Unit 2
A bond purchased at $900 with a 5% coupon and a five-year maturity has a current yield of: A) 5.56% B) 7.80% C) 5.00% D) 7.40%
A) 5.56% Current yield is determined by dividing the 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.
An investor purchased a bond with a 6% coupon rate exactly three months after its most recent interest payment. As a result: (2 answers) A) the buyer will pay $15 accrued interest B) the buyer will receive $15 accrued interest C) the seller will pay $15 accrued interest D) the seller will receive $15 accrued interest
A) the buyer will pay $15 accrued interest D) the seller will receive $15 accrued interest First of all, a 6% bond pays $30 semiannually (half of $60 per year). Therefore, the accrued interest on this bond purchased halfway between interest payments is half of $30 or $15. That $15 dollars is added to the purchaser's cost and will be paid to the seller as it represents the interest the seller earned for holding the bond for three months. At the next interest payment date, the purchaser will receive the full $30 payment representing the accrued interest paid to the seller plus the interest earned for the three months the purchaser held the bond.
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) $1.00 per bond B) $2.50 per bond C) $2.00 per bond D) $1.50 per bond
B) $2.50 per bond The first bonds are 5% and pay $50 per year per bond. The new bonds are 5¼% and pay $52.50 per year per bond. A 5% coupon rate × $1,000 face value = $50 per year per bond; a 5¼% coupon rate × $1,000 face value = $52.50 per year per bond.
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) 9.36% B) 8.19% C) 8.68% D) 8.50%
B) 8.19% 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 of the relationship between prices and yields.
Which of the following would make a corporate bond more subject to liquidity risk? (2 answers) A) Short-term maturity B) Long-term maturity C) High credit rating D) Low credit rating
B) Long-term maturity D) Low credit rating 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 will 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.
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) $102.21 B) $1,022.10 C) $1,026.56 D) $1,022.21
C) $1,026.56 Treasury notes are quoted in 32nds, where each 32nd equals $0.3125. The 102 in the quote equals $1,020 and the 21/32 is an additional $6.56, bringing the total to $1,026.56.
What is the name of the bond document that states the issuer's obligation to pay back a specific amount of money on a specific date? A) The debenture B) The bond agreement C) The indenture D) The bond coupon
C) The indenture The indenture is the contract that sets forth the promises of the issuer of the bond and the rights of the lenders (the investors). A debenture is an unsecured long-term debt security (that has an indenture). One of the details in the indenture is the coupon (interest) rate that will be paid on the loan.
A European corporation seeking a short-term loan would probably be most concerned about an increase to: A) the eurobond rate B) the Fed funds rate C) the SOFR D) the U.S. Treasury bill rate
C) the SOFR For more than 40 years, the London Interbank Offered Rate—commonly known as LIBOR—was a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages, and corporate debt. Over the last decade, LIBOR has been burdened by scandals and crises. Effective January 2022, LIBOR is no longer being used to issue new short-term loans in the U.S. It was replaced by the Secured Overnight Financing Rate (SOFR) which many experts consider a more accurate and more secure pricing benchmark. As is always the case with NASAA, we do not know when the exam questions will be updated. One thing we can promise you is that any question relating to this topic will not have both LIBOR and SOFR as choices, so you should choose whichever one appears.
The current yield on a bond with a coupon rate of 7.5% currently selling at 105½ is approximately: A) 8.00% B) 7.50% C) 6.50% D) 7.11%
D) 7.11% 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 7.11%.
The price of which of the following will fluctuate most with a change in interest rates? A) Short-term bonds B) Money market instruments C) Common stock D) Long-term bonds
D) Long-term bonds Long-term debt prices fluctuate more than short-term debt prices as interest rates rise and fall.
The yield to maturity is: A) determined by dividing the coupon rate by the current market price of the bond B) the annualized return of a bond if it is held to call date C) set at issuance and printed on the face of the bond D) the annualized return of a bond if it is held to maturity
D) the annualized return of a bond if it is held to maturity The yield to maturity reflects the annualized return of a bond if it is held to its 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 yield to call.
