying more risk, produce higher current income than other funds.

Partners with the U.S. in the creation of Brady Bonds were the: I. International Monetary Fund (IMF). II. Import/Export Bank. III. United Nations. IV. World Bank. A) I and IV. B) I and II. C) II and III. D) III and IV.

Answer: A Joining in with the United States in creating Brady Bonds were the IMF and the World Bank.

All of the following are money market instruments EXCEPT: A) newly issued Treasury notes. B) Treasury bills. C) jumbo (negotiable) CDs. D) commercial paper.

Answer: A Money market securities have a maximum maturity of 1 year. Treasury notes are issued with maturities of 2 to 10 years. Treasury bills are money market instruments with maturities of 52 weeks or less. Jumbo CDs are issued by banks and have maturities of 1 year or less. Commercial paper (issued by corporations) is unsecured short-term debt with maturities of 270 days or less.

The interest from which of the following bonds is exempt from federal income tax? I. State of California bonds. II. City of Anchorage bonds. III. Treasury bonds. IV. GNMA bonds. A) I and II. B) I and III. C) II and IV. D) III and IV.

Answer: A Municipal bonds are exempt from federal income tax. Treasury bonds are exempt from state tax but not federal tax. GNMAs are subject to federal, state, and local income tax.

All of the following are true of negotiable, jumbo certificates of deposit EXCEPT: A) they are secured obligations of the issuing bank. B) they are usually issued in denominations of $100,000 to $1 million. C) they are readily marketable. D) they usually have maturities of 1 year or less.

Answer: A Negotiable CDs are general obligations of the issuing bank; they are not secured by any specific asset. They do qualify for FDIC insurance (up to $250,000), but that is not the same as stating that the bank has pledged specific assets as collateral for the loan.

Which of the following would be reviewed in an effort to reduce a client's exposure to default risk of a debt security? A) S&P rating. B) Beta. C) Earnings history. D) Investment return compared to the inflation rate.

Answer: A Standard and Poor's and Moody's are both rating services that rate an issuer's bonds. These ratings give an investor an indication of likelihood that a company will be able to pay its debt service. To lower the investor's exposure to credit risk, you should raise the average rating in his portfolio.

If a convertible bond is purchased at its $1,000 par value and is convertible at $83.33 per common share, what is the conversion ratio of common shares per bond? A) 12 shares for each bond. B) 1.2 shares for each bond. C) 2 shares for each bond. D) 8 shares for each bond.

Answer: A The conversion ratio is determined by dividing the par value of the bond, or $1,000, by its conversion price of $83.33 per common share. This results in a conversion ratio of 12 shares for each bond.

When an investor notices that a bond's coupon yield is lower than its current yield, that is an indication that the bond: A) is selling at a discount. B) is selling at a premium. C) is in danger of going into default. D) is probably rated investment grade.

Answer: A The coupon yield, or nominal yield, is the rate stated on the face of the bond. It never changes. However, because the current yield is computed by dividing the coupon rate by the current market price, this return will constantly be in flux. Anytime the price of the bond is below par (selling at a discount), its current yield will be higher than the coupon.

An investor in the 25% federal income tax bracket is considering the purchase of some fixed-income instruments. Which of the following would provide the investor with the greatest after-tax return? A) 7% Ba rated corporate bond. B) 4.8% AAA rated insured municipal bond. C) 5% U.S. Treasury bond. D) 6% FDIC insured CD.

Answer: A The greatest after-tax return is provided by the instrument listed that, after subtracting 25% for income tax, leaves the investor with the greatest amount. Since the Treasury bond, the CD, and the corporate bond are all taxable at the same rate, the 7% bond must be the best deal. Even though the municipal bond is not taxed, its 4.8% net yield is far lower than the 5.25% ($70 − 25% tax) return on the corporate bond.

If a customer is in the 15% federal income tax bracket and his main investment objective is current income, which of the following securities should the agent recommend? A) Investment-grade corporate bond. B) U.S. government bond. C) City of Milwaukee GO bond. D) Zero-coupon bond.

Answer: A The investor is in a low-tax bracket, so the tax-exempt municipal bond is not a suitable investment. To maximize income, the best recommendation is the corporate bond which offers a higher yield than a government bond with a similar maturity.

While listening to a commentator on cable TV, you hear the statement, "the flight to quality has ended." What would you expect the effect of this to be? A) yield spreads are narrowing B) yield spreads are widening C) airline stocks are in for a beating D) pessimism is spreading

Answer: A The term yield spread refers to the difference in yield between very high quality debt instruments, such as US government bonds, and those with lower ratings. The spread compensates for the additional risk. When investors perceive that the risk has lessened, they won't demand as much in return from the lower rated instruments.

Rank the following from highest to lowest yield when a bond is trading at a premium. Current yield. Nominal yield. Basis or yield to maturity. A) II, I and III. B) I, II and III. C) I, III and II. D) III, II and I.

Answer: A Trading at a premium indicates that current interest rates are lower than when the bonds were issued. The nominal (coupon) yield is the highest, followed by the current (annual income) yield, then the yield to maturity (basis).

A client has a TIPS with a coupon rate of 3.5%. The inflation rate has been 4% for the last year. What is the inflation-adjusted return? A) 3.50%. B) -0.50%. C) 4.00%. D) 7.50%.

Answer: A Treasury Inflation Protected Securities (TIPS) adjust the principal value each 6 months to account for the inflation rate. Therefore, the real rate of return will always be the coupon.

To secure the debt that a subsidiary is offering, a railroad holding company transfers to a trustee the common stock of another subsidiary. The offering is one of: A) collateral trust certificates. B) guarantee trust bonds. C) equipment trust certificates. D) secured income notes.

Answer: A When a company uses the securities of one subsidiary to collateralize a bond issue of another subsidiary, the bonds are known as collateral trust certificates.

What happens to outstanding fixed-income securities when interest rates decline? A) Prices increase. B) Yields increase. C) Coupon rates increase. D) No change.

Answer: A When interest rates drop, prices will rise, decreasing effective yield. Thus, there is an inverse relationship between interest rates and bond prices.

A client in the 30% tax bracket owns a 5% XYZ, Inc., debenture due to mature shortly. What yield in a municipal will give him the same after-tax return that he now has with his debenture? A) 2%. B) 5.30%. C) 3.50%. D) 1.50%.

Answer: C The client's tax rate is 30%; 70% of 5% is 3.5%. A nontaxable municipal bond with a 3.5% yield would give the client the same return.

The type of municipal bond that is backed by the full taxing authority of the governmental unit that issued it is known as a: A) collateralized mortgage obligation. B) general obligation bond. C) revenue bond. D) collateral trust bond.

Answer: B A general obligation bond is backed by the full taxing authority of the municipality that issued it. A revenue bond depends on the income or revenue from a specific facility to ensure payment to bondholders. Collateral trust bonds and collateralized mortgage obligations are both types of secured bonds.

Treasury bills are: A) issued in bearer form. B) issued in book entry form. C) issued at par. D) callable.

Answer: B All Treasury securities are issued in book entry form. Treasury bills are always issued at a discount and are never callable.

The most common collateral securing a Brady Bond is A) an asset, or group of assets, pledged by the borrowing entity B) US Treasury zero-coupon bonds with a maturity corresponding to the maturity of the individual Brady bond C) the credit standing of the sovereign nation issuing the Brady Bond D) the credit standing of the banking institution acquiring the Brady Bond

Answer: B Although other securities may be pledged, the most common is zero-coupon US Treasuries, selected to mature at roughly the same time as the specific Brady Bond. An investor purchasing a Brady with collateralized principal knows that at maturity, a third-party paying agent will receive a payment from the US Treasury that will be used to repay the principal on the Brady issue. In the event of default, the bondholder will receive the principal collateral on the maturity date.

Bond prices are quoted as a percentage of: A) market value. B) par value. C) stated value. D) conversion value.

Answer: B Bond prices are quoted as a percentage of par value. On the exam, the par value of bonds is always $1,000.

In the event of a company's insolvency, which of the following has first claim on assets? A) Members of the board of directors. B) Bondholders. C) Preferred stockholders. D) Common stockholders.

Answer: B Bondholders have contractual rights to the assets of a business that must be honored on insolvency before claims of stockholders or directors.

In general, advantages to investing in Brady Bonds over those issued by countries classified as emerging economies are: I. Greater safety. II. Higher yields. III. Increased liquidity. IV. Shorter maturities. A) II and IV. B) I and III. C) I and II. D) II and III.

Answer: B Brady bonds are issued to take over the debt of failing commercial loans in emerging economies. They are secured by collateral, often US Treasury zero-coupon bonds thereby making them more secure than direct issues of that country. This backing also increases the liquidity as there is a larger pool of potential investors. These benefits cause the yields to be lower - less risk, less reward.

Which of the following is NOT a money market instrument? A) Banker's acceptances. B) Newly issued Treasury notes. C) Commercial paper. D) Treasury bills.

Answer: B Commercial paper, Treasury bills, and banker's acceptances are debt instruments with maturities of 1 year or less and are therefore money market instruments. A newly issued Treasury note would have a maturity of 2 to 10 years and therefore would not be a money market instrument.

Which of the following choices offers the highest tax-equivalent yield? A) 6% municipal bond to an individual in the 25% tax bracket. B) 5% municipal bond to a corporation in the 39% tax bracket. C) 4% municipal bond to an individual in the 35% tax bracket. D) 5.5% municipal bond to an individual in the 28% tax bracket.

Answer: B Corporations receive the same tax break on municipal bonds as do individuals. Therefore, receiving a 5% return in the 39% tax bracket is equivalent to 8.20% before tax. A 4% bond to someone in the 35% bracket is equivalent to 6.15%; a 5.5% coupon to someone in the 28% bracket is equivalent to 7.64%; and a 6% bond to someone in a 25% bracket is equivalent to 8.0%.

Six percent XYZ debentures are trading for $1,200. Other similarly rated bonds are being offered at 4.5%. What is the current yield on the 6% XYZ debentures? A) 7.50%. B) 5%. C) 1.50%. D) 6%.

