Unit 2 - Debt Securities
The minimum face amount of a negotiable CD is:
$100,000.
A customer bought a bond that yields 6-½% with a 5% coupon. If the bond matures at this point, the customer will receive:
1,025
Private label CMOs never use government issued securities as collateral can use government issued securities as collateral are considered as safe as agency issued CMOs can carry greater risk than agency issued CMOs
II and IV
Bondholders may not take action against the corporation if it fails to make interest payments for:
Income bonds pay interest only if earnings are sufficient and declared by the board of directors. This is not true of any of the other fixed-income securities listed (debentures, subordinated debentures, or convertible bonds).
Consider a municipal bond issue that has been defeased. Which of the following statements is NOT true?
The rating on the issue decreases. -Once a municipal issue has been defeased (pre-refunded), its rating increases as it is now backed by U.S. government securities held in escrow. As the rating of a bond increases, so does its marketability. Once defeased, the issue is no longer considered part of the issuer's outstanding debt (although it will remain outstanding with interest paid until called).
Debt instruments put up for auction by the U.S. treasury that offer intermediate maturities best describes:
Treasury notes. -T-notes are the intermediate maturity (two to ten years). T-bills are short term (less than one year), Anticipation notes are short term revenue notes, and T-bonds are long term (ten years or more).
If a customer sells a zero-coupon bond before maturity, gain or loss will be the difference between sales proceeds and:
accreted value.
Treasury bills are:
issued in book entry form.
T-bills are quoted:
on an annualized discount yield basis.
For both U.S. Treasury notes and Ginnie Maes:
quotes are as a percentage of par, in 32nds.
A corporation with a single outstanding bond issue chooses to refund this debt. This means that the corporation:
replaces one debt with another.
Yield quotes on CMOs are based on the:
tranche's expected life.
A customer purchases ten 8% Treasury notes at 101-16. What is the dollar amount of this purchase?
$10,150
Which of the following statements describes the discount rate?
Charge on loans to member banks by the New York Federal Reserve Bank.
A customer expresses the need to invest a fixed dollar sum now that will return a fixed dollar sum in 10 years. He mentions several investments. Of those listed which would not be a suitable recommendation for his objective?
Collateralized mortgage obligations (CMOs)
Which of the following debt securities does NOT have a fixed maturity date?
Collateralized mortgage obligations (CMOs) are mortgage-backed securities. Because mortgages are often paid off ahead of the scheduled maturity, the exact maturity date of a CMO is uncertain.
Which of the following interest rates is NOT market driven?
Discount rate. -The discount rate is set by vote of the Federal Reserve Board. The remaining interest rates are directly or indirectly set by their markets.
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.
II & IV The most marketable bonds have shorter maturities and higher credit ratings.
Which of the following types of bonds would be characterized by decreasing interest costs to the issuer?
Serial bonds.
Which of the following is TRUE concerning the payment of the repo rate?
The original seller pays the original buyer.
A money market mutual fund would be least likely to invest in which of the following assets?
U.S. Treasury notes. -A money market mutual fund typically invests in money market instruments, or those with a maturity date not exceeding 397 days. Treasury notes have maturity dates of 2-10 years.
A collateralized mortgage obligation (CMO) issued by a financial institution or a home builder would be known as
a private label issued CMO
All of the following statements regarding a 6% municipal bond that is puttable at par are true EXCEPT the:
bond is likely to trade at a discount in the secondary market when it is puttable. -Once a bond becomes puttable, the holder has the right to put the bond to the issuer at par. As a result, the bond would not trade below par in the secondary market. This effectively insulates the holder from interest rate risk-the risk that rising rates will force prices down.
The dated date on a municipal bond issue is the:
date on which the bonds begin accruing interest. -The dated date is the date on which newly issued bonds begin to accrue interest.
All of the following statements regarding municipal bond put options are true EXCEPT that the put option:
is generally exercisable immediately after the bond has been issued.
A Notice of Defeasance informs bondholders that:
the funds for the principal and the interest are in escrow. -A defeased issue is one in which the issuer placed U.S. government securities in the bank as collateral for the old issue.
If all of the following bonds mature on September 1, 2020, which would have the highest price?
6-1/4% coupon at 6.10
Which of the following statements regarding CMOs is TRUE?
CMO returns are affected by interest rate changes.
Your customer has listed income and safety of principal as his primary investment objectives. Which of the following might be the least suitable recommendation?
Sovereign debt securities
ABC Company issues a 10% bond due in 10 years. The bond is convertible into ABC common stock at a conversion price of $25 per share. The ABC bond is quoted at 90. Parity of the common stock is:
The bond is quoted at 90, so it is selling for $900. The parity price of the common stock is $22.50, calculated as follows: the bondholder could convert the bond into 40 shares of stock ($1,000 face amount / $25 per share = 40 shares). Because the bond has a current price of $900, divide $900 by 40 to get the underlying parity price (90% × $25 = $22.50).
Consider a municipal bond issue that has been defeased. Which of the following statements is NOT true?
The rating on the issue decreases.
