Series 66 Chapter 13
A $1,000 bond with a nominal yield of 8% will pay how much interest each year? A) $160.00 B) $40.00 C) $80.00 D) $800.00
C
A bond analyst who determines the value of a debt security by adding the present value of the future coupons to the present value of the maturity value is using which of the following valuation methods? A) Present value B) Future value C) Discounted cash flow D) Dividend discount
C
Many fixed-income investors are looking to avoid loss of principal. Which of the following would likely have the lowest degree of exposure to credit risk? A) Ba-rated corporate mortgage bond B) Baa-rated municipal revenue bond C) Aa-rated corporate debenture D) A-rated general obligation municipal bond
C A bond's rating takes into consideration all factors, including collateral and tax base. The higher the rating, the lower the credit risk.
Mr. Beale buys 10M 6.6s of 10 at 67. What will his annual interest be? A) $1,000.00 B) $820.00 C) $670.00 D) $660.00
D
An 8% corporate bond is offered on a 8.25 basis. Which of the following statements are TRUE? Nominal yield is higher than YTM. Current yield is higher than nominal yield. Nominal yield is lower than YTM. Current yield is lower than nominal yield.
2, 3
A popular tool used by analysts is discounted cash flow (DCF). Most use this tool to evaluate A) the present value of future cash flows to determine the value at a specified date in the future. B) the present value of future cash flows to determine an appropriate current value. C) the future value of future cash flows to determine the value at a specified date in the future. D) the future value of present cash flows to determine an appropriate current value.
B
Which of the following factors has a direct relationship to a bond's duration? A) Rating B) Time to maturity C) Coupon rate D) Yield to maturity
B
A corporation issued a bond with a coupon of 6%, callable at 103. The bond matures in 2059. Current interest rates are 8%. It is most likely that A) the bond will go into default. B) the coupon will be increased. C) the bond is selling at a discount. D) the bond will be called.
C
Your client owns a 91-day T-bill, a 2-year T-note, a 20-year T-bond, and a 20-year STRIP. The market price of which of these is likely to have the smallest movement when there are changes to the discount rate? A) T-note B) T-bond C) T-bill D) STRIP
C
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 a premium C) at par D) at a discount
D
With respect to safety of principal, of the following investments, the least risky is A) common stock B) exchange-listed warrants C) equity options D) corporate AA debentures
D
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 stay the same. B) The price of the bonds would increase. C) The nominal yield of the bonds would increase. D) The price of the bonds would decrease.
D Bond prices fall when interest rates rise because bond prices have an inverse relationship with interest rates.
Which of the following would make a corporate bond more subject to liquidity risk? Short-term maturity Long-term maturity High credit rating Low credit rating
2, 4
An investor sells ten 5% bonds at a profit and buys another 10 bonds with a 5¼% coupon rate. The investor's yearly return will increase by A) $1.50 per bond B) $2.50 per bond C) $2.00 per bond D) $1.00 per bond
B
Which of the following bonds is most affected by interest rate risk? A) 7.5s of '34 yielding 7.2%. B) 7.6s of '41 yielding 7.2% C) 7s of '32 yielding 7% D) 7.8s of '37 yielding 7.3%
B
Which of the following indicates a bond selling at a discount? A) 5% coupon yielding 5% B) 7% coupon yielding 7.5% C) 7% coupon yielding 6.5% D) 10% coupon yielding 9%
B
A customer purchased new issue bonds at par 2 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) Their market price has declined. B) Their market price has increased. C) This cannot be determined from the information presented. D) Their market price has remained unchanged.
B Because inflation is down and bond yields have declined, the bonds are selling for a premium due to an increase in value.
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.
C
A sudden decrease in market interest rates will have the effect of increasing the trading price of an existing bond because A) the future value of the bond's present cash flows increases B) a reduction in market interest rates generally signifies a stronger economy C) the present value of the bond's future cash flows increases D) lower interest rates will result in a higher rating for the bond
C Bond valuations using discounted cash flow take into consideration the present value of the bond's future cash flows. That is, the greater the value of the interest payments to be received in the future, the higher the price of the bond. When market interest rates decline, because the coupon rate of the existing bond is fixed, the present value of those interest payments increases, creating a higher value for the bond.