Answer: B Current yield is defined as the annual income (or coupon rate) from a bond divided by the bond's current market price. Accordingly, $60 ÷ $1,200 = 0.05 × 100 = 5%. The current yield will be lower than the coupon rate when the bond is trading at a premium.

Although there are a number of risks to owning a debt security that are common to all investors, which specific risk is avoided when a U.S. resident purchases a Eurodollar bond? A) Default risk B) Currency risk C) Interest rate risk D) Inflation risk

Answer: B Eurodollar bonds are denominated in dollars; therefore, no currency risk exists for a U.S. resident.

An investor is considering the purchase of $100,000 maturity value of zero-coupon AAA rated corporate bonds scheduled to mature in 20 years. Among the risks that this investor will be assuming are I. Default risk. II. Interest rate risk. III. Pre-payment risk. IV. Reinvestment risk. A) III and IV. B) I and II. C) I and IV. D) II and III.

Answer: B Even though these bonds are rated AAA, 20 years is a long time and it is possible that this corporation may not even exist when the maturity date arrives. Adding to the risk is the fact that there are no interest payments in the interim. That is why the most commonly recommended zero-coupon bonds are those issued or guaranteed by the U.S. Treasury. Since zero-coupon bonds have the longest duration for their maturity of any bonds, they have the greatest exposure to interest rate changes. Pre-payment risk is only found with mortgage-backed securities and one of the benefits of zeroes is that there is no reinvestment risk.

Which two of the following investments would offer your clients the best chance of minimizing inflation risk? I. Common stock. II. Cumulative preferred stock. III. Money market mutual funds. IV. TIPS. A) III and IV. B) I and IV. C) I and II. D) II and III.

Answer: B Historically, common stock has been the best hedge against inflation. TIPS (Treasury Inflation Protection Securities) are Government guaranteed debt issues that automatically adjust the principal based upon the inflation rate.

Which of the following are characteristics of negotiable jumbo CDs? I. Issued in amounts of $100,000 to $1 million. II. Typically pay interest on a monthly basis. III. Always mature in 1 to 2 years with a prepayment penalty for early withdrawal. IV. Trade in the secondary market. A) II and IV. B) I and IV. C) I and III. D) II and III.

Answer: B Negotiable jumbo CDs are issued for $100,000 to $1 million and trade in the secondary market. Most jumbo CDs are issued with maturities of one year or less. Being negotiable, there is no prepayment penalty. These CDs generally pay interest on a semi-annual basis, not monthly.

If a client who holds a convertible preferred stock believes the company may go bankrupt within the next 3 years, what would you advise the client to do with the stock? A) Sell calls on the preferred stock. B) Sell the security. C) Immediately convert to common stock because the preferred dividends may no longer be paid. D) Buy puts on the common stock as a hedge.

Answer: B In the event of bankruptcy, all debt holders have priority over equity holders in claims on the assets of the corporation in liquidation. The safest alternative is to sell the stock. Buying puts on the underlying common stock would be an effective hedge, but with a 3-year wait, the position would have to be renewed several times as the usual option only has a life of 9 months; this would lead to increased transaction costs.

Which of the following is TRUE of GNMA securities? I. Interest is subject to federal income tax. II. Interest is exempt from federal income tax. III. They are backed by farm mortgages. IV. They are backed by residential mortgages. A) II and IV. B) I and IV. C) I and III. D) II and III.

Answer: B Income received by investors in Government National Mortgage Association (GNMA) securities is subject to both state and federal income tax, and the asset backing them is residential mortgages.

Mr. Beale buys 10M 6.6s of 10 at 67. What will his annual interest be? A) $1,000.00 B) $660.00 C) $670.00 D) $820.00

Answer: B Interpret "10M" as "$10,000 worth of." Mr. Beale receives the nominal yield of the bonds, which is 6.6% of $10,000.

A European corporation seeking a short-term loan would probably be most concerned about an increase to the: A) U.S. Treasury bill rate. B) LIBOR. C) Eurobond rate. D) FED funds rate.

Answer: B LIBOR stands for London Interbank Offered Rate and, for the rest of the world outside of the U.S., is the standard upon which short-term rates are based.

Money market instruments are: A) long-term debt. B) short-term debt. C) intermediate debt. D) long-term equity.

Answer: B Money market instruments are high-quality debt securities with maturities that do not exceed 1 year

One would look at the average maturities when doing a cash flow analysis for A) revenue bonds B) mortgage-backed pass-through securities C) Brady bonds D) subordinated debentures

Answer: B Mortgage-backed pass-through securities pass through interest and principal payments to their investors. The rate at which the cash flows are generated depends, among other things, on the rate at which the mortgages mature.

A category of bonds were created in the late 1980's in an attempt to "bail-out" defaulted commercial loans issued by banks from developing countries. These are commonly known as: A) Series BB Bonds. B) Brady Bonds. C) Greenspan Bonds. D) Resolution Trust Bonds.

Answer: B Named after U.S. Secretary of the Treasury Nicholas Brady, these bonds were created in 1989 to exchange defaulted commercial bank loans issued in less-developed countries, particularly Latin America.

Which of the following are characteristics of negotiable certificates of deposit? I. Minimum face value of $100,000. II. Maturities rarely extend beyond 360 days. III. May be sold on the secondary market. A) II and III. B) I, II and III. C) I and II. D) I and III.

Answer: B Negotiable certificates of deposit usually have a minimum face value of $100,000. It is rare to find one with a maturity that exceeds 360 days. Unlike nonnegotiable certificates of deposit, they may be bought and sold on the secondary market and have no prepayment penalties.

The DERP Corporation has an outstanding convertible bond issue with a conversion price of $125 per share. If the current market price of the bond is 80, the parity price of the stock is: A) $125 per share. B) $100 per share. C) $64 per share. D) $156.25 per share.

Answer: B Parity means equal. With a conversion price of $125, the bond is convertible into 8 shares (Par of $1,000 divided by $125). If the bond is currently selling for $800, then, to be of equal value (parity), the 8 shares must be selling at $100 each.

A client is in the 28% marginal federal income tax bracket, and the 3% state income tax bracket. Which of the following investments would produce the highest after-tax yield for the client? A) The answer cannot be determined using the information provided. B) Public purpose municipal bond yielding 6%. C) Federally backed Treasury note yielding 7%. D) AAA corporate bond yielding 7.75%.

Answer: B Since your client is in the 28% tax bracket, he has to earn more than the 6% on a taxable bond for the yield to be equal to, or higher than, the tax-free bond. That number can easily be calculated because 72% of the taxable amount must be equal to or greater than the 6% return (6% ÷ 72% = 8.33%). The 8.33% is higher than the return on the other bonds listed, so the public purpose municipal bond would produce the highest retained return. This would be even more appropriate if the issue was tax exempt in the client's state.

If a group of money managers were having a discussion and the term LIBOR was mentioned, the topic would most likely be: A) long-term borrowing rates. B) short-term borrowing rates. C) contract negotiations with the employee's union. D) current economic conditions in Liberia.

Answer: B The British Banker's Association LIBOR is the most widely used benchmark or reference rate for short-term interest rates world-wide. The acronym stands for London Interbank Offered Rate.

A TIPS bond is issued in the principal amount of $1,000, paying 3.5%. Over the security's 5-year term, the inflation rate is 4%. What is the amount of the final semiannual interest check? A) $42.66. B) $21.33. C) $17.50. D) $35.00.

Answer: B The semiannual interest of a TIPS bond is computed on the basis of the inflation-adjusted principal. Because the principal increases with the inflation rate, at the end of the 5-year term, it has grown to $1,219 ($1,000 × 102% ten times). Therefore, the final interest check is for $1,219 × 1.75% (remember it is a semiannual check).

Which of the following investments gives the investor the least exposure to reinvestment risk? A) Common stock in an electric utility. B) Treasury STRIPS/zero-coupon bonds. C) Treasury notes. D) Preferred stock in a growth company.

Answer: B Treasury STRIPS (Separate Trading of Registered Interest and Principal of Securities) are zero-coupon bonds paying no interest. Thus, there is no income to reinvest during the holding period and therefore no reinvestment risk.

Which of the statements below best describes why a normal yield curve is positively sloped? A) Stocks generally have lower yields than bonds, although their total returns may be higher. B) Investors demand higher interest when lending their money for longer periods. C) Investors logically demand higher returns from government securities than they do from corporate securities. D) Short-term bonds generally fluctuate in price more than long-term bonds.

Answer: B When the yield curve is positively sloped (and thus normal), long-term bonds carry higher interest rates than short-term bonds of the same quality.

A money market mutual fund would be least likely to invest in which of the following assets? A) Newly issued ​U.S. Treasury bills B) Bank certificates of deposit C) Newly issued ​U.S. Treasury notes D) Repurchase agreements

Answer: C A money market mutual fund typically invests in money market instruments; those with a maturity date not exceeding 397 days. Treasury notes are issued with maturity dates of 2-10 years.

One of the ways in which U.S. government agency issues differ from those offered directly by the U.S. Treasury is that: A) agency issues are more likely to be issued in larger amounts. B) agency issues are taxable on the federal level while Treasury issues are not. C) agency issues typically carry higher returns than Treasury issue because of the lack of direct government backing. D) agency issues frequently trade on the NYSE while Treasuries never do.

Answer: C Agencies, with only a very few exceptions, GNMA being one, do not carry the direct backing of the U.S. Treasury. While they are quite safe, that lack of direct backing causes their yields to be somewhat higher. Agencies are never traded on the stock exchanges and their float is almost always smaller than Treasuries. Both are taxable on the federal level.

Which of the following is not included in adjusted gross income on an individual's federal income tax return? A) Salary and commissions B) Unemployment compensation C) Municipal bond interest D) Dividends paid on preferred stock

Answer: C Although tax-exempt interest is reported on the Form 1040 (line 8b), it is not included in adjusted gross income.

Your client in the 35% federal income tax bracket currently owns some corporate bonds with a coupon yield of 7%. In order to receive the same income after taxes, he would need to buy municipal bonds with a coupon of: A) 2.45%. B) 9.45%. C) 4.55%. D) 7.00%.