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) $1,027.81 B) $1,020.25 C) $1,022.50 D) $102.25
A) $1,027.81 Treasury notes are quoted in 32nds, where each 32nd equals $0.3125. The 102 in the quote equals $1,020 and the 25/32 is an additional $7.81, bringing the total to $1,027.81.
A client approaches the investment adviser representative handling the advisory account with a request to find a preferred stock that will offer a 5.4% income return. The IAR suggests a stock paying a $1.73 quarterly dividend. That stock will meet the income objective if it has a current market price of: A) $128.15 B) $32.04 C) $37.37 D) $78.03
A) $128.15 The first thing to do is annualize the dividend by multiplying the $1.73 by 4. Once we have the annual dividend of $6.92, divide by 5.4% and the result is $128.148148 or $128.15 properly rounded. If your math skills are a bit rusty, all you have to do is multiply each of the 4 choices by 5.4% to see which one is closest to $6.92.
An investor buys 10M RAN 6.6s of 32 at 67. What is the total purchase price? A) $6,700 B) $10,200 C) $10,000 D) $6,600
A) $6,700 For those of you not familiar with bond listings, this means that the investor 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.
If an investor pays 95.28 for a Treasury bond, how much did the bond cost? A) $958.75 B) $9,528.00 C) $95.28 D) $950.28
A) $958.75 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.
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
A) 12 shares for each bond 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.
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) 20 shares B) 24 shares C) 20 shares plus cash for fractional shares D) 2.4 shares
A) 20 shares The conversion ratio always uses the par value ($1,000), never the current market price. With a par value of $1,000 and a conversion price of $50 per share, this bond is convertible into 20 shares ($1,000 / $50). Remember, the number of shares in a conversion never changes. When the market price changes, the parity price changes, but that isn't relevant to this question.
GHI currently has earnings of $4.00 and pays a $0.50 quarterly dividend. If GHI's market price is $40.00, the current yield is: A) 5.00% B) 1.25% C) 10.00% D) 15.00%
A) 5.00% The quarterly dividend is $0.50, so the annual dividend is $2.00; $2 ÷ $40 market price = 5% current yield.
Which of the following indicates a bond selling at a premium? A) 8% coupon yielding 7.5% B) 8% coupon yielding 8.5% C) 5% coupon yielding 5.0% D) 10% coupon yielding 11.0%
A) 8% coupon yielding 7.5% Whenever the yield is less than the coupon, the bond is selling at a premium over the par value. In our question, the coupon or nominal rate is 8%, but the bond is selling at a price that makes its current yield 7.5%. That happens only when the investor pays more than par (face) value, a premium, for the bond.
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? (2 answers) A) Bought it at a discount B) Bought it at a premium C) Sold it at a discount D) Sold it at a premium
A) Bought it at a discount D) Sold it at a premium 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.
Which of the following are characteristics of negotiable jumbo CDs? (2 answers) A) Issued in amounts of $100,000 to $1 million or more B) Typically pay interest on a monthly basis C) Always mature in one to two years with a prepayment penalty for early withdrawal D) Trade in the secondary market
A) Issued in amounts of $100,000 to $1 million or more D) Trade in the secondary market Negotiable jumbo CDs are issued for $100,000 to $1 million or more 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 semiannual basis, not monthly.
Which of the following are characteristics of commercial paper? (2 answers) A) It represents a loan by the holder to the issuer B) It is a certificate of ownership in the corporation C) It is commonly issued to raise working capital for a corporation D) It is junior in preference to convertible preferred stock
A) It represents a loan by the holder to the issuer C) It is commonly issued to raise working capital for a corporation 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 should be considered a liquid asset for emergency fund purposes? A) Savings account B) A personal residence C) Life insurance cash values D) Stock mutual funds
A) Savings account A savings account can be accessed immediately if funds are needed right now. The redemption period for mutual funds is seven days. That is quick but not same day as the savings account is. Another factor is that there could be a redemption or back-end load to cash in the fund shares, while there is no fee to draw on a savings account. Life insurance cash values can take 30 days or longer, and selling a house is not the way to meet an emergency.