Which of the following bonds would appreciate the most if interest rates fell? A) 30-year maturity, selling at a premium B) 15-year maturity, selling at a premium C) 30-year maturity, selling at a discount D) 15-year maturity, selling at a discount
C The general rule of thumb is that bonds with long-term maturities will have greater fluctuations in price than will short-term maturities, given the same move in interest rates. Furthermore, discounted bonds, with their lower coupon rates, have a longer duration than a bond selling at a premium and will respond more favorably to falling rates than will those premium bonds. Thus, the 30-year discounted bond will move faster than the others.
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? The current yield on the debenture will be higher than 5%. The current yield on the debenture will be lower than 5%. The dollar price per bond will be higher than par. The dollar price per bond will be lower than par.
1, 4
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? The dollar price per bond will be higher than par. The dollar price per bond will be lower than par. The current yield on the issue will be higher than the coupon. The current yield on the issue will be lower than the coupon.
2, 3
A corporation has issued a 4% $60 par convertible stock with a conversion price of $20. With the preferred stock selling at $66 per share, an investor holding 100 shares of this stock would benefit by converting if the price of the common stock was A) above $22 per share B) above $18.20 per share C) below $22 per share D) above $20 per share
A
Which of the following bonds would be the least price sensitive to changes in market interest rates? A) 4.5% Treasury bond due in 20 years with a YTM of 4.1% B) 10% BB bond due in 21 years with a YTM of 8.7% C) Zero due in one year with a YTM of 6% D) 6% AA bond due in 18 years with a YTM of 6.8%
C
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's current yield is lower than its yield to maturity. C) The bond is a discount bond. D) The bond's current yield is calculated by dividing its annual interest by its current market price.
D
Which of the following statements regarding the properties of duration is NOT true? A) Duration measures the effect of an interest rate change on the price of a bond or bond portfolio. B) Duration is a weighted-average term to maturity of a bond's cash flows. C) Duration measures a bond's price volatility by weighting the length of time it takes for a bond to pay for itself. D) Duration measures the holding period return on a bond.
D
Assuming all of the following mature at about the same time, which of the following bonds should experience the greatest price decline if interest rates rise by 1%? A) Treasury bond issued at par carrying a 7% coupon B) Treasury bond issued at par and carrying a 4% coupon C) Treasury bond issued at par carrying a 6% coupon D) Treasury bond issued at par carrying a 5% coupon
B
High-yield bonds are frequently called junk bonds. Which of the following expresses the highest rating that would apply to a junk bond? A) CC B) BB C) CCC D) BBB
B
One year ago, ABC Widgets, Inc., funded an expansion to its manufacturing facilities by issuing a 20-year first mortgage bond. The bond is secured by the new building and land. The bond was issued with a 5.5% coupon and is currently rated Aa. The current market price of the bond is 105 resulting in a current yield of approximately A) 4.99%. B) 5.61%. C) 5.24%. D) 5.50%.
C
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) $125 per share B) $80 per share C) $100 per share D) $64 per share
C
One of the likely consequences of a rating downgrade on a bond is A) the call feature will be employed. B) the current yield will be reduced. C) a reduction in the market price of the bond. D) an increase to the coupon by the issuer.
C If the rating agencies downgrade the quality of a bond, potential investors will look to compensate for the increased risk by demanding a greater yield on the issuer's bonds. This will inevitably result in a lower bond price. A change in ratings is unlikely to lead to a call. In fact, with the reduction in the market price, the bond may be selling below par giving the issuer the opportunity to retire the debt at a discount. Bonds are fixed-income securities because the coupon rate is fixed when the bond is issued and does not change.
The Wall Street pundits are predicting a substantial increase in interest rates. If they are correct, which of the following bonds would be most sensitive to that increase? A) 5s of 2040 B) 5s of 2035 C) 4s of 2020 D) 5s of 2045
D
The portfolio manager of the Insatiate Bond Fund, an open-end investment company, believes that interest rates are going to increase in the near future. As such, it would be wise for that manager to A) increase the equity portion of the portfolio. B) shift into higher-rated bonds. C) lengthen the average duration of the portfolio. D) shorten the average duration of the portfolio.