Answer: C Because the 7% on the corporate bond is fully taxable, the client receives a net of 4.55% ($70 per bond less 35% in taxes {$24.50}, or $45.50 per year). Interest on municipal bonds is tax-free so a 4.55% coupon will result in the same amount of after tax income.

A bond selling for $20 above par would be quoted: A) 1,020.00 B) 1,200.00 C) 102 D) 120

Answer: C Bonds are quoted in percentages of $1,000 (par) (1% of $1,000 = $10). The proper quote would be 102; 102 is 102% of $1,000.

Your client with $100,000 to invest is looking for maximum current income. Which of the following would offer the highest current return? A) $200,000 of utility common stock paying a current dividend of 3.5%. B) $100,000 of zero-coupon bonds with a yield to maturity of 6%. C) $100,000 market value of corporate bonds selling at a premium and yielding 6% to maturity. D) $100,000 AA rated corporate bonds trading at par with a 6% coupon rate.

Answer: C Bonds selling at a premium have higher coupons than those selling at par. Therefore, the current yield on those bonds is higher than the ones at par, even though they would have the same yield to maturity. The zero-coupon bonds offer no current income and the investor only has $100,000 to invest so the utility stock is not a viable option.

Which of the following are characteristics of commercial paper? I. It represents a loan by the holder to the issuer. II. It is a certificate of ownership in the corporation. III. It is commonly issued to raise working capital for a corporation. IV. It is junior in preference to convertible preferred stock. A) II and III. B) II and IV. C) I and III. D) I and IV.

Answer: C Commercial paper instruments are debt securities; they represent loans to the issuing corporation by the holder. They are commonly issued to raise working capital and, as debt obligation, are senior in preference to preferred stock in claims against an issuer.

Which of the following are characteristics of commercial paper? I. Backed by money market deposits. II. Negotiated maturities and yields. III. Issued by insurance companies. IV. Not registered with the SEC. A) I and III. B) III and IV. C) II and IV. D) I and II.

Answer: C Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Both yield and maturity are open to negotiation. Because commercial paper is issued with maturities of no more than 270 days, it is exempt from registration under the Securities Act of 1933.

Which of the following statements regarding convertible bonds is NOT true? A) Coupon rates are usually lower than nonconvertible bond rates of the same issuer. B) If there is no advantage to converting the bonds into common stock, they would sell at a price based on their market value without the convertible feature. C) Coupon rates are usually higher than nonconvertible bond rates of the same issuer. D) Convertible bondholders are creditors of the corporation.

Answer: C Coupon rates are not higher; they are lower because of the value of the conversion feature. The bondholders are creditors. If the stock price falls, the conversion feature will not influence the bond's price.

The current yield of a callable bond selling at a premium is calculated: A) as a percentage of its call price. B) to its maturity date. C) as a percentage of its market value. D) as a percentage of its par value.

Answer: C Current yield for any security is always computed on the basis of the current market value.

Your client is interested in investing in preferred stocks in an effort to receive dividend income. The client's target goal is a 6% current return on investment (ROI). If the RIF Series B preferred stock is paying a quarterly dividend of $.53, your client's goal will be achieved if the RIF can be purchased at A) $22.55 B) $50.00 C) $35.33 D) $8.83

Answer: C First, take the quarterly dividend and annualize it (4 × $.53 = $2.12). Then, divide that number by 6% and you get $35.3333, which rounds down to $35.33. Or, if you wish, but it takes more time, multiply each of the choices by 6% to see which one equals $2.12.

Which of the following statements represents an advantage of a municipal general obligation bond over a revenue bond? A) A GO bond issuer is required to conduct a feasibility study. B) Only a facility's users pay for a GO bond. C) A GO bond generally involves less risk to the investor. D) A GO bond is not charged against the municipality's borrowing limits.

Answer: C GO bonds are generally less risky than revenue bonds because they are backed by taxes rather than revenues.

One of the advantages of owning a corporation's debentures is that you have prior claim over A) secured creditors B) employees C) preferred stockholders D) general creditors

Answer: C Holders of a company's debentures are general creditors and, as such, only have prior claim over equity holders.

A client is trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors are equal and your client is in a 28% marginal income tax bracket, which bond do you tell the client to purchase and why? A) The corporate bond because the after-tax yield is 4.5%. B) The corporate bond because the after-tax yield is 6.25%. C) The municipal bond because its equivalent taxable yield is 6.6%. D) The municipal bond because its equivalent taxable yield is 6.3%

Answer: C If we compute the tax equivalent yield of the muni, we see that it is 6.6%, which is a higher return than the 6.25% on the corporate bond. The formula to get this starts by taking the investor's tax bracket and subtracting that from 100%. 100% − 28% = 72%. We then divide the muni coupon of 4.75% by the 72% and the result rounds off to 6.6%.

A TIPS bond is issued in the principal amount of $1,000, paying 3.5%. Over the security's 5-year term, the inflation rate is 4%. What is the principal value of the bond at the end of 5 years? A) $1,200. B) $1,440. C) $1,219. D) $1,000.

Answer: C In addition to paying interest, a TIPS bond increases its principal value semiannually by the amount of inflation. If the inflation rate is 4% for 5 years, the principal value of the bond increases semiannually by that inflation rate. Allowing for compounding, the best choice would be the $1,219. This is computed by multiplying $1,000 by 102% 10 times.

If a customer buys 1 US Treasury 7-½% due Dec 2019 at 102, which of the following statements regarding this bond is TRUE? A) It has a nominal yield of less than 7-½%. B) Interest paid on it is subject to state and local taxes. C) Interest paid on it is subject to federal income tax. D) It has a yield to maturity of more than 7-½%.

Answer: C Interest earned on U.S. government obligations is subject to federal tax. This bond is trading at a premium ($1,020), so its yield to maturity is lower than the nominal yield of 7-½%. The nominal yield is the same as the coupon rate (7-½%). Interest on U.S. government obligations is exempt from state and local taxes.

A client of yours owns some convertible preferred stock. She notices an article in the business section of her local newspaper that reports the company is going to pay a 20% stock dividend on their common stock. She wants to know how this will affect her? A) she will also receive 20% more shares because preferred stock has a priority claim ahead of common. B) there will be no effect. C) if there is an anti-dilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend. D) more than likely, the price of the preferred stock will rise.

Answer: C Most convertible securities are sold with anti-dilutive clauses that provide for an adjustment in the number of shares based upon stock splits or stock dividends.

An investor owns a debenture convertible into 20 shares of the issuer's common stock. After a 2 for 1 stock split, the terms of the debenture provide for conversion into 40 shares. This is because the debenture has: A) increased its par value to $2,000 to account for the split. B) warrants attached. C) an anti-dilution clause. D) pre-emptive rights.

Answer: C Most convertible securities are sold with anti-dilutive clauses that provide for an adjustment in the number of shares based upon stock splits or stock dividends.

The minimum face amount of a negotiable CD is: A) $25,000.00 B) $50,000.00 C) $100,000.00 D) $10,000.00

Answer: C Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are traded in blocks of $1 million.

Which of the following agency securities is guaranteed by the U.S. government? A) Fannie Mae. B) Federal Home Loan Bank. C) Ginnie Mae. D) Freddie Mac.

Answer: C Only Ginnie Mae securities are backed by the full faith and credit of the U.S. government. Other agency securities have lines of credit at the Treasury, but this credit does not constitute a full guarantee.

When an investor owns a convertible security where, upon conversion, the account value would remain the same, it is considered that the convertible and the common are selling at: A) equivalent value. B) the nominal yield. C) parity. D) the arbitrage level.

Answer: C Parity means equal. When one could convert the security and realize the same value, it is said that both are at parity.

The DERP Corporation has an outstanding convertible bond issue that is convertible into 8 shares of stock. If the current market price of the bond is 80, the parity price of the stock is: A) $80 per share. B) $64 per share. C) $100 per share. D) $125 per share.

Answer: C Parity means equal. With a conversion ratio of 8 shares per bond, the investor can convert the bond into 8 shares. If the bond is currently selling for $800, then, to be of equal value (parity), the 8 shares must be selling at $100 each.

When referring to municipal bonds, the formula of (1 - tax bracket) is found in the computation of: A) current yield. B) return on investment. C) tax-equivalent yield. D) yield to maturity.

Answer: C The computation for the tax-equivalent yield of a municipal bond is performed by dividing the bond's coupon rate by (1 − the investor's tax bracket). If the bond has a coupon of 4% and the investor is in the 20% bracket, the tax-equivalent yield is 4% divided by (1 − .20) or 4% divided by .80 = 5%

Annual interest payment divided by current dollar price of a bond is the A) yield to maturity B) tax equivalent yield C) current yield D) nominal yield

Answer: C The current yield is the annual interest (in dollars) divided by the bond's market price (in dollars). A bond's nominal yield is the coupon yield, or stated interest rate. Yield to maturity takes into account the bond's price as well as its interest rate.

DERP Corporation's 5% convertible debentures maturing in 2030 are currently selling for 120. The conversion price is $40. One would expect the DERP common stock to be selling: A) somewhat above $30 per share. B) somewhat below $30 per share. C) somewhat below $48 per share. D) somewhat above $48 per share.

Answer: C The first step here is to compute the parity price. A conversion price of $40 means the debenture is convertible into 25 shares of the common stock (Par of $1,000 divided by $40 = 25 shares). With a current market price of $1,200, the parity price of the stock would be $48. Since convertible securities generally sell at a slight premium over their parity price, the stock should have a current market value a bit less than $48 per share.

With respect to safety of principal, of the following investments, the least risky is: A) equity options. B) exchange-listed warrants. C) corporate AA debentures. D) common stock.

Answer: C The least risky investment listed is the corporate debenture because, as a debt instrument, it has priority over the others.

A bond offered at par has a coupon rate: A) less than its yield to maturity. B) greater than its yield to maturity. C) equal to its current yield. D) less than its current yield.

Answer: C When a bond is selling at par, its coupon or nominal rate, current yield, and yield to maturity are all the same.

If interest rates are dropping, an investor with a maturing bond will be most concerned with: A) a negative yield curve. B) the quality declining with the yield. C) the difficulty in finding another investment with a like yield. D) a positive yield curve.

