Series 65 unit 2
One of the advantages of owning a corporation's debentures is that you have prior claim over
A) secured creditors. B) general creditors. C) preferred stockholders. D) employees. ANS:B Holders of a company's debentures are general creditors and, as such, have prior claim only over equity holders.
An investor purchasing 10 corporate bonds at a price of 102¼ each will pay
A) $10,225.00. B) $1,022.50. C) $1,020.25. D) $10,202.50. ANS: A) 10,225 (At 102¼, each bond costs $1,022.50 (102 = 1,020 and ¼ of $10 = $2.50). There are 10 bonds, so the total is $1,022.50 × 10 = $10,225.)
Which of the following projects is most likely to be financed by a general obligation rather than a revenue bond?
A) Municipal hospital B) Public library C) Expansion of an airport D) Public golf course ANS: B) PUBLIC LIBRARY (Hospitals, airports, and golf courses all generate revenue and can be financed with revenue bond issues. Public libraries are financed through general obligation (GO) bond sales with the backing of taxes.)
Which of the following would you not expect to see issued at a discount?
A) Zero-coupon bond B) Treasury bill C) Commercial paper D) Bank jumbo CD ANS:D) Bank jumbo CD (Of these securities, only the bank jumbo (negotiable) CDs are always interest bearing and issued at par or face value.)
If an investor pays 95.28 for a Treasury bond, how much did the bond cost?
A) $9,528.00 B) $958.75 C) $950.28 D) $95.28 ANS: B Treasury bonds are quoted as a percentage of par ($1,000) plus 32nds. In this case, the price is $950 plus 28/32 (i.e., ⅞) of $10, for a total of $958.75
Which of the following statements regarding convertible bonds is not true?
A) Convertible bondholders are creditors of the corporation. B) The conversion rate is set at issuance and does not change. C) 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. D) Coupon rates are usually higher than nonconvertible bond rates of the same issuer. ANS: D) Coupon rates are usually higher than nonconvertible bond rates of the same issuer.
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) $156.25 per share. B) $64.00 per share. C) $100.00 per share. D) $125.00 per share. ANS: C) $100 per share
A TIPS bond is issued in the principal amount of $1,000, paying 3.5%. Over the security's 5-year term, the annual inflation rate is 6%. What is the principal value of the bond at the end of 4 years?
A) $1,267 B) $1,240 C) $1,344 D) $1,300 ANS: B The unique feature of a TIPS bonds is its semiannual adjustment to principal based on the inflation rate. With an annual inflation rate of 6%, there is a 3% increase to the principal value every 6 months. The arithmetic is $1,000 multiplied by 103% consecutively 8 times (there are 8 semiannual periods in 4 years). Be sure to stop at 4 years—the question doesn't ask for the ending value for the 5th year. If this math is too challenging, there is a simple method that always works. That simple method has you take the annual inflation rate (6% = $60) for 4 years ($240) and add that to the original $1,000 face value. That is $1,240, and the correct answer on the exam will always be the next higher number ($1,267 in this case). This simple step means you are calculating the simple interest while the bond's principal growth is actually compounding.
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 $0.53, your client's goal will be achieved if the RIF can be purchased at
A) $35.33. B) $8.83. C) $50.00. D) $22.55. ANS: A) $35.33 (First, take the quarterly dividend and annualize it (4 × $0.53 = $2.12). Dividing that number by 6% gets you $35.3333, which rounds down to $35.33. Alternatively if you wish (but which takes more time), multiply each of the choices by 6% to see which of them equals $2.12.
Which of the following is not a money market instrument?
A) Commercial paper B) Newly issued Treasury notes C) Banker's acceptances D) Treasury bills ANS: B) Newly Issued Treasury Notes ( Commercial paper, Treasury bills, and banker's acceptances are debt instruments with maturities of one year or less and are therefore money market instruments. A newly issued Treasury note would have a maturity of two to 10 years and therefore would not be a money market instrument.)
MNO is planning to raise capital through an offering of 30-year bonds. Which call price would be most beneficial to MNO?
A) 106 B) 102 C) 110 D) 104 ANS: B) 102 ( 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.)
Which of the following statements regarding U.S. government agency securities is true?
A) They generally offer higher yields than direct U.S. obligations. B) Interest received on agency securities is exempt from federal income tax. C) They generally trade on the major stock exchanges. D) They are direct obligations of the U.S. government. ANS: B In most cases, securities issued by U.S. government agencies are obligations of that agency rather than the U.S. government. As such, they carry slightly higher risk, and that means investors demand a higher return. They do not trade on any exchange. Their interest, like that of all U.S. government securities, is taxable on the federal level while being tax exempt on the state level.
In general, among the advantages to investing in Brady bonds over those issued by countries classified as emerging economies is
A) greater risk. B) increased liquidity. C) shorter maturities. D) higher yields. ANS:B Brady bonds are issued to take over the debt of failing commercial loans in emerging economies. They are secured by collateral—often U.S. 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. There is nothing unique about the maturities of Brady bonds.
Which of the following debt instruments generally presents the least amount of default risk?
A) Convertible senior debentures B) Municipal general obligation bonds C) High-yield corporate bonds D) Municipal revenue bonds ANS: B) Municipal general obligation bonds (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 potentially greater degree of risk, as is a junk or high-yield corporate bond.)
You are meeting with a relatively unsophisticated investor who doesn't understand very much about stocks and bonds. The investor asks, "Can you list the advantages of owning common stock as compared to bonds?" Among other reasons, you could reply that
A) bonds must be surrendered at maturity or at a call while the owner of common stock can hold the investment as long as desired. B) there is limited liability. C) bonds have priority over any equity security in the event of liquidation. D) income payments are more reliable. ANS: A) bonds must be surrendered at maturity or at a call while the owner of common stock can hold the investment as long as desired.
The owner of a convertible debt issue
A) is a creditor of the issuer. B) has the choice of receiving the bond's interest or dividends on the underlying stock, whichever is higher. C) is generally in a senior position to other bondholders. D) generally expects a higher current return than with a nonconvertible bond of the same quality and maturity. ANS: A) is a creditor of the issuer (The owner of any bond is a creditor of the issuer. Dividends are paid only 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 securities invariably accept a lower coupon rate resulting in a lower current yield (return). In almost all cases, convertible debt securities are debentures and, therefore, junior to secured bonds.)
A bond with a par value of $1,000 and a coupon rate of 6% paid semiannually is currently selling for $1,200. The bond is callable in 15 years at 105. In the computation of the bond's yield to call, which of these would be a factor?
A) Future value of $1,200 B) Present value of $1,050 C) Interest payments of $30 D) 15 payment periods ANS:B The yield to call (YTC) computation involves knowing the amount of interest payments to be received, the length of time to the call, the current price, and the call price. A bond with a 6% coupon will make $30 semiannual interest payments. With a 15-year call, there are 30 semiannual payment periods, not 15. The present value is $1,200 and the future value is $1,050, which is the reverse of the numbers indicated in the answer choices.