D
A method of assessing the value of a fixed-income security by looking at the future expected free cash flow and discounting it to arrive at a present value is known as A) internal rate of return B) future value C) current yield D) discounted cash flow
D
In order to perform a discounted cash flow estimation of the value of a bond, it would be necessary to know all of the following EXCEPT A) the future cash flow B) the parity price of the bond C) the discount rate D) the number of interest payments
B
The price of which of the following will fluctuate most with fluctuating interest rates? A) Common stock B) Long-term bonds C) Money market instruments D) Short-term bonds
B
Being concerned about price volatility, a bond investor wishes to compute the duration of a bond being considered for her portfolio. Which of the following is NOT a necessary component of that calculation? A) Coupon rate B) Time until maturity C) Rating of the bond D) Current market price
C
A bond's duration is A) identical to its maturity for an interest-bearing bond B) expressed as a percentage C) an indication of a bond's yield that ignores its price volatility D) longer for a 10-year bond with a 5% coupon than it is for a 10-year bond with a 10% coupon
D
Bond investors use the discounted cash flow formula to A) compute their income tax liability. B) evaluate the risk of investing in a bond. C) determine the annual interest paid on a bond. D) translate future cash flows to be received from interest and principal repayment into their present value.
D
Which of the following is NOT a valuation method for a fixed-income security? A) Discounted cash flow B) Conversion parity C) Price-to-earnings ratio D) Dividend discount model
C
A bond fund owns $100 million each of a number of different corporate bonds. The duration of those individual bonds is 3, 4, 5, 6, 8, and 10 years. From this information, you would estimate the average duration of the bond fund to be A) 5.5 years B) 4 years C) 8 years D) 6 years
D
A client's bond portfolio consists of 5 Treasury issues in equal amounts. Their durations are: 4, 5, 7, 9, and 15 years. What is the average duration of the portfolio? A) 13.76 years B) 7 years C) 40 years D) 8 years
D
One of your clients owns 2 different 6% corporate bonds maturing in 15 years. The first bond is callable in 5 years, while the second has 10 years of call protection. If interest rates begin to fall, which bond is likely to show a greater change in price? A) Both will decrease by the same amount B) Both will increase by the same amount C) Bond with the 5-year call D) Bond with the 10-year call
D
One of the reasons why the discounted cash flow method of valuation is useful in assessing the value of fixed income instruments is A) the availability of ratings B) the priority of claim on earnings C) the known maturity date D) the predictability of income
D Discounted cash flow evaluates the expected cash flow from an investment and then factors in the time value of money. Obviously, if there is no predictable cash flow (as there is with the interest payments on a bond), there are no reliable numbers to plug into the formula.
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) More than likely, the price of the preferred stock will rise. C) There will be no effect. D) If there is an antidilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend.
D Most convertible securities are sold with antidilutive clauses that provide for an adjustment in the number of shares based on stock splits or stock dividends.
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) the arbitrage level D) parity
D
Mr. Beale buys 10M RAN 6.6s of 32 at 67. What is his total purchase price? A) $6,600 B) $10,000 C) $6,700 D) $10,200
C
Which of the following expressions describes the current yield of a bond? A) Yield to maturity divided by current market price B) Yield to maturity divided by par value C) Annual interest payment divided by current market price D) Annual interest payment divided by par value
C
An investor is considering the purchase of some bonds to diversify his portfolio. If he should decide to purchase Treasury STRIPS instead of Treasury Bonds, his major risk would be A) reinvestment risk B) credit risk C) purchasing power risk D) interest rate risk
D Treasury STRIPS are zero-coupon bonds and, as such, have a longer duration than those paying semiannual interest. The longer the duration, the greater the interest rate risk. Because both are guaranteed by the U.S. government, there is no credit risk. Both have the same purchasing power risk, and there is no reinvestment risk with a zero-coupon bond.