Answer: C When interest rates decline, investors with maturing bonds will have to accept a lower return on their reinvested principal. This is often referred to as reinvestment risk. Although zero-coupon bonds avoid this risk until maturity, once the bond matures, just like any other bond, the matured principal will have to be invested at current market yields.

On the initial public offering, an investor buys a $10,000 Aa rated 20 year corporate bond with a 4% coupon rate. One year later, the prevailing market rate is 5% and the bond has had its rating increased to Aa1. Which of the following statements is most likely true with reference to the current market price of this bond? A) Premium B) Cannot be determined from the information given C) Discount D) Par value

Answer: C When interest rates go up, bond prices go down. Had interest rates remained the same, the slight improvement in rating would have probably caused the bond to sell at a very slight premium, but that rating increase is not nearly strong enough to offset a 25% increase in market interest rates.

On the initial public offering, an investor buys a $10,000 Aa rated 20 year corporate bond with a 4% coupon rate. One year later, the prevailing market rate is 5% and the bond has had its rating increased to Aa1. Which of the following statements is most likely true with reference to the current market price of this bond? A) Premium. B) Cannot be determined from the information given. C) Discount. D) Par value.

Answer: C When interest rates go up, bond prices go down. Had interest rates remained the same, the slight improvement in rating would have probably caused the bond to sell at a very slight premium, but that rating increase is not nearly strong enough to offset a 25% increase in market interest rates.

A respected analyst reports that last week's T-bill rate at 6% is lower than the rate for the preceding week and lower than the average for the past month. Which of the following is TRUE? A) The general level of interest rates is increasing. B) Investors are paying less for T-bills. C) Investors are paying more for T-bills. D) The yield curve is inverted.

Answer: C When the rate is lower, the price has gone up; this means investors are paying more as interest rates are going down.

When current interest rates are at 6%, you would expect a bond with a nominal yield of 4% to be: A) selling at a premium. B) in danger of default. C) selling at a discount. D) selling at par.

Answer: C With the market rate of return at 6%, a 4% bond just isn't as valuable so, the only way investors would be interested is if they could acquire it at a discount. That discount would work out to be a figure that would work out to a 6% return for the purchaser. Remember, as interest rates go up, bond prices go down and vice versa.

Which type of risk is a mortgage-backed security most likely to experience? A) Market risk. B) Exchange rate risk. C) Business or financial risk. D) Reinvestment risk.

Answer: D A mortgage-backed security, such as a collateralized mortgage obligation (CMO), is most likely to experience reinvestment rate risk. As mortgages are paid off early and refinanced in the event of declining interest rates, the interim cash flows received from the obligation must be reinvested in lower yielding securities. This is the practical effect of prepayment risk.

The term" eurodollars "refers to: A) obsolete currency that was formerly backed by the gold standard. B) a worldwide currency system that is expected to someday replace existing currency systems. C) European currency held in U.S. banks. D) American dollars held by banks in other countries, especially in Europe.

Answer: D American dollars held in international banks, especially, but not exclusively, in Europe, are known as eurodollars.

An investor who chooses to use preferred stock as an income source instead of bonds would potentially incur which of the following risks? I. Loss of principal II. Price volatility of preferred stock is closely related to interest rates III. Preferred stock cannot be traded as readily as bonds IV. If the stock is callable, the client's income can be suddenly lowered A) I, II, III, and IV B) I and II C) III and IV D) I, II, and IV

Answer: D Because bonds have seniority over any equity security, there is a greater risk of loss of principal with preferred stock than with bonds. The price volatility of preferred stocks, like bonds, is impacted by interest rate changes. Unlike bonds, however, preferred stock does not have a maturity date. This means that preferred shares may never return to their par value as bonds do at maturity date. Because the preferred stock may have a callable feature, the company can redeem its shares at any time after the call protection period (if any) is over. This usually happens when interest rates have declined so the client whose stock was called will not be able to reinvest the proceeds at the same rate and could, therefore, suffer an unexpected drop in income. Preferred shares, particularly those listed on the exchanges, are generally easier to trade than corporate bonds (and certainly no worse).

Your client in the 28% federal income tax bracket currently owns some U.S. Government bonds with a coupon yield of 6%. In order to receive the same income after taxes, she would need to buy municipal bonds with a coupon of: A) 1.68%. B) 6.00%. C) 7.68%. D) 4.32%.

Answer: D Because the 6% on the government bond is fully taxable on a federal basis, the client receives a net of 4.32% ($60 per bond less 28% in taxes {$16.80}, or $43.20 per year). Interest on municipal bonds is tax-free so a 4.32% coupon will result in the same amount of after tax income.

All the following securities are bought at a discount EXCEPT A) Treasury bills B) zero coupon bonds C) commercial paper D) CDs

Answer: D CDs are interest-bearing debt instruments issued by banks at their face value. All of the others are issued at a discount. In truth, only about 85% of commercial paper is, but that's good enough for NASAA.

Prepayment risk is a major concern to an investor purchasing: A) callable bonds. B) convertible debentures. C) industrial revenue bonds. D) CMOs.

Answer: D CMOs are a form of mortgage-backed security. When interest rates fall, there is an increase in refinancing causing the mortgages to be paid off ahead of schedule. This results in the investor receiving a return of principal ahead of time, but only able to reinvest at the current lower rate. This is called prepayment risk.

Which of the following debt securities does not have a fixed maturity date? A) General obligation bond. B) Treasury STRIPS. C) Subordinated debenture. D) Collateralized mortgage obligation (CMO).

Answer: D Collateralized mortgage obligations (CMOs) are mortgage-backed securities which are often paid off ahead of the scheduled maturity so the maturity date remains uncertain. The operative word is "fixed"; as opposed to "scheduled".

In the secondary market, Treasury bond prices are most influenced by the: A) Treasury department. B) primary dealers. C) prime rate. D) inflation rate.

Answer: D In the secondary market, the rate of inflation has the greatest influence on all bond prices.

If a resident of New York City purchases an Albany, New York, general obligation bond that yields $600 of interest during the course of the year, how is the interest taxed? A) It is subject to federal income tax at ordinary rates. B) It is subject to state income tax at ordinary rates. C) Taxation is deferred until the bond matures. D) It is not subject to federal income tax.

Answer: D Interest from municipal bonds is exempt from federal income tax. While municipal bond interest is usually taxed at the state level, most states have an internal rule that exempts interest on their state and local municipal bonds.

Currently, a company issues 5% Aaa/AAA debentures at par. Two years ago, the corporation issued 4% AAA-rated debentures at par. Which of the following statements regarding the outstanding 4% issue are TRUE? I. The dollar price per bond will be higher than par. II. The dollar price per bond will be lower than par. III. The current yield on the issue will be higher than the coupon. IV. The current yield on the issue will be lower than the coupon. A) I and III. B) I and IV. C) II and IV. D) II and III.

Answer: D Interest rates in general have risen since the issuance of the 4% bonds, so the bond's price will be discounted to produce a higher current yield on the bonds. Remember that as interest rates go up, the price of outstanding debt securities goes down.

An investor in the 28% income tax bracket is considering purchasing either an 8% municipal bond or a 10% corporate bond. Which of the following regarding the bonds is TRUE? A) The yields of the bonds are equivalent on an after-tax basis. B) The corporate bond yield is higher than the municipal yield after taxes. C) The yield difference cannot be determined. D) The municipal yield is higher than the corporate yield on an after-tax basis.

Answer: D Investors are interested in their return after taxes (what they get to keep). The 2 bonds must be compared on a tax-equivalent basis. For example, the tax-equivalent yield of a municipal bond equals tax-free yield divided by 100% minus tax rate. The tax equivalent rate in this case is .08 ÷ .72 (100% − 28%) = 11.11%. In other words, a client in the 28% tax bracket would have to invest in a taxable bond that yields 11.11% to get the same after-tax return that the 8% tax-free bond offers.

Knowing the average maturities would be most important when doing a cash flow analysis on: A) common stock. B) preferred stock. C) REITs. D) mortgage-backed securities.

Answer: D Mortgage-backed pass-through securities pass through interest and principal payments to their investors. The rate at which the cash flows are generated depends, among other things, on the rate at which the mortgages mature.

Which of the following statements about municipal bonds is NOT true? A) Municipal bonds are bonds issued by governmental units at levels other than the federal. B) The interest on municipal bonds is usually not subject to federal income tax. C) Municipal bonds generally carry lower coupon rates than corporate bonds of the same quality. D) Municipal bonds are generally considered riskier than corporate bonds.

Answer: D Municipal bonds are generally considered second only to treasury instruments in relative safety.

Which of the following would you NOT expect to see issued at a discount? A) Commercial paper B) Treasury Bill C) Zero-coupon bond D) Bank jumbo CD

Answer: D Of these securities, only the bank jumbo (negotiable) CDs are always interest bearing and issued at par or face value.

If interest rates decline sharply, which of the following bonds is likely to appreciate the most? A) 15-year 8% bond trading on a 7.90 basis B) 15-year 8% bond trading on an 8.10 basis C) 15-year 7% bond trading at par D) 15-year zero coupon bond trading on a 7.80 basis

Answer: D Prices of zero-coupon bonds tend to be more volatile than prices of interest-bearing bonds because of their longer duration.

Which of the following best describes the liquidation order when a company files for bankruptcy? I. common stockholders. II. debenture holders. III. preferred stockholders. IV. secured creditors. A) III, IV, II, I. B) IV, III, II, I. C) I, II, III, IV. D) IV, II, III, I.

Answer: D Secured creditors, including secured bondholders, have the first claim on assets. They are followed by general creditors, including debenture holders. The final claim is that of stockholders (equity) with preferred coming ahead of common.

What rate of interest would a bank in England charge another British bank for a short-term loan? A) Discount rate. B) Fed funds rate. C) Prime rate. D) LIBOR.

Answer: D The British Banker's Association LIBOR is the most widely used benchmark or reference rate for short-term interest rates. LIBOR stands for the London Interbank Offered Rate and is the rate of interest at which banks could borrow funds from other banks, in marketable size, in the London interbank market.