The federal funds rate is the rate:
that banks charge each other for overnight loans and is subject to daily change.
If interest rates are dropping, an investor with a maturing bond will be most concerned with:
the difficulty in finding another investment with a like yield.
Which of the following are issued by the Federal Intermediate Credit Banks (FICB)? Discount notes. Debentures. Mortgage-backed securities. Equity securities.
I & II -FICB (Federal Intermediate Credit Banks) is one of the associations in the Federal Farm Credit Bank system that issues notes and bonds. Since the bonds are not backed by the government or by any specific assets, they are considered debentures backed only by the faith and credit of the bank issuer or issuers.
Which of the following statements regarding GNMA securities are TRUE? Interest is subject to federal income tax. Interest is exempt from federal income tax. They are backed by farm mortgages. They are backed by residential mortgages.
I & IV -Government National Mortgage Association (GNMA) securities are subject to both state and federal income tax and are backed by residential mortgages.
A 10-year bond, callable in 5 years at par, is sold at a discount. Rank the following yields from lowest to highest. Nominal yield. Current yield. Yield to call. Yield to maturity.
I, II, IV, III. -The lowest of all yields for a discount bond is the nominal yield (coupon rate), which is a fixed percentage of par. The highest possible return to the owner of a bond purchased at a discount would occur if the bond were called before maturity, because less time must elapse for the investor to receive the discount.
Your customer has listed income and safety of principal as his primary investment objectives. Which of the following might be the least suitable recommendation?
Sovereign debt securities -The least suitable of the answer choices given would be sovereign debt securities due to the unique and varied risks with which they are associated. Amongst those risks would be the instability of the issuing government, unfavorable changes in currency exchange rates, or inaccurate estimates of the payback from the projects the bonds finance. All of these risks can adversely impact the investment.
A customer purchased 10 9% convertible debentures at 98. The bonds are callable at 101. The conversion ratio is 40. The bonds are called while the common is trading at $24 and the debenture is trading at 98. Which of the following options would be most beneficial to the customer?
Tender the bonds to the corporation.
Defeasement can be best described as a:
prerefunding -Pre-refunding involves issuing one bond to call an outstanding bond at a future date. When this is done, the money raised is held in escrow to redeem the outstanding bonds at a future call date. What was originally pledged to back the bonds is now replaced by the escrowed funds. The issuer no longer has to show these bonds as an obligation on its debt statement. This is known as defeasement. The escrowed funds are invested in U.S. government securities.
If interest rates increase, the interest payable on outstanding corporate bonds will:
remain unchanged. -The interest payable is the nominal yield, which is stated on the face of the bond. It is the percentage of face value the bond will pay each year regardless of the prevailing interest rates in the market. It is the market price of bonds, not the interest payable, which responds inversely to changes in interest rates.
A corporation with a single outstanding bond issue chooses to refund this debt. This means that the corporation:
replaces one debt with another. -Refunding is synonymous with refinancing. When we refinance, we take out a new debt and use the proceeds of that debt to pay off the old one.
Brokered CDs, like other CDs issued by a bank directly to customers, carry FDIC insurance up to
250,000
If all of the following bonds mature on September 1, 2020, which would have the highest price? A) 6-¾% coupon at 6.80 B) 5-½% coupon at 5.50 C) 6-1/4% coupon at 6.10 D) 5-¾% coupon at 5.85
6-1/4% coupon at 6.10 -A bond that is trading at a premium has a yield to maturity that is lower than its coupon rate. Of the choices given, only the 6-1/4% coupon with a 6.10 yield to maturity is trading at a premium. The other bonds shown are either trading at a discount (their yield to maturity is higher than the coupon rate) or at par (their yield to maturity is equal to the coupon rate).
All of the following have been recognized by the SEC under the Credit Rating Agency Reform Act as being registered with the commission to rate debt instruments. Which of the following historically has specialized in ratings for the insurance sector?
A.M. Best -historically has specialized exclusively on the insurance marketplace. They issue financial strength ratings measuring insurance companies' ability to pay claims and rate financial instruments issued by insurance companies, such as bonds and notes. They can issue debt and financial strength ratings for other sectors as well, under the Credit Rating Agency Reform Act.
Which of the following debt instruments is unsecured?
Aaa/AAA rated debentures. -Corporate debentures are unsecured bonds backed by the credit of the issuing corporation; they are not secured by underlying collateral. Mortgage bonds are secured with real estate serving as collateral. Collateral trust bonds are secured by securities that a corporation owns in other companies or bonds. Equipment trust certificates are secured by transportation equipment owned by the corporation.
Which of the following corporate bonds is backed by other securities?
Collateral trust bond. -Collateral trust bonds are backed by a portfolio of other securities; mortgage bonds are backed by real estate. Equipment trust certificates are backed by equipment. Debentures are backed only by the company's promise to pay.
A customer expresses the need to invest a fixed dollar sum now that will return a fixed dollar sum in 10 years. He mentions several investments. Of those listed which would not be a suitable recommendation for his objective?