The yield to maturity is A) set at issuance and printed on the face of the bond B) the annualized return of a bond if it is held to call date C) determined by dividing the coupon rate by the current market price of the bond D) the annualized return of a bond if it is held to maturity
D
Charlie Mindel is the portfolio manager for the Steady Yield Bond Fund. If Charlie was of the opinion that interest rates were going to fall, he would A) keep the average duration the same. B) decrease the average duration of the portfolio. C) move more of the portfolio into cash. D) increase the average duration of the portfolio
D As interest rates go down, prices of bonds rise. Those with the longest duration will have the greatest price increase. To benefit from this move, managers of bond portfolios will lengthen the average duration of the portfolio. The reverse action would be taken if Charlie thought that interest rates were going to rise. Of course, if interest rates move in the opposite direction of that the manager expects, the fund might start looking for a new manager.
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 is most likely TRUE with reference to the current market price of this bond? A) Par value B) Premium C) Discount D) Cannot be determined from the information given
C
An investor is looking to add some bonds to her portfolio. One of the bonds she is analyzing has a 3% coupon and the other a 6% coupon. Assuming both bonds have the same maturity date, a change in interest rates will have a more profound effect upon the market price of which bond? A) The 6% coupon B) Changes in interest rates affect both bonds equally C) The bond with the lower rating D) The 3% coupon
D
Current market interest rates are 6%. A bond with an 8% coupon would be most likely to have a net present value of zero when the bond's internal rate of return is A) 4%. B) 0%. C) 8%. D) 6%.
D
Managers of bond portfolios who anticipate an increase in interest rates should A) increase the portfolio duration B) assume higher risk in the secondary market C) invest in high-yield or junk bonds D) decrease the portfolio duration
D
Which of the following bonds has the shortest duration? A bond with A) a 20-year maturity, 6% coupon rate. B) a 10-year maturity, 6% coupon rate. C) a 20-year maturity, 10% coupon rate. D) a 10-year maturity, 10% coupon rate.
D
An investor purchases a Treasury note and the confirmation shows a price of $102.25. Rounded to the nearest cent, the investor's cost, excluding commissions, is A) $1,020.25. B) $102.25. C) $1,022.50. D) $1,027.81.
D
As a bond's duration changes, A) its maturity date changes. B) its rating might be affected. C) the income received by the bondholder changes. D) its sensitivity to changes in interest rates changes.
D
BFJ Corp's 5% convertible bond is trading at 120. The bond is convertible at $50. An investor buying the bond now and immediately converting into common stock, would receive A) 24 shares B) 2.4 shares C) 20 shares plus cash for fractional shares D) 20 shares
D
Duration is A) equivalent to the yield to maturity B) a measure of a bond's price sensitivity with respect to a change in interest rates C) the deviation of a bond's returns from its average returns D) identical to a bond's maturity
B Duration measures a bond's sensitivity to a change in interest rates. The longer the duration, the greater the change in a bond's price with respect to interest rate changes.
If a customer buys a 6% bond maturing in 8 years on a 7.33 basis, the price of the bond is A) inverted B) above par C) below par D) at par
C
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 increased B) cannot be determined C) has declined D) has stayed at par
C When inflation is on the rise, interest rates often rise. When interest rates increase, bond prices may be expected to decline.
Which of the following factors has an inverse relationship to a bond's duration? A) Time to maturity B) Rating C) Yield to maturity D) Par value
C Yield to maturity has an inverse relationship to duration. That is, the higher the YTM, the lower (shorter) the duration. The longer the time to maturity, the higher (longer) the duration; it is a direct relationship. The bond's rating and par value are irrelevant.
All of the following factors have an inverse relationship to a bond's duration except A) time to maturity. B) coupon rate. C) current yield. D) yield to maturity.