A municipal bond has a coupon of 6.25% and at the present time, its yield to maturity is 6.75%. From this information, it can be determined that the municipal bond is trading: A) flat. B) at par. C) at a premium. D) at a discount.

Answer: D The YTM is greater than the nominal yield, or coupon yield. Therefore, the bond is trading at a discount.

The current yield of a 6% bond offered at 95 is: A) the nominal yield. B) the yield to maturity. C) 6%. D) 6.3%.

Answer: D The current yield of 6.3% is computed by dividing the annual interest payment ($60) by the current market price ($950).

Which of the following must an investment adviser representative consider before recommending a municipal security to a customer? Customer's state of residence. Customer's tax status. Municipal security's rating. Customer's highest education level. A) I and II. B) II and III. C) I, II and IV. D) I, II and III.

Answer: D The customer's state of residence and tax status are essential when determining suitability for a municipal security. The security's rating is also critical because it measures the safety and quality of the bond.

One of your clients approaches you looking for an investment that will provide ready marketability and income. Which of the following would be the most appropriate recommendation? A) bank insured CDs. B) NYSE listed common stock. C) limited partnership in rental real estate. D) U.S. treasury notes.

Answer: D The key is meeting both needs - marketability and income and only the treasury notes supply both. A CD will provide income, but they are non-marketable - they can only be redeemed at the bank and, if done prior to maturity, will invariably suffer a penalty to interest, principal, or both. NYSE common stock will be marketable, but there are no guarantees as to the income and the limited partnership will almost always have limited to no marketability.

The owner of a convertible bond A) has the choice of receiving the bond's interest or dividends on the underlying stock, whichever is higher B) generally expects a higher current return than with a nonconvertible bond of the same quality and maturity C) is generally in a senior position to other bondholders D) is a creditor of the issuer

Answer: D The owner of any bond is a creditor of the issuer. Dividends are only paid on stock and the investor will have to convert in order to be a stockholder. Because of the growth potential of the common stock, holders of convertible bonds invariably accept a lower coupon rate. In almost all cases, convertibles are debentures and therefore junior to secured bonds.

Although there may be some slight differences in methodology, when S&P or Moody's evaluate a security in order to assign a rating, they would be least likely to consider the issuer's A) cash flow to debt ratio B) liquidity ratio C) profitability ratio D) asset turnover ratio

Answer: D The rate at which assets are turned over is not nearly as important to determining a rating as the other three.

A client in the 28% marginal federal income tax bracket invests in a corporate bond with an 8% coupon. To calculate the client's after-tax rate of return: A) divide .08 by .28. B) divide .08 by .72. C) multiply .08 by .28. D) multiply .08 by .72.

Answer: D To determine a taxable bond's after-tax rate of return, multiply the coupon rate by the compliment of the client's marginal federal income tax bracket. The client's tax bracket is .28, so the compliment is 100 − .28 = .72.

If your customer wants to set aside $40,000 for when his child starts college, but does not want to endanger the principal, you should recommend: A) corporate bonds with high rates of interest. B) municipal bonds for their tax benefits. C) common stock. D) Zero coupon bonds backed by the US Treasury.

Answer: D Treasury STRIPS are guaranteed by the US government so there is no chance of default. They are zero-coupon bonds and offer no current income, which is appropriate for a client who wants 100% return paid at a future date for college expenses.

The MNO Manufacturing Company, headquartered in Springfield, has just filed for bankruptcy. Under federal bankruptcy law, which of the following would have highest priority with the bankruptcy trustee? A) Property taxes owed to the city of Springfield B) Holders of mortgage bonds C) Holder of first lien, senior preferred stock D) Employee wages earned within the 180 days prior to the bankruptcy filing

Answer: D Under federal bankruptcy law, there are several categories of unsecured claims that have a higher priority than secured ones. Two of the most common are employee wages as long as the wages were earned during the 180 days prior to the bankruptcy filing, and certain taxes. No matter how many adjectives are placed ahead of preferred stock, it always comes after everyone who is owed money.

Your client in the 25% federal income tax bracket lives in a state where his earnings place him in the 6% bracket for state income tax purposes. If he were to purchase a 4% bond issued by a political subdivision of another state, his total tax equivalent yield would be: A) 4%. B) Slightly more than 5.33%. C) Approximately 12.90%. D) Slightly less than 5.33%.

Answer: D When an individual owns a municipal bond issued in a state other than his state of residence, although the interest is tax-free on a federal basis, it is taxable, (at least in all cases on the exam), in that state. Therefore, the tax equivalent yield here is slightly lower than it would be if we only computed using the federal tax rate. Since that would be 4.0% divided by .75 (100% minus the 25% tax bracket) or 5.33%, paying the state income taxes would decrease the yield slightly.

Your client in the 25% federal income tax bracket lives in a state where his earnings place him in the 6% bracket for state income tax purposes. If he were to purchase a 4% bond issued by a political subdivision of his state, his total tax equivalent yield would be: A) 4%. B) Slightly less than 5.33%. C) Approximately 12.90%. D) Slightly more than 5.33%.

Answer: D When an individual owns a municipal bond issued in his state of residence, not only is the interest tax-free on a federal basis, but, (at least in all cases on the exam), it is non-taxed in that state. Therefore, the tax equivalent yield here is slightly higher than it would be if we only computed using the federal tax rate. Since that would be 4.0% divided by .75 (100% minus the 25% tax bracket) or 5.33%, saving on state income taxes would increase the yield slightly.

U.S. Treasury bills are issued for all of the following maturities EXCEPT: A) 26 weeks. B) 8 weeks. C) 4 weeks. D) 13 weeks.

Answer: B U.S. Treasury bills are issued with 4-, 13-, 26-week, and 52-week maturities. There are no 8-week T-bills.

A $1,000 bond with a nominal yield of 8% will pay how much interest each year? A) $80.00 B) $40.00 C) $160.00 D) $800.00

Answer: A The nominal yield (or coupon rate) is the interest rate stated on the bond and is the rate the bondholder promises to pay on the bond until the bond matures. A $1,000 bond with an 8% nominal yield will pay $80 per year in interest.

Which of the following statements is TRUE if a corporate bond is callable? A) The issuing corporation has the option to redeem the bond before it matures. B) The issuing corporation may change the coupon rate at any time by giving the owner of the bond written notice. C) The owner of the bond may exchange it for shares of stock. D) The owner of the bond may demand that the issuing corporation redeem the bond before it matures.

Answer: A A callable bond is one that may be redeemed by the issuing corporation before it matures. One reason a corporation might call a bond is to sell new bonds with a lower interest rate.

An unsecured bond is also known as a(n): A) debenture. B) mortgage bond. C) collateral trust bond. D) equipment trust certificate.

Answer: A An unsecured bond is known as a debenture. Mortgage bonds, collateral trust bonds, and equipment trust certificates are all types of secured bonds.

Assume that a corporation issues a 5% Aaa/AAA rated debenture at par. Two years later, similarly rated debt issues are being offered in the primary market at 5.5%. Which of the following statements regarding the outstanding 5% debenture are TRUE? I. The current yield on the debenture will be higher than 5%. II. The current yield on the debenture will be lower than 5%. III. The dollar price per bond will be higher than par. IV. The dollar price per bond will be lower than par. A) I and IV. B) I and III. C) II and III. D) II and IV.

Answer: A Because interest rates have risen after the issue of the 5% debenture, the bond's price will be discounted to result in a higher current yield (computed as annual income divided by current market price). Accordingly, the discounting of the issue will make the 5% debenture competitive with new issues offered with a 5.5% coupon.

All of the following statements regarding convertible bonds are true EXCEPT: A) holders receive a higher interest rate. B) holders may share in the growth of the common stock. C) the issuer pays a lower interest rate. D) holders have a fixed interest rate.

Answer: A Because of the possibility of participating in the growth of the common stock through an increase in the market price of the common, the convertible can be issued with a lower interest rate.

Which of the following debt instruments generally present the least amount of default risk? A) Municipal general obligation bonds. B) High-yield corporate bonds. C) Convertible senior debentures. D) Municipal revenue bonds.

Answer: A Because the full taxing power of the municipality backs a general obligation municipal bond, it will exhibit the least amount of default risk. A corporate debenture is an unsecured bond with a greater degree of risk, as is a junk or high-yield corporate bond.

Which of the following are true of Ginnie Maes but NOT of CMOs? A) Backed by the full faith and credit of the U.S. government. B) Collateralized by mortgages. C) Yield more than T-bonds. D) Are pass-through securities.

Answer: A CMOs are not backed by the full faith and credit of the U.S. government. However, both Ginnie Maes and CMOs are collateralized by mortgages, yield more than T-bonds, and are pass-through securities.

A new convertible bond has a provision that it cannot be called for five years after the issue date. This call protection is most valuable to a recent purchaser of the bond if: A) the market price of the underlying common stock is increasing. B) interest rates are falling. C) interest rates are rising. D) interest rates are stable.

Answer: A Convertible bonds are more sensitive to the price of the underlying common stock than they are to interest rates. Call protection would enable this investor to hold onto the bond while the stock rises in value rather than having the bond called away.

Which of the following best describes that which secures a debenture issued by an industrial corporation? A) The assets of the issuing company. B) The securities of the issuing company. C) The mortgages and real estate of the issuing company. D) The assets of a company other than the issuing company.

Answer: A Debentures are general obligations of the issuing company. They are actually backed by the assets of the company. Prior claims to those specific assets by secured debt issues take precedence over the debentures.

Which of the following usually does NOT pay interest semiannually? A) GNMA. B) Treasury bonds. C) Public utility bonds. D) Treasury notes.

Answer: A GNMA pass-through certificates pay principal and the interest monthly. All other choices usually pay interest semiannually.

An investor interested in monthly interest income should invest in: A) GNMAs. B) Treasury bonds. C) utility company stock. D) corporate bonds.

Answer: A GNMAs pay monthly interest and principal, treasury bonds pay semiannual interest, utility stocks pay quarterly dividends, and corporate bonds pay semiannual interest.

Ginnie Mae pass-throughs will pay back both principal and interest: A) monthly. B) quarterly. C) semiannually. D) annually.