Assume that a corporation issued 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? (2 answers) A) The current yield on the debenture will be higher than 5% B) The current yield on the debenture will be lower than 5% C) The dollar price per bond will be higher than par D) The dollar price per bond will be lower than par
A) The current yield on the debenture will be higher than 5% D) The dollar price per bond will be lower than par 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.
A bond issued by the GEMCO Corporation has been rated BBB by a major bond-rating organization. This bond would be considered: A) an investment-grade corporate bond B) callable C) a high-yield corporate bond D) secured
A) an investment-grade corporate bond 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.
For a bond selling at a discount, the yield to maturity will be: A) higher than the nominal yield B) higher than the yield to call C) equal to the nominal yield D) lower than the nominal yield
A) higher than the nominal yield 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.
Although bonds are issued by many different entities, most of their features are the same. With few exceptions, included in that list of similarities would be all of these except: A) safety of principal B) price movement that is inverse to interest rates C) a stated interest date D) a stated maturity date
A) safety of principal The safety of principal largely depends on the issuer. For example, there are no bonds as safe as U.S. Treasury bonds. On the other hand, there are some corporate bonds that are quite speculative. In general, all bonds have a stated maturity date , interest rate, and interest payment date, and they are exposed to interest rate risk. That is the risk that as interest rates rise, the price of the bonds will decline.
The annual interest payment divided by the current dollar price of a bond is: A) the current yield B) the nominal yield C) the tax-equivalent yield D) the yield to maturity
A) the current yield 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.
The minimum face amount of a negotiable CD is: A) $50,000 B) $100,000 C) $25,000 D) $10,000
B) $100,000 Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are usually traded in blocks of $1 million or more.
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 AA rated corporate bonds trading at par with a 6% coupon rate B) $100,000 market value of corporate bonds selling at a premium and yielding 6% to maturity C) $100,000 of zero-coupon bonds with a yield to maturity of 6% D) $200,000 of utility common stock paying a current dividend of 3.5%
B) $100,000 market value of corporate bonds selling at a premium and yielding 6% to maturity When you read the full question, including the answer choices, you can immediately disregard two of the four options. With $100,000 to invest, the answer cannot be to purchase $200,000 of anything. 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 KISS (Keep It Simple Student) answer. For those who want to delve further, here we go. For example, if current market interest rates are 6% (likely the case here because the AA rated bonds with a 6% coupon are trading at par), then a bond with a 7% coupon will be selling at a premium. The current yield on $100,000 of the 6% bonds would be $6,000 per year. If a bond's yield to maturity is 6% and it is selling at a premium, it must be that the coupon is higher than 6%. For example (and we're doing the math that you won't have to do), $93,000 par (93 times $1,000) value of bonds with a 7% coupon, selling at $100,000 (a premium over the $93,000), and maturing in 10 years has a YTM of 6%. Investing $100,000 into these bonds will result in current income of $6,510 per year ($93,000 par times the 7% coupon).
A bond selling for $20 above par would be quoted: A) 120 B) 102 C) 1,200 D) 1,020
B) 102 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.
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) 2% B) 5% C) 10% D) not determinable from the information given
B) 5% 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%.
The current yield on a bond with a coupon rate of 5.5% selling at 110 is: A) 6.0% B) 5.0% C) 2.0% D) 5.5%
B) 5.0% The current yield of any security, equity, or debt is always the income return (dividend or interest) divided by the current market price. In this case, it is the annual interest of $55 ($1,000 × 5.5%) divided by $1,100, and that equals 5%.
The value of which of the following would be least likely to be impacted by changes in interest rates? A) A laddered bond portfolio B) A bank CD maturing in 5 years C) A convertible preferred stock D) A U.S. Treasury bond issued 25 years ago with a 30-year maturity
B) A bank CD maturing in 5 years This question is dealing with interest rate (or money-rate) risk. That risk refers to the inverse relationship between the price of fixed-income investments and interest rates. That is, when interest rates go up, the price of fixed-income securities falls (and vice versa). However, this risk only affects investments that are marketable (those with a fluctuating market price). Bank CDs are nonnegotiable (we're not referring to the negotiable jumbo CDs with a maturity of one year or less) and, as a result, will not fluctuate in price, regardless of changes to interest rates. In this case, interest rate risk is eliminated. That is one of the reasons why the exam's first choice for capital preservation is insured bank CDs. Will a laddered bond portfolio reduce interest rate risk? Yes, but it will not eliminate it. Is a convertible preferred (or bond) less subject to changes in interest rates than one without the conversion feature? Yes, but the risk is still there. Does a 30-year T-bond with 5 years remaining to maturity have a short duration and, therefore, a reduced interest rate risk? Yes, but the price of the bond will still be affected by changes in the market interest rates.