A
Five years ago, an investor purchased an ABC Corporation BBB-rated debenture with a coupon of 6% maturing in 2037. Currently, new BBB-rated debentures maturing in 2037 are being issued with coupons of 5%. Based on the discounted cash flow method, one could say that the present value of the investor's security is A) more than the par value B) positive C) equal to the par value D) less than the par value
A
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) 8 shares for each bond C) 2 shares for each bond D) 1.2 shares for each bond
A
One would look at the average maturities when doing a cash flow analysis for A) mortgage-backed pass-through securities B) Brady bonds C) revenue bonds D) subordinated debentures
A
When current interest rates are at 6%, you would expect a bond with a nominal yield of 4% to be A) selling at a discount B) in danger of default C) selling at par D) selling at a premium
A
The current yield on a bond with a coupon rate of 5.5% selling at 110 is A) 6% B) 2% C) 5% D) 5.5%
C
When doing cash flow analysis on a mortgage-backed pass-through security, you would want to know A) size of the tranche being analyzed B) whether there is a real estate "bubble" C) the average maturities D) the quality of the mortgages
C
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? Bought it at a discount Bought it at a premium Sold it at a discount Sold it at a premium
1, 4
Which of the following bonds is most likely to exhibit the greatest volatility due to interest rate changes? A bond with A) a low coupon and a long maturity. B) a low coupon and a short maturity. C) a high coupon and a long maturity. D) a high coupon and a short maturity.
A
Which of the following is a discounted cash flow computation? A) Net present value B) Current yield C) Holding period return D) Standard deviation
A
A bond is selling at a premium over par value. Therefore, its A) none of the above B) nominal yield is less than its current yield C) yield to maturity is greater than its current yield D) current yield is less than its nominal yield
D
The XYZ Corporation's A-rated convertible debenture is currently selling for 90. If the bond's conversion price is $40, what is the parity price of the stock? A) $36 per share B) $44 per share C) $40 per share D) $22.50 per share
A
What happens to outstanding fixed-income securities when interest rates decline? A) Prices increase B) Coupon rates increase C) No change D) Yields increase
A
Your client has the following bonds in her portfolio: If interest rates were to suddenly rise, which of her bonds would suffer the greatest decline in market price? A) XYZ 3s of 44 B) QRS 9s of 43 C) NOP 12s of 42 D) TUV 6s of 45
A
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 probably rated investment grade D) is in danger of going into default
A
Current market interest rates are 6%. A bond with an 8% coupon would be most likely to have a net present value of zero when the bond is A) selling at a discount. B) selling at a premium. C) selling at par. D) called for redemption.
A A bond's NPV is most likely to be zero when its IRR is equal to the current market interest rate. In this case, that would be 6%. The only way for a bond with an 8% coupon to have a yield to maturity of 6% is if the bond is selling at a premium.
A company has two outstanding bond issues, both with a coupon rate of 8%. Bond A will mature in 2 years, while Bond B will mature in 15 years. If market interest rates were to increase to 10%, which of the following statements is CORRECT? A) Bond B will be selling at a greater discount than Bond A. B) Both bonds will be selling at a premium. C) The company will attempt to postpone the maturity of Bond A. D) Bond B will be selling at a greater premium than Bond A.
A An increase in interest rates in the marketplace will cause the price of a debt security to fall. The nearer the maturity, the shorter the duration, hence the less impact. Therefore, Bond B with a much longer maturity (and longer duration) will see its market price fall far more than Bond A.
If interest rates were to decline sharply, which of the following securities is likely to appreciate the most? A) 20-year zero-coupon Treasury bond currently trading at a deep discount B) 20-year municipal bond currently trading at par C) 20-year corporate bond currently trading at a small premium D) 20-year mortgage-backed security currently trading at a small discount
A As a rule, the longer the duration, the greater the price appreciation. In this case, all the fixed-income securities have 20-year maturities. Another general rule is that the lower the coupon on the bond, the longer the duration. The zero-coupon bond has the lowest coupon and would likely appreciate the most.
A bond selling for $20 above par would be quoted A) 102 B) 120 C) 1,200.00 D) 1,020.00
A 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.