Answer: A Ginnie Mae (GNMA) securities are called pass-through certificates because the monthly home mortgage payments, which consist of both principal and interest, pass through to the GNMA investor monthly.

Which of the following statements regarding U.S. government agency issues is NOT true? A) Government National Mortgage Association (GNMA) obligations are mortgage-backed securities that pass through principal and interest free of federal, but not state income tax. B) Government National Mortgage certificates carry higher interest rates than U.S. Treasury securities because of prepayment risk. C) Federal National Mortgage Association (FNMA) is a publicly held corporation that provides mortgage capital in much the same fashion as GNMA, except that Fannie Maes are backed by the general credit of the FNMA, and not by the full faith and credit of the U.S. government, as is the case with GNMAs. D) The Federal Intermediate Credit Banks (FICBs) lend money to credit companies, agricultural institutions, and commercial banks which in turn lend the money to farmers.

Answer: A Government National Mortgage Association (GNMA) obligations are mortgage-backed securities that pass-through principal and interest and are backed by the U.S. government. However, the interest is taxed on all levels; federal, state and local. Government National Mortgage certificates carry higher interest rates than U.S. Treasury securities because of prepayment or reinvestment risk. The Federal National Mortgage Association (FNMA) is a publicly held corporation that provides mortgage capital in much the same fashion as GNMA. However, Fannie Maes are backed by the general credit of the FNMA and not by the full faith and credit of the U.S. government, as is the case with GNMAs. The Federal Intermediate Credit Banks (FICBs) lend money to credit companies, agricultural institutions, and commercial banks which in turn lend the money to farmers.

An investor sells ten 5% bonds at a profit and buys another 10 bonds with a 5-¼% coupon rate. The investor's yearly return will increase by: A) $2.50 per bond. B) $1.00 per bond. C) $1.50 per bond. D) $2.00 per bond.

Answer: A The first bonds are 5% and pay $50 per year per bond. The new bonds are 5-¼% and pay $52.50 per year per bond. 5% coupon rate × $1,000 face value = $50 per year per bond; 5-¼% coupon rate × $1,000 face value = $52.50 per year per bond.

The price of which of the following will fluctuate most with a change in interest rates? A) Long-term bonds. B) Common stock. C) Money-market instruments. D) Short-term bonds.

Answer: A Long-term debt prices fluctuate more than short-term debt prices as interest rates rise and fall.

When a corporation issues a long-term bond, one of the factors influencing the bond's interest rate is the credit rating of the issuer. Another factor is the: A) cost of money in the marketplace. B) call loan rate. C) par value of the bond. D) tax status of the bond.

Answer: A Money is a commodity, and its cost is determined by supply and demand. When the cost of money is higher, borrowers incur a higher interest rate. The call loan rate impacts broker/dealers, not issuers of bonds. The par value of the bond has nothing to do with the cost of borrowing and, with almost no exception, all corporate bonds pay taxable interest so that is not a variable factor.

The best time for an investor seeking returns to purchase long-term, fixed-interest-rate bonds is when: A) long-term interest rates are high and beginning to decline. B) short-term interest rates are high and beginning to decline. C) short-term interest rates are low and beginning to rise. D) long-term interest rates are low and beginning to rise.

Answer: A The best time to buy long-term bonds is when interest rates have peaked. In addition to providing a high initial return, as interest rates fall, the bonds will rise in value.

Which of the following regarding U.S. government agency obligations are TRUE? I. They are direct obligations of the U.S. government. II. They generally have higher yields than direct U.S. obligations. III. The Federal National Mortgage Association is a publicly traded corporation. IV. Securities issued by GNMA trade on the NYSE floor. A) II and III. B) I and II. C) I and III. D) II and IV.

Answer: A U.S. government agency debt is an obligation of the issuing agency. This causes agency debt to trade at slightly higher yields reflecting this greater risk. FNMA was created as a government agency but was spun off in 1968 and is now (because of the problems it had during mortgage meltdown of 2008-9), traded on the OTC Bulletin Board rather than the NYSE. GNMA pass-through certificates trade OTC. GNMAs are the only agency whose securities are direct US government obligations.

An investor purchases zero-coupon bonds issued by the U.S. Treasury due to mature in 18 years at $100,000. Which of the following might describe the primary reason for selecting that investment vehicle? I. The investor is 65 years old and needs the reliability of current income. II. The investor is 45 years old and has purchased these in an IRA rollover account and wants the assurance of funds for retirement. III. The investor is 30 years old and has a newborn child and wishes to assure funds for a college education. IV. The investor is 20 years old, has just received an inheritance, and wishes to shelter income for as long as possible. A) II and III. B) I and II. C) I and IV. D) III and IV.

Answer: A Zero-coupon bonds maturing in 18 years would assure the 45-year-old of the face value at age 63. Being in an IRA, there would be no current taxation and, upon maturity, if desired, the funds could be distributed without the 10% penalty. Zero-coupon bonds are one way to guarantee funds for college education. However, with no current income, they would not be suitable for the 65-year-old and would not offer any tax shelter to the 20-year-old.

Which of the following is true of a zero-coupon bond? I. The rate of return is locked in. II. There is no reinvestment risk. III. The imputed interest is taxed as ordinary income on an annual basis. IV. A check for the interest is paid at maturity. A) I, II and III. B) I only. C) I, III and IV. D) I and IV.

Answer: A Zero-coupon bonds pay no periodic interest and are always issued at a discount from par. The appreciation of the zero from its discounted purchase price to its face value is thought of as interest to the bondholder, but this annual "phantom income", so named because you don't receive it, is taxed as ordinary income on an annual basis. When the bond is purchased, the investor locks in that yield and, with nothing to reinvest, there is no reinvestment risk.

Of the following securities, which is most commonly recommended to fund a child's college education? A) Zero-coupon Treasury bonds. B) Investment-grade corporate bonds. C) Municipal bonds. D) Treasury bills.

Answer: A Zero-coupon bonds, particularly those carrying the guarantee of the US Treasury, are a favored investment vehicle for saving for a child's higher education. They have the advantage of providing a certain, quantifiable sum at a certain date in the future.

If a corporate bond is a convertible bond, this means that: A) the owner of the bond may exchange it for a bond paying a higher coupon rate. B) the owner of the bond may exchange it for a set number of shares of stock. C) the corporation may redeem the bond before its maturity date. D) the owner of the bond may exchange it for a debenture.

Answer: B A convertible bond is usually a debenture that allows the owner to exchange it for a set number of shares of stock.

All of the following statements regarding bonds with both a convertible and callable feature are correct EXCEPT: A) the coupon rate on a convertible bond would be less than the rate for comparable nonconvertible debt. B) if called, the owners have the option of retaining the bonds and will continue to receive interest. C) after the call redemption date, interest payments will cease. D) dilution of company stock will occur on conversion of the bonds.

Answer: B After bonds are called, the issuer no longer pays interest. Conversion of convertible bonds causes more shares outstanding, resulting in a reduced proportionate ownership interest (dilution) for current shareholders. The coupon rate paid on convertible bonds is lower than the coupon for nonconvertible bonds. There is a trade-off in the amount of interest for the ability to convert the bonds into common stock.

A customer purchased new issue bonds at par two years ago. Since then, the CPI has declined by almost half and the current yield on his bonds has also declined. Which of the following best describes the value of the bonds he purchased? A) This cannot be determined from the information presented. B) They have increased in value. C) They have declined in value. D) There has been no change.

Answer: B Because inflation is down and bond yields have declined, the bonds are selling for a premium due to an increase in value.

A corporate bond valued at $1,012.50 is shown in the Standard & Poor's Bond Guide as: A) 101-4/16. B) 101-¼. C) 101.25. D) 101-8/32.

Answer: B Corporate bonds are quoted as a percentage of par in eighths. The quote of 101-¼ = $1,012.50 is correct. This represents $1,010 (101% of par) + $2.50 (¼ of $10). Each point in a corporate bond is equal to $10.

Which of the following debt instruments is unsecured? A) Equipment trust certificates. B) Aaa/AAA rated debentures. C) Junior lien mortgage bonds. D) Collateral trust certificates.

Answer: B Corporate debentures are unsecured bonds backed by the credit of the issuing corporation; they are not secured by underlying collateral. Mortgage bonds are secured with real estate serving as collateral. Collateral trust bonds are secured by securities that a corporation owns in other companies or bonds. Equipment trust certificates are secured by transportation equipment owned by the corporation.

A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of: A) 7.80% B) 5.56% C) 5.00% D) 7.40%

Answer: B Current yield is determined by dividing annual interest payment by the current market price of the bond ($50 ÷ $900 = 5.56%). Years to maturity is not a factor in calculating current yield.

Corporate bonds that are issued on the general credit of the issuer and are NOT otherwise secured are called: A) convertible. B) debentures. C) participating. D) consolidated mortgages.

Answer: B Debentures are corporate bonds issued on the general credit of the corporation and are not backed by any specific assets.

Which of the following regarding corporate debentures are TRUE? I. They are certificates of indebtedness. II. They give the bondholder ownership in the corporation. III. They are unsecured bonds issued to finance capital expenditures or to raise working capital. IV. They are the most senior security a corporation can issue. A) III and IV. B) I and III. C) I and II. D) II and IV.

Answer: B Debentures are debt securities that represent unsecured loans of the issuer. They are senior to common and preferred stock in claims against an issuer. They are issued to finance capital expenditures or raise working capital.

Securities issued by which of the following agencies offer direct government backing? A) Federal Intermediate Credit Bank. B) Government National Mortgage Association. C) Federal National Mortgage Association. D) Student Loan Marketing Association (Sallie Mae).

Answer: B FNMA and FICB are considered GSEs (government-sponsored enterprises) and, although their securities are quite safe, they do not have the direct backing of the Treasury. By the end of 2004, Sallie Mae no longer had any connection to the U.S. government.

Which of the following is a direct obligation of the U.S. government? A) Government bond mutual funds. B) Ginnie Maes. C) Bank for Cooperatives bonds. D) Fannie Maes.

Answer: B Ginnie Maes are backed by the full faith and credit of the United States. Other agencies have a moral, but not direct, government backing. Government bond mutual funds are not backed by the U.S. government.