Collateralized mortgage obligations (CMOs) -Due to the interest rate sensitivity of mortgage-backed securities and the possibility of high prepayment risk (receiving the invested funds back earlier than anticipated) CMOs would not be suitable. TIPs, designed to protect against inflation, and the high yield corporate bond if held to maturity, could each meet the objective. Zero coupon bonds are specifically designed to meet the objective of investing a fixed sum now and realizing a fixed sum later and in this regard would be the most suitable of those listed.
Which of the following statements are TRUE regarding Sallie Mae debentures? Interest is generally paid monthly. Interest is generally paid semiannually. Interest is exempt from state and local taxation. Interest is not exempt from state and local taxation.
II & III -As a general rule, debentures pay interest every six months. Further, interest on nonmortgage-backed government securities is taxable at the federal level and exempt from state and local taxation.
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.
II & III -Interest rates in general have risen since the issuance of the 4% bonds, so the bond's price will be discounted to produce a higher current yield on the bonds. Remember that as interest rates go up, the price of outstanding debt securities goes down.
A married couple with a two-year-old child wants a suitable investment to help meet the financial obligations for the child's college education. Which of the following choices are the most suitable alternatives? A CMO tranche scheduled to mature in 5 years A STRIP scheduled to mature in 15 years Treasury receipts A money-market fund
II and III -STRIPs and treasury receipts are forms of zero-coupon bonds. STRIPs are backed in full by the US government and treasury receipts by the financial institutions that issue them. Purchased at a discount and maturing at face value in the future, they are suitable investments for those wishing to save for anticipated expenses such as college tuition sometime in the future. A CMO maturing in five years doesn't align with the time horizon for this child's college education and carry other unsuitable risks. A money market fund would hardly meet the growth requirement needed to meet college tuition needs.
U.S. government securities that are deposited with a trustee against which certificates are sold representing principal payments only on the securities are: clipped bonds. stripped bonds. subject to annual taxation on the per year accreted amount. subject to taxation at maturity.
II and III. -U.S. government securities that are deposited with a trustee and against which certificates are sold representing principal payments only on the securities are referred to as Treasury STRIPS. These are zero-coupon bonds issued by the U.S. government and are subject to annual taxation on the per-year accreted amount.
ABC Corporation has outstanding a 7-¾% convertible debenture currently trading at 102. The bond is convertible into common stock at $40. ABC stock is trading $45 per share. Which of the following statements is TRUE?
To profit in this situation, the investor should buy the bonds and short the stock. -With a conversion price of $40, the bond is convertible into 25 shares of ABC common stock ($1,000 / $40 = 25 shares). As the common stock is currently trading at $45 per share, the value of the stock as converted would be $1,125 (25 shares × $45 = $1,125), which is greater than the current price of the bond ($1,020). Therefore, the bond and the stock are not at parity. An investor could profit in this situation by shorting the stock and buying an equivalent number of bonds. A bond could be purchased for $1,020 and immediately converted into stock worth $1,125, a risk-free profit opportunity.
If ABC Corporation reports a loss for the year, it is obligated to pay interest on all of the following EXCEPT:
adjustment bonds. -Even if a corporation reports a loss, the corporation is obligated to pay interest on all of its outstanding debt except for income (adjustment) bonds. Income, or adjustment bonds, require interest to be paid only if declared by the board of directors.
A customer buys a 6% Treasury bond, maturing in 10 years, at a price of 91.07. The yield to maturity is:
greater than nominal yield. -A bond whose price is below par or at a discount has a higher yield to maturity than current yield, which in turn is higher than the nominal yield.
Corporate bonds that are guaranteed are:
guaranteed as to payment of principal and interest by another corporation.
An inverted yield curve is the result of:
investors buying long-term bonds and selling short-term bonds.
If an investor watches the latest T-bill auction fall to 4.71% from 4.82%, the best interpretation is that:
investors who purchased bills at this auction paid more for them than purchasers last week. -The rates on the T-bills fell, so prices rose and the investor paid more for the bills this week than last week. The decline in yields indicates there was good demand for the securities because the price rose, driving the yields down. The question does not indicate the price of T-bills 12 weeks ago; it is unclear if the investor paid less for the T-bills then. The federal funds rate and other short-term interest rates would decline, not rise, in line with those of T-bills.
All of the following statements regarding municipal bond put options are true EXCEPT that the put option:
is generally exercisable immediately after the bond has been issued. -Put options are exercisable only after the put protection period has passed; this protects the issuer. Once puttable, the put feature isolates the bondholders from market risk-the risk that rising rates will force prices down.
Transactions in all of the following are affected in the money market, as opposed to the capital market, EXCEPT
municipal revenue bonds -The money market is the marketplace for short-term (less than one year) debt obligations. The capital market is where long-term capital is raised. Municipal bonds, being long term, are a part of the capital market.
All of the following are true of negotiable, jumbo certificates of deposit EXCEPT:
they are fully insured in any denomination by the FDIC.
All of the following are true of negotiable, jumbo certificates of deposit EXCEPT:
they are fully insured in any denomination by the FDIC. -The FDIC insures only up to $250,000.