An investment adviser representative has a client who prefers the safety of securities guaranteed by the U.S. Government, yet is concerned about volatility due to uncertainties in the future direction of interest rates. Which of the following recommendations would best address these concerns? A) 8% Treasury bond maturing in 2036 B) 6% Treasury bond maturing in 2035 C) 5% Treasury bond, maturing in 2037 D) Treasury STRIPS, maturing in 2036
A Generally speaking, those bonds with the highest coupons have the shortest duration, therefore, are the least subject to interest rate risk. STRIPS, which are zero-coupon bonds, are the most volatile because they have the longest duration. The actual calculation of the duration of each of the other bonds given is beyond the scope of this exam.
Several years ago, an investor purchased an investment-grade bond with a 6% coupon. Today that bond is priced to yield 4.6% to maturity in 5 years. If the bond is called at par in one year, the bond's yield would be A) less than 4.6%. B) the coupon rate of 6% because it is called at par value. C) 4.6%. D) more than 4.6%.
A Let's take things in order. A bond with a 6% coupon is showing a YTM below 6%, the bond must be selling at a premium. When bonds selling at a premium are called in advance of the maturity date, the "loss" (the difference between the premium and the par value") is recognized sooner than expected. This results in a yield to call (YTC) that is less than the YTM.
Your client with $100,000 to invest is looking for maximum current income. Which of the following would offer the highest current return? A) $100,000 market value of corporate bonds selling at a premium and yielding 6% to maturity B) $200,000 of utility common stock paying a current dividend of 3.5% C) $100,000 of zero-coupon bonds with a yield to maturity of 6% D) $100,000 AA-rated corporate bonds trading at par with a 6% coupon rate
A Maximizing current income excludes zero-coupon bonds because there is no current income. Now, to the correct choice. Why does a bond sell at a premium over par? Although there are exceptions, primarily it is because the coupon rate on that bond is higher than the current market interest rate. Therefore, with a higher coupon rate, the current income on the same amount of principal invested ($100,000 in our question) will always be higher for a bond selling at a premium. That is the K.I.S.S (Keep It Simple Student) answer.
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 below $48 per share B) somewhat above $48 per share C) somewhat below $30 per share D) somewhat above $30 per share
A 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. Because 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.
An investor is considering a 10-year stripped U.S. Treasury and a 10-year U.S. Treasury note, both with a yield to maturity of 4.8%. Compared to the note, the strip has A) less reinvestment risk and more interest rate risk. B) more reinvestment risk and less interest rate risk. C) more liquidity risk and less interest rate risk. D) more interest rate risk and less liquidity risk.
A The strip is a zero-coupon security so it has no cash flows to reinvest and therefore no reinvestment risk. However, it has more interest rate risk (longer duration) than the Treasury note. Remember, the duration of a zero-coupon bond is its maturity date while any debt security paying periodic interest (Treasury notes pay semiannually) will always have a duration shorter than its length to maturity.
Richard purchased a 30-year bond for 103½ with a stated coupon rate of 8.5%. What is the approximate yield to maturity for this investment if Richard receives semiannual coupon payments and expects to hold the bond to maturity? A) 8.68% B) 8.19% C) 9.36% D) 8.50%
B No calculation is necessary here. Why not? Because anytime a bond is purchased at a premium over par (103½% is a premium), the YTM must be less than the nominal (coupon) rate. There is only one choice lower than 8.5%. It isn't about your computational skills; it is about your understanding the relationship between prices and yields.
If investors hold bonds until maturity, their realized rate of return, assuming all interim cash flows are reinvested at that same rate, would be equal to A) the income return. B) the yield to maturity. C) the price return. D) the coupon return.
B The yield to maturity is an investor's total return if they purchase the bond at any point and then hold it until maturity, assuming all interim cash flows are reinvested at that same YTM. This, therefore, takes into consideration any capital gain or loss and therefore the yield to maturity will fluctuate with the bond's price.
Five years ago, an investor purchased an ABC Corporation BBB-rated debenture with a coupon of 6% maturing in 2037. Currently, new BBB-rated debentures maturing in 2037 are being issued with coupons of 7%. Based on the discounted cash flow method, one could say that the present value of the investor's security is A) negative B) more than the par value C) less than the par value D) equal to the par value
C
For a bond selling at a discount, the yield to maturity will be A) equal to the nominal yield B) lower than the nominal yield C) higher than the nominal yield D) higher than the yield to call
C
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
C Current yield for any security is always computed on the basis of the current market value.