MNO is planning to raise capital through an offering of 30-year bonds. Which call price would be most beneficial to MNO? A) 110 B) 102 C) 104 D) 106

Answer: B MNO would benefit most from the ability to call bonds at the lowest possible price. The call feature enables MNO to buy the bonds before maturity to reduce their fixed interest costs. A call price of 102 requires the lowest call premium of the options shown.

A company with 20 million shares outstanding paid $36 million in dividends. If the current market value of the company's shares is $36, the current yield is: A) not determinable from the information given. B) 5%. C) 2%. D) 10%.

Answer: B The current yield formula is annual dividends per share divided by current market price. The dividends per share are $36 million ÷ 20 million shares = $1.80 per share. Current yield is $1.80 ÷ $36.00 = 5%.

If GHI currently has earnings of $3 and pays an annual dividend of $1.75 and GHI's market price is $35, the current yield is: A) 8.6%. B) 5%. C) 1.75%. D) 3%.

Answer: B The current yield is calculated by dividing the annual dividend by the current market value ($1.75 ÷ $35 = 5%).

If a company's dividend increases by 5% but its market price remains the same, the current yield of the stock will: A) remain at 7%. B) increase. C) decrease. D) remain at 5%.

Answer: B The current yield of a stock is the annual dividend divided by the market price. If a company's dividend increases and its market price remains the same, its current yield will increase.

A customer purchased a 5% U.S. government bond yielding 6%. A year before the bond matures, new U.S. government bonds are being issued at 4%, and the customer sells the 5% bond. The customer probably did which of the following? I. Bought it at a discount. II. Bought it at a premium. III. Sold it at a discount. IV. Sold it at a premium. A) II and IV. B) I and IV. C) I and III. D) II and III.

Answer: B The customer purchased the 5% bond when it was yielding 6% (at a discount). The customer sold the bond when other bonds of like kind, quality, and maturity were yielding 4%. The bond is now at a premium. Therefore, the customer realized a capital gain.

If an investor in the 27% federal marginal income tax bracket invests in municipal general obligation public purpose bonds nominally yielding 4.5%, what is the tax equivalent yield? A) 16.67%. B) 6.16%. C) 3.29%. D) 5.72%.

Answer: B The formula for computing tax equivalent yield is: nominal yield divided by (1 − federal marginal income tax rate) 0.045 ÷ (1 − 0.27) = 6.16%.

Which of the following statements regarding corporate zero-coupon bonds are TRUE? I. Interest is paid semiannually. II. The discount is in lieu of periodic interest payments. III. The discount must be accreted and is taxed annually. IV. The discount must be accreted annually with taxation deferred until maturity. A) II and IV. B) II and III. C) I and III. D) I and IV.

Answer: B The investor in a corporate zero-coupon bond receives the return in the form of growth of the principal amount over the bond's life. The bond is purchased at a deep discount and redeemed at par at maturity. That discount from par represents the interest that will be earned at maturity date. However, the discount is accreted annually and the investor pays taxes yearly on the imputed interest.

Ms. Libby Ralph sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an 11-¼% coupon, are convertible into common stock at $10.50, and are being issued to the public at 100. The proceeds of the issue will be used specifically for purchasing new Southwest barges. Ms. Ralph's concerns about the issue could include: A) nothing, because the bonds will be first in liquidation. B) the issue may be junior-in-lien to another security issue. C) the new barges might sink, and the collateral would be gone. D) the company might demand that she accept common stock for her bond.

Answer: B The word "subordinated" is the key to the question. A subordinated bond has other debt holders ahead of it in the event of liquidation. The barges do not serve as collateral because the bonds are identified as debentures, and having to convert to common stock is not a threat because she is the one that will exercise the conversion privilege if she desires.

A bond's yield to maturity is: A) the annualized return of a bond if it is held to call date. B) the annualized return of a bond if it is held to maturity. C) set at issuance and printed on the face of the bond. D) determined by dividing the coupon rate by the bond's current market price.

Answer: B The yield to maturity is the annualized return of a bond if it is held to maturity. The computation reflects the internal rate of return and is frequently referred to as the market required rate of return for a debt security. The rate set at issuance and printed on the face of the bond is the nominal or coupon rate. Dividing the coupon rate by the current market price of the bond provides the current yield. The return of a bond if it is held to the call date is the YTC.

Which of the following debt instruments pays no interest? A) TIPS. B) T-bills. C) T-notes. D) T-bonds.

Answer: B Treasury Bills are always issued at a discount from their face value. At maturity, the investor receives par.

Which of the following U.S. government securities do NOT bear a stated interest rate but are sold at a discount through weekly auctions? A) TIPS. B) Treasury bills. C) Treasury notes. D) Treasury bonds.

Answer: B Treasury bills bear no stated interest rate. They are sold at a discount through weekly auctions and are actively traded in the money market. Treasury notes and Treasury bonds both carry stated interest rates.

For a bond selling at a discount, the yield to maturity will be: A) higher than the yield to call. B) higher than the nominal yield. C) lower than the nominal yield. D) equal to the nominal yield.

Answer: B Yield to maturity is a measure of the total return on a long-term bond, including capital appreciation and interest, while nominal yield measures the interest rate stated on the face of the bond. An investor who buys a $1,000 bond at a discount (for less than $1,000) will receive the interest payments on the bond at the nominal rate and will still receive $1,000 for the bond when it matures. As a result, the total return will be higher than the nominal yield. When a bond is selling at a discount the YTC will always be higher than the YTM.

The current yield on a bond with a coupon rate of 7.5% currently selling at 105-½ is approximately: A) 7.50%. B) 8%. C) 7.10%. D) 6.50%.

Answer: C A bond with a coupon rate of 7.5% pays $75 of interest annually. Current yield equals annual interest amount divided by bond market price, or $75 ÷ $1,055 = 7.109%, or approximately 7.1%.

Which of the following statements regarding a $1,000 corporate 8.50% bond offered at 110 is TRUE? A) To determine the bond's current yield, its stated rate must be compared against other fixed-rate investments in the client's portfolio. B) The bond is a discount bond. C) The bond's current yield is calculated by dividing its annual interest by its market price. D) The bond's current yield is lower than its yield to maturity.

Answer: C A bond's current yield is calculated by dividing its annual interest by its current (market) price. The current yield will be higher than its yield to maturity which will include the premium return. The determination of a bond's yield is unrelated to other bonds. In addition, this is a premium bond, not a discount bond.

A corporation is likely to call eligible debt when interest rates are: A) volatile. B) stable. C) declining. D) rising.

Answer: C A corporation generally calls in its debt when interest rates are declining, in order to replace old, higher interest-rate debt with new, lower interest-rate issues.

Which of the following statements about zero-coupon bonds are TRUE? I. Zero-coupon bonds are sold at a deep discount from face value. II. Zero-coupon bonds pay periodic interest payments. III. The owner of a zero-coupon bond receives his return only at maturity. A) II and III. B) I, II and III. C) I and III. D) I and II.

Answer: C A zero-coupon bond is a type of debt security that pays no periodic interest payments. Instead, the investor receives his return only at maturity, when the bonds are redeemed. Zero-coupon bonds are sold at a deep discount from face value, but are redeemed at full face value when they mature.

A CMO makes a combination principal and interest payment to an investor. This payment will be: A) taxed as a capital gain if underlying mortgage is prepaid. B) tax free. C) partly taxed as ordinary income and partly a tax-free return of principal. D) taxed as ordinary income.

Answer: C All interest payments made by CMOs are taxed as ordinary income. CMOs may make principal and interest payments to investors, which would be partly taxed as ordinary income and partly a tax-free return of principal.

A bond issued by the GEMCO Corporation has been rated BBB by a major bond rating organization. This bond would be considered: A) secured. B) callable. C) an investment grade corporate bond. D) a high-yield corporate bond.

Answer: C An investment-grade bond has a bond rating between AAA and BBB. Lower-rated bonds are considered high-yield bonds and are often referred to as junk bonds The bond may or may not be secured: the rating does not indicate that fact.

An investor purchased $10,000 of a 15 year AA rated corporate bond with a 6% coupon in the secondary market 3 years ago at par. The bond matured last week and the investor has just received a check for $10,300. Which of the following is a true statement? A) The investors cost basis has been reduced to $9,700. B) $300 is considered a return of principal. C) $300 is taxed as ordinary income. D) $300 is taxed as long-term capital gain.

Answer: C At maturity, the bondholder receives both the principal ($10,000) and the final interest check (6% of $10,000 = $600 per year/paid semi-annually) of $300. This interest, like all corporate bond interest, is ordinary income.

GNMA mortgage-backed securities are: A) exempt from federal income tax for the interest payments received by the bondholders. B) available to investors through a minimum purchase of $5,000. C) a direct obligation of the US government. D) backed exclusively by a pool of mortgages.

Answer: C GNMA securities are a direct obligation of the U.S. government and are backed by a pool of mortgages. The monthly payments are partially a return of principal and partially taxable interest, which is subject to state and federal income tax. GNMA pass-through securities are available to investors with a minimum issue price of $25,000.

All of the following debt instruments pay interest semiannually EXCEPT: A) municipal revenue bonds. B) industrial development bonds. C) Ginnie Mae pass-through certificates. D) municipal General Obligation bonds.

Answer: C Ginnie Maes pay interest on a monthly basis, not semiannually.

A customer buys a 5% bond at par. The bond is callable in 5 years at par and matures in 10 years. Which of the following statements is TRUE? A) YTC is lower than YTM B) Nominal yield is higher than either YTM or YTC C) YTC is the same as YTM D) YTC is higher than YTM

Answer: C If a bond is trading at par, the nominal yield (coupon rate) = current yield = yield to maturity = yield to call (unless the call price is at a premium in which case the YTC would be higher). YTC is higher than YTM if the bond is trading at a discount to par. YTC is lower than YTM if the bond is trading at a premium over par. Nominal yield is higher than either YTM or YTC if the bond is trading at a premium over par.