Which of the following statements regarding credit risk is not true? A) Credit risk can be assessed by referring to the independent credit rating agencies B) An A-rated mortgage bond has less credit risk than a AA rated debenture C) Credit risk is the probability of the issuer defaulting on their payment obligations D) A rating downgrade may or may not result in a lower market price for a bond
B) An A-rated mortgage bond has less credit risk than a AA rated debenture The rating agencies split bonds into two distinct classes: investment grade and noninvestment grade. The highest investment-grade rating is AAA (Aaa) and the lowest is BBB (Baa). The more As the bond has, the lower the credit risk. That is why the AA debenture has less credit risk than the A-rated mortgage bond. The rating agencies take into consideration any collateral, such as a mortgage, when giving the rating.
An 8% corporate bond is offered on an 8.25 basis. Which of the following statements are true? (2 answers) A) Nominal yield is higher than YTM B) Current yield is higher than nominal yield C) Nominal yield is lower than YTM D) Current yield is lower than nominal yield
B) Current yield is higher than nominal yield C) Nominal yield is lower than YTM 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 a discount to par. For discount bonds, the nominal yield is lower than both the current yield and the yield to maturity.
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) GHI Index Fund B) DEF High-Yield Bond Fund C) JKL Municipal Bond Fund D) ABC Growth and Income Fund
B) DEF High-Yield Bond Fund High-yield (junk) bonds, although carrying more risk, produce higher current income than other funds.
A bond with a par value of $1,000 and a coupon rate of 8% paid semiannually is currently selling for $1,150. The bond is callable in 10 years at $1,100. In the computation of the bond's yield to call, which of these would be a factor? A) Future value of $1,150 B) Interest payments of $40 C) Present value of $1,100 D) 60 payment periods
B) Interest payments of $40 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 an 8% coupon will make $40 semiannual interest payments. With a 10-year call, there are only 20 payment periods, not 60. The present value is $1,150 and the future value is $1,100, the reverse of the numbers indicated in the answer choices.
Which of the following is unlikely to be issued at a discount? A) Commercial paper B) Jumbo CD C) Zero-coupon bond D) Treasury bill
B) Jumbo CD Jumbo (negotiable) CDs are one of the few money market instruments issued at face value. Unlike those issued at a discount, they are interest bearing.
A customer purchased new issue bonds at par two years ago. Since then, the cost of living as measured by the consumer price index (CPI) has declined by almost half and the current yield on the bonds has also declined. Which of the following best describes the value of the bonds purchased? A) Their market price has declined B) Their market price has increased C) It cannot be determined from the information presented D) Their market price has remained unchanged
B) Their market price has increased The annual coupon interest payment on the bonds has not changed, but the current yield has. If the yield has decreased, it means the market price of the bonds must have increased. For example, if the bond has a 5% coupon but the current yield is now 4%, the bond's price must be 125 ($1,250) because $50 annual interest on $1,250 is a current return of 4%. Remember the inverse relationship: if interest rates decline, bond price rise (and vice versa).
One of the likely consequences of a rating downgrade on a bond is: A) the current yield will be reduced B) a reduction in the market price of the bond C) the call feature will be employed D) an increase to the coupon by the issuer
B) a reduction in the market price of the bond 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 rating 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.
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 discount C) at a premium D) at par
B) at a discount The YTM is greater than the nominal yield, or coupon yield. Therefore, the bond is trading at a discount.
With respect to safety of principal, of the following investments, the least risky is: A) common stock B) corporate AA debentures C) equity options D) exchange-listed warrants
B) corporate AA debentures The least risky investment listed is the corporate debenture because, as a debt instrument, it has priority over the others.
