Unit 2: Debt Securities Unit Test

Which of the following investments is most suitable for an investor seeking monthly income? A) GNMA B) Mutual fund investing in small-cap issues C) Growth stock D) Zero-coupon bond

A GNMA is the most suitable investment for an investor seeking monthly income. Zero-coupon bonds, growth stocks, and mutual funds which invest in small-cap issues offer higher long-term growth potential, but they are not designed to provide monthly income.

An investor who has purchased a CMO: A) is subject to federal, state, and local taxation B) should expect a yield slightly lower than that of Treasury securities C) receives semiannual interest D) owns a security that is fully backed by the U.S. government

A Interest on CMOs is subject to federal, state, and local taxation. CMOs pay interest monthly and yield more than Treasury securities. They are issued by financial institutions, including banks and broker/dealers, and are not backed by the U.S. government.

Prices quoted for immediate payment and delivery of currencies are known as? A) spot prices B) last sales C) future prices D) forward prices

A Spot rates or prices are those quoted for immediate payment and delivery of foreign currencies. Settlement for actively traded currencies will take place in 1 business day and for less actively traded currencies in 2 business days.

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

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

A debt instrument, which may or may not be exchange traded, where the final payment at maturity is based on the return of a single stock, a basket of stocks, or an equity index is known as:

An equity- or index-linked note (ELN or ILN) Equity-linked notes are debt instruments where the final payment at maturity is based on the return of a single stock, a basket of stocks, or an equity index. Some, but not all, are exchange traded and those that are can be referred to as exchange-traded notes (ETNs).

A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of: A) 7.4% B) 5.6% C) 5% D) 7.8%

B Current yield is determined by dividing annual interest payment by the current market price of the bond ($50 / $900 = 5.6%). Years to maturity is not a factor in calculating current yield.

Which of the following is NOT a risk to a U.S. resident owning a Eurodollar bond? A) Inflation risk B) Currency risk C) Interest rate risk D) Default risk

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

A bond is convertible at $25. The market value of the stock is $30. What is the parity price of the bond? A) $800 B) $1,200 C) $750 D) $1,100

B If a bond is convertible at $25, each $1,000 bond will convert to 40 shares. Forty shares × $30 = $1,200 parity of the bond.

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 par D) at a premium

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

Which of the following callable debentures is least likely to be called? A) 6% maturing in 2018, callable at 100 B) 8% maturing in 2024, callable at 100 C) 6% maturing in 2017, callable at 102 D) 8% maturing in 2018, callable at 102

C The bond with the shortest maturity is the least likely to be called, because it will cost the issuer the least in net interest over the life of the bond. When determining which bonds to call, the comparison in order of priority is: (1) years to maturity, (2) coupon rate