Adam has a portfolio of bonds worth approximately $125,000. He is concerned that interest rates will increase in the near term. Which of the following would be the least desirable strategy for Adam? A) Sell Treasury bonds and buy Treasury bills B) Sell long-term bonds and buy short-term bonds C) Sell bonds with a short duration and buy those with a longer duration D) Sell bonds with lower coupons and buy those with higher coupon
C Prices of bonds decline when interest rates rise. An investor expecting an increase in interest rates should sell more volatile bonds and purchase less volatile bonds. Bonds with higher coupons and shorter durations are less price volatile than low coupon, long-term, and long duration 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 6 years at 103. In the computation of the bond's yield to call, which of the following would be a factor? A) Future value of $1,200 B) Present value of $1,030 C) Interest payments of $30 D) 20 payment periods
C The 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 6-year call, there are only 12 payment periods, not 20. The present value is $1,200 and the future value is $1,030, the reverse of the numbers indicated in the answer choices.
DERP Corporation has issued 5% convertible debentures maturing in 2040. The conversion price is $40 and the common is currently trading at $48 per share. One would expect the DERP debentures to be selling somewhat A) below $1,000. B) below $1,200. C) above $1,200. D) above $1,000.
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 $48 per share, the parity price of the convertible would be $1,200 (25 x $48). Because convertible securities generally sell at a slight premium over their parity price, the debentures should have a current market value a bit higher than $1,200.
When the market interest rate is 8%, which of the following equally-rated bonds will have the potential for the greatest relative price volatility to changes in interest rates? A) 12% coupon bond with 12 years to maturity B) 12% coupon bond with 6 years to maturity C) 8% coupon bond with 12 years to maturity D) 8% coupon bond with 6 years to maturity
C The question is all about the effects of a bond's duration on its price volatility. As the duration increases, so does the price volatility. When comparing bonds, generally, a low coupon bond is more susceptible to price fluctuations than a high coupon bond and a long-term bond is more susceptible to price fluctuations than a short-term bond. The bond with the lowest coupon (8%) and longest maturity (12 years) is subject to the greatest price volatility. The bond with the shortest duration, and least price volatility, would be the one with the highest coupon (12%) and the nearest maturity (6 years).
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) warrants attached B) increased its par value to $2,000 to account for the split C) preemptive rights D) an antidilution clause
D
An investor purchases a Treasury note and the confirmation shows a price of $102.21. Rounded to the nearest cent, the investor's cost, excluding commissions, is A) $1,022.21. B) $102.21. C) $1,022.10. D) $1,026.56.
D
Market interest rates rise by 50 basis points. If each of these bonds has about the same maturity date, which of the following would decline the least? A) AAA corporate bond carrying a 6% coupon B) Treasury bond issued at par carrying a 6% coupon C) AA corporate bond carrying a 7% coupon D) Treasury bond issued at par carrying a 7% coupon
D All other factors being equal, bonds of higher quality experience less price volatility than do bonds of lower quality. Treasury securities have higher quality than other debt securities due to the elimination of default risk. When market interest rates rise, bonds having higher coupons will decline less than bonds having lower coupons.
A bond investor's portfolio consists of the following 3 bonds: 1. ABC First Mortgage bond, current market value of $4 million with a duration of 5 years. 2. DEF Debenture, current market value of $5 million with a duration of 8 years. 3. U.S. Treasury bond, current market value of $1 million with a duration of 10 years. What is the average duration of the portfolio? A) 6.54 years B) 7.67 years C) 3.04 years D) 7 years
D It is unlikely that you will have a question this complicated on the exam, but, just in case, we wanted to show you the way to do it. Computing average duration of a bond portfolio involves taking each bond and figuring the proportion of the portfolio its duration represents. In this question, ABC is 40% of the portfolio so we take 40% of its 5-year duration (2). Then, we do the same with the other two bonds. DEF is 50% of 8 (4) and the Treasury bond is 10% of 10 (1). When we add the 3 numbers together, it results in an average duration of 7 years.