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 price return B) the yield to maturity C) the coupon return D) the income return
B) the yield to maturity 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 takes into consideration any capital gain or loss; therefore, the yield to maturity will fluctuate with the bond's price.
An investor buys 10M 6.6s of 10 at 67. The investor will receive annual interest of: A) $820 B) $1,000 C) $660 D) $670
C) $660 Interpret "10M" as "$10,000 worth of." The investor receives the nominal yield of the bonds, which is 6.6% of $10,000. The M is from the roman numeral for 1,000.
During the past year, the market price of Kapco common stock has increased from $47 to $50 per share. Over that period, Kapco's earnings per share (EPS) have increased from $2.00 to $2.50 per share, and their dividend payout ratio has decreased from 50% to 40%. Based on this information, the current yield on Kapco common stock is: A) 2.13% B) 4.26% C) 2.00% D) 6.34%
C) 2.00% The current yield on a stock is computed by dividing the annual dividend rate by the current market price. With EPS of $2.50 and a 40% payout ratio, the annual dividend is $1.00. This dollar divided by the current market price of $50.00 results in a current return of 2%.
GHI common stock has a $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) 6.7% D) 10%
C) 6.7% 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%). The par value of the common stock has no relevance to this question.
Which of the following indicates a bond selling at a discount? A) 7% coupon yielding 6.5% B) 10% coupon yielding 9% C) 7% coupon yielding 7.5% D) 5% coupon yielding 5%
C) 7% coupon yielding 7.5% Whenever the yield is higher than the coupon, the bond is selling at a discount from the par value. When the question says "yielding," it is generally referring to the yield to maturity. However, whether referring to the YTM or the current yield, the answer here is the same: the yield is higher than the coupon.
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) A-rated general obligation municipal bond B) Baa-rated municipal revenue bond C) Aa-rated corporate debenture D) Ba-rated corporate mortgage bond
C) Aa-rated corporate debenture A bond's rating takes into consideration all factors, including collateral and tax base. The higher the rating, the lower the credit risk.
All the following securities are issued at a discount except: A) commercial paper B) zero-coupon bonds C) CDs D) Treasury bills
C) CDs 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.
When an income-oriented investor wishes to compute the current yield of a specific investment, which one of these items would not be considered? A) Current market price B) Dividends paid C) Net present value D) Interest coupon
C) Net present value The current yield of any investment is the income return (dividends on equity; interest on debt) divided by the current market price. The NPV is a tool that evaluates the reasonableness of the price of an investment.
Which of the following statements regarding a $1,000 corporate 8.50% bond offered at 110 is true? A) The bond's current yield is lower than its yield to maturity B) To determine the bond's current yield, its stated rate must be compared against other fixed-rate investments in the client's portfolio C) The bond's current yield is calculated by dividing its annual interest by its current market price D) The bond is a discount bond
C) The bond's current yield is calculated by dividing its annual interest by its current market price A bond's current yield is calculated by dividing its annual interest by its current (market) price. In this case, it would be $85 ÷ $1,100. The current yield will be higher than its yield to maturity, which takes into consideration the $100 difference between the purchase price and the par value (a loss of $100). The determination of a bond's yield is unrelated to other bonds. In addition, this bond is selling at a premium (more than $1,000), not at a discount (less than $1,000).
An investor purchased a 6% corporate bond selling at par. Because the next interest payment date is not for another two months, the bond carries accrued interest of $20. Disregarding commissions, which of the following statements is correct? A) The buyer will pay $1,000, and the seller will receive $1,020 B) The buyer will pay $1,020, and the seller will receive $1,000 C) The buyer will pay $1,020, and the seller will receive $1,020 D) The buyer will pay $1,020, and the seller will receive $980
C) The buyer will pay $1,020, and the seller will receive $1,020 When a bond is purchased or sold in between semiannual interest payment dates, the interest that has accrued since the previous payment is added to the purchaser's price. In our question, $1,000 plus $20 equals $1,020. That interest belongs to the seller who has held that bond since the previous interest payment. Therefore, the seller receives the selling price ($1,000) plus the accrued interest of $20 for a total of $1,020. Remember, the buyer will be getting the full six months interest of $30 (6% of $1,000 is $30 semiannually) in two months. That represents $10 for the two months the bond was held plus reimbursement for the four months of interest paid to the seller. You will not need to know how to calculate the accrued interest; it will be given in the question as is the case here.