Which of the following would make a corporate bond more subject to liquidity risk? I. Short-term maturity II. Long-term maturity III. High credit rating IV. Low credit rating A) I and IV B) II and III C) II and IV D) I and III

Answer: C Liquidity risk is the risk that when an investor wishes to dispose of an investment, no one will be willing to buy it, or that a very large purchase or sale would not be possible at the current price The available pool of purchasers for bonds with a low credit rating is much smaller than for those with investment grade ratings (many institutions are only able to purchase bonds with higher credit ratings). As a result, the lower the credit rating, the greater chance of the bond having liquidity issues. Similarly, bonds with short-term maturities attract many more investors than those with long-term maturities causing the long-term bonds to be less liquid.

All of the following statements regarding government and agency securities are true EXCEPT: A) interest paid is always subject to federal income tax. B) they are authorized by Congress. C) they are always directly backed by the federal government. D) they are considered safer than corporate debt securities.

Answer: C Only GNMAs are directly backed by the federal government. FNMAs and FHLMCs are only indirectly backed but are still considered less risky than corporate debt. All are subject to federal taxation, and all were authorized by Congress.

From first to last, in what order would claimants receive payment in the event of bankruptcy? I. Holders of secured debt. II. Holders of subordinated debentures. III. General creditors. IV. Preferred stockholders. A) III, I, II and IV. B) IV, I, II and III. C) I, III, II and IV. D) I, II, III and IV.

Answer: C The liquidation order is as follows: wages, taxes, secured debt holders, unsecured debt holders (including general creditors), holders of subordinated bonds, preferred stockholders, and common stockholders.

Of the following bonds, which has the greatest price volatility? A) Corporate bond fund. B) AA corporate bond with 7 years to maturity. C) Zero-coupon bond with 15 years to maturity. D) Zero-coupon bond with 5 years to maturity.

Answer: C The longer the duration of a bond, the greater the volatility will be of its market price when interest rates change. Because zero-coupon bonds do not make interest payments but are priced at a deep discount to par value, they are more volatile than coupon-bearing bonds.

A company currently has earnings of $4 and pays a $0.50 quarterly dividend. If the market price is $40, what is the current yield? A) 10%. B) 15%. C) 5%. D) 1.25%.

Answer: C The quarterly dividend is $0.50, so the annual dividend is $2.00; $2 ÷ $40 (market price) = 5% annual yield (current yield).

The market price of a convertible bond depends on all of the following EXCEPT: A) current interest rates. B) the rating of the bond. C) the conversion prices of bonds from similar companies. D) the value of the underlying stock into which the bond can be converted.

Answer: C There are two factors that impact the current market price of all bonds; current interest rates and the rating of the bond. A third factor is unique to convertible bonds and that is the conversion value. The conversion value is based on the price of the underlying stock into which the bond can be converted. Comparing the conversion price of one issuer's bond to another's tells us nothing about the value of a specific bond.

Which two of the following are ordinarily TRUE concerning prepayment of CMOs? I. If interest rates fall, prepayments increase. II. If interest rates rise, prepayments increase. III. If interest rates fall, prepayments decrease. IV. If interest rates rise, prepayments decrease. A) II and III. B) III and IV. C) I and IV. D) I and II.

Answer: C When interest rates fall, homeowners often refinance their homes to take advantage of lower interest rates, resulting in the existing mortgages being paid off early. Also, homeowners tend to sell their homes to upgrade to larger homes when mortgage interest rates (and monthly payments) are low. When interest rates rise, homeowners do not usually refinance, and housing turnover is reduced.

An 8% corporate bond is offered on a 8.25 basis. Which of the following statements are TRUE? I. Nominal yield is higher than YTM. II. Current yield is higher than nominal yield. III. Nominal yield is lower than YTM. IV. Current yield is lower than nominal yield. A) I and III. B) I and IV. C) II and IV. D) II and III.

Answer: D A bond offered on an 8.25 basis is the same as at a YTM of 8.25%. Because the yield quoted is higher than the 8% coupon, the bond is trading at discount to par. For discount bonds, the nominal yield is lower than both the current yield and the yield to maturity.

Corporate bonds are considered safer than common stock issued by the same company because: A) bonds and similar fixed-rate securities are guaranteed by SIPC. B) the par value of bonds is generally higher than that of stock. C) if there is a shortage of cash, dividends are paid before interest. D) bonds place the issuer under an obligation but stock does not.

Answer: D A bond represents a legal obligation to repay principal and interest by the company. Common stock carries no such obligation.

If a customer buys a 6% bond maturing in 8 years on a 7.33 basis, the price of the bond is: A) above par. B) at par. C) inverted. D) below par.

Answer: D A bond with a basis, or yield to maturity, greater than its coupon is trading at a discount, or below par.

An investor interested in acquiring a convertible bond as part of his investment portfolio would: A) be interested in tax advantages available to convertible debt securities. B) want the assurance of a guaranteed dividend on the underlying common stock. C) seek to minimize changes in the bond price during periods of steady interest rates. D) want the safety of a fixed-income investment along with potential capital appreciation.

Answer: D An investor who wants the safety of a fixed-income investment with the potential for capital gains would be most interested in purchasing a convertible bond. However, because convertible bonds can be exchanged for common stock, their market price tends to be more volatile during times of steady interest rates than other fixed-income securities.

What would likely happen to the market value of existing bonds during an inflationary period coupled with rising interest rates? A) The price of the bonds would increase. B) The price of the bonds would stay the same. C) The nominal yield of the bonds would increase. D) The price of the bonds would decrease.

Answer: D Bond prices fall when interest rates rise because bond prices have an inverse relationship with interest rates.

A company has paid a dividend every quarter for the past 20 years. If the stock's price has fallen dramatically over the past quarter, but the dividend has remained the same, it may be concluded that: A) current dividend yield has decreased. B) current dividend yield has remained the same. C) dividend yield to maturity has decreased. D) current dividend yield has increased.

Answer: D Current dividend yield is income dividend divided by price. If the price of a stock decreases and the dividend remains the same, dividend yield will increase.

GHI stock is at $10 par value and is selling in the market for $60 per share. If the current quarterly dividend is $1, the current yield is: A) 1%. B) 1.7%. C) 10%. D) 6.7%.

Answer: D Current yield is determined by dividing the annual dividend of $4 ($1 per quarter × 4 = $4) by the current stock price of $60 ($4 ÷ $60 = 6.7%).

Mr. Beale buys 10M RAN 6.6s of 32 at 67. What is his total purchase price? A) $6,600 B) $10,000 C) $10,200 D) $6,700

Answer: D For those of you not familiar with bond listings, this means that Mr. Beale bought $10,000 (10M) of the RAN Corporation bonds with a 6.6% coupon (interest rate stated on the face of the bond) that mature in 2032 (32). The price is 67, which represents 67% of $10,000, or $6,700.

All of the following statements regarding Government National Mortgage Association (GNMA) pass-through securities are true EXCEPT: A) investors receive a monthly check representing both interest and a return of principal. B) the minimum initial investment is $25,000. C) investors own an undivided interest in a pool of mortgages. D) GNMAs are considered to be the riskiest of the agency issues.

Answer: D GNMA securities, which are backed by the full faith and credit of the U.S. government, are considered to be the safest of the agency issues.

All of the following statements regarding bonds selling at a discount are correct EXCEPT A) they will appreciate more than comparable bonds selling at a premium if interest rates fall B) they can indicate that interest rates have risen C) they can indicate that the issuer's credit rating has fallen D) they are more likely to be called than comparable bonds selling at a premium

Answer: D Issuers tend to call bonds with higher coupons. Bonds trading at a premium have higher coupons than those trading at a discount (and are more likely to be called - wouldn't you pay off your high interest debt before the low interest debt?). The longer the duration, the more volatile the bond's price. Lower coupon rates mean a longer duration. If rates rise, prices fall. If a bond's rating falls, so does its price.

When doing cash flow analysis on a mortgage-backed pass-through security, you would want to know: A) the quality of the mortgages. B) whether there is a real estate "bubble." C) size of the tranche being analyzed. D) the average maturities.

Answer: D Mortgage-backed pass-through securities pass through interest and principal payments to their investors. The rate at which the cash flows are generated depends, among other things, on the rate at which the mortgages mature.

Which of the following expressions describes the current yield of a bond? A) Yield to maturity divided by par value. B) Yield to maturity divided by current market price. C) Annual interest payment divided by par value. D) Annual interest payment divided by current market price.

Answer: D The current yield on a bond is calculated by dividing the annual interest payment by the current market price of the bond.

ABC's stock has paid a regular dividend every quarter for the last several years. If the price of the stock has remained the same over the past year, but the dividend amount per share has increased, it may be concluded that ABC's: A) current yield per share has decreased. B) current yield per share has been unaffected. C) yield to maturity has gone up. D) current yield per share has increased.

Answer: D The current yield would have increased because current yield is the income (dividend) divided by price. A higher dividend divided by the same price results in a higher yield. Stocks do not have a yield to maturity.

A high-coupon bond is selling at a premium. Call of this bond is most beneficial to the: A) underwriter. B) bondholder. C) broker/dealer. D) issuer.

Answer: D When bonds are selling at a premium, it means interest rates are low. The issuer should be able to refinance the bonds by calling in the bonds at the preset call price (invariably below the current market) and save interest costs.

A customer buys a 10-year 6% AAA bond at par when it was issued. Two years later, if the CPI has increased from 2% to 4%, the price of the bond most likely: A) has stayed at par. B) has increased. C) cannot be determined. D) has declined.

Answer: D When inflation is on the rise, interest rates often rise. When interest rates increase, bond prices may be expected to decline.

An analyst is comparing two discounted 8% AA bonds. Both have 20 years to maturity. One of the bonds is callable in 4 years and the other is callable in 9 years. If interest rates fall, which will have the greatest increase in price? A) The bond with the 4-year call. B) Both will increase the same. C) Both will decrease the same. D) The bond with the 9-year call.

Answer: D When interest rates fall, bond prices move inversely (they go up). All other things being equal, the longer the maturity, the greater the movement. In this case, both bonds have the same 20-year maturity, but one is callable much sooner than the other. This makes the bond less attractive because an investor may have this bond called away in as little as 4 years.