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) preemptive rights C) an antidilution clause D) increased its par value to $2,000 to account for the split
C) an antidilution clause 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 a bond is selling at a premium, a bond callable at par will: A) have a current yield that is less than the YTM B) have a YTM that is more than the coupon C) have a YTC that is less than the YTM D) have a YTC that is more than the coupon
C) have a YTC that is less than the YTM A bond selling at a premium will always have a yield that is lower than the coupon. The highest of the computed yields will be the current yield because, unlike the YTM or the YTC, the loss at payoff of the principal is not included. Comparing YTM and YTC, because in both cases the investor is getting back the same par value, the YTC is lower because the loss is occurring sooner (bonds are always called prior to maturity).
An individual purchases a $10,000 CD with a 5-year maturity from her local bank branch. In doing so, she is eliminating: A) inflation risk B) purchasing power risk C) interest rate risk D) opportunity cost
C) interest rate risk Interest rate risk is the uncertainty that changes to market interest rates will cause the price of an investment to fluctuate in value. Because this type of bank CD is nonnegotiable (it doesn't trade), changes to interest rates do not impact the principal value of the investment—she can always redeem the CD for $10,000 (although there could be a penalty for early withdrawal). As a fixed-income investment, though, it does suffer from purchasing power risk, also known as inflation risk, and the investor has the opportunity cost of settling for a lower rate of return than could potentially be obtained with equities.
When an investor notices that a bond's coupon yield is lower than its current yield, this is an indication that the bond: A) is in danger of going into default B) is nearing its maturity date C) is selling at a discount D) is selling at a premium
C) is selling at a discount A bond's current yield is the coupon (nominal) yield divided by the current market price. When those two are the same, the bond is selling at its par (face) value. When selling below par (at a discount), the coupon yield will be lower than the current yield (if you pay less, you get more). Although a bond's market price will generally get closer to par as the maturity date approaches, anytime the price of the bond is below par (selling at a discount), its current yield will be higher than the coupon.
A client plans to purchase a home within the next three months and will require $100,000 for the down payment. The client has the money in her DDA and asks you for your recommendation as to the best place to put the money. Your recommendation would probably be for the client to: A) use the money to buy IPOs until the home is purchased B) move the money into a 1-year CD C) keep the money where it is D) purchase a GNMA for the monthly income
C) keep the money where it is DDA stands for demand deposit account, usually a checking account at a bank. Because this client cannot afford any risk to principal, and the bank account is covered by FDIC insurance, this is the most attractive option. The 1-year CD would offer more income, but there would likely be a penalty for early withdrawal. Even though the GNMA is directly backed by the U.S. government, it is subject to market fluctuation, a risk this client cannot take.
Bond prices are quoted as a percentage of: A) market value B) conversion value C) par value D) stated value
C) par value Bond prices are quoted as a percentage of par value. On the exam, the par value of bonds is always $1,000.
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) selling at par C) selling at a discount D) in danger of default
C) selling at a discount With the market rate of return at 6%, a 4% bond just isn't as valuable, so the only way investors will be interested is if they can acquire it at a discount. That discount works out to be a figure that will result in a 6% return for the purchaser. Remember, as interest rates go up, bond prices go down, and vice versa.
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 be called B) the bond will go into default C) the bond is selling at a discount D) the coupon will be increased
C) the bond is selling at a discount There is excess information in this question (a favorite trick of the test authors). We don't need to know the call price or the maturity date. We have a 6% bond when current market interest rates are 8%. The inverse relationship between interest rates and bond prices teaches us that this bond is going to be selling at a discount. Bonds are called when interest rates go down, not when they rise. The coupon on a bond is fixed.
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) the current dividend yield has decreased B) the current dividend yield has remained the same C) the current dividend yield has increased D) the dividend yield to maturity has decreased
C) the current dividend yield has increased The current dividend yield is income dividend divided by price. If the price of a stock decreases and the dividend remains the same, the dividend yield will increase.
The GHIJ Corporation has a 3% convertible debenture outstanding with a conversion price of $40. The bond's current market price is 126. The most probable reason for this is: A) the current market price of the GHIJ common stock is approximately $35 per share B) interest rates have risen since the debenture was issued C) the current market price of the GHIJ common stock is approximately $50 per share D) GHIJ's earnings have risen since the debenture was issued
C) the current market price of the GHIJ common stock is approximately $50 per share With a conversion price of $40, the bond is convertible into 25 shares. Convertible securities generally sell at a slight premium to their parity price, which—at $1,260—would be $50.40 per share.
An investor purchasing 10 corporate bonds at a price of 102¼ each will pay: A) $10,202.50 B) $1,022.50 C) $1,020.25 D) $10,225.00
D) $10,225.00 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.
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) $40.00 per share B) $44.00 per share C) $22.50 per share D) $36.00 per share
D) $36.00 per share If the bond's conversion price is $40, it means the bond is convertible into 25 shares ($1,000 par value divided by the $40 conversion price). Parity means equal, so what does each share have to be worth so that 25 of them are equal to $900? Remember, bonds are quoted as a percentage of the $1,000 par value, so a price of 90 means $900. Dividing $900 by 25 shares results in a parity price of $36. That does not mean the stock is selling for $36 per share (probably a bit less), but at $36, holding the bond, or converting into the stock, gives the investor equal value. Some students quickly see that the bond is 10% below its par value, so the stock—to be equal—must be 10% below the conversion price. Take 10% off $40 and the result is $36. Either way works.
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) 5.50% B) 5.61% C) 4.99% D) 5.24%
D) 5.24% Corporate bonds are quoted as a percentage of the $1,000 par value. A market price of 105 is equal to $1,050 (105% × $1,000). Each $1,000, 5.5% bond pays $55 of interest annually ($1,000 × 5.5% = $55). Current yield equals the annual interest divided by the current price of $1,050. The calculation is $55 ÷ $1,050, which is equal to approximately 5.24%. Because the bond is at a premium, the current yield must be below the nominal yield, which removes two of the choices from consideration.
Which of the following would be most likely to increase a bond's liquidity? A) A longer maturity B) A lower rating C) No call protection D) A higher rating
D) A higher rating 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 is, the greater the chance is 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. The absence of call protection is negative to many investors, thus limiting the number of potential investors.
A bond with a par value of $1,000 and a coupon rate of 5%, paid semiannually, is currently selling for $1,200. The bond matures in 10 years and is callable in six 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) 20 payment periods D) Interest payments of $25
D) Interest payments of $25 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 5% coupon will make $25 semiannual interest payments. With a six-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.
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 nominal yield of the bonds would increase C) The price of the bonds would stay the same D) The price of the bonds would decrease
D) The price of the bonds would decrease Bond prices fall when interest rates rise because bond prices have an inverse relationship with interest rates.
When comparing a time deposit account and a demand deposit account, you would expect: A) lower penalties for withdrawing funds from a time deposit account B) FDIC insurance on the time deposit account but not on the demand deposit account C) easier access to the funds in a time deposit account D) a higher rate of interest paid on the time deposit account
D) a higher rate of interest paid on the time deposit account The best example of a time deposit account is a CD. Money is deposited for a fixed length of time, generally at a fixed interest rate. Demand deposit accounts are checking accounts. Because the bank expects to have longer use of time deposit funds, interest rates are generally higher. DDAs offer the instant access of check-writing (or online payments). Typically CDs, have penalties for early withdrawal; there is no such charge on a checking account. Both are covered by FDIC up to the applicable limit.
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 $48 per share B) somewhat below $30 per share C) somewhat above $30 per share D) somewhat below $48 per share
D) somewhat below $48 per share 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.
All of the following are true of negotiable, jumbo certificates of deposit except: A) they are usually issued in denominations of $100,000 to $1 million or more B) they usually have maturities of one year or less C) they are readily marketable D) they are secured obligations of the issuing bank
D) they are secured obligations of the issuing bank 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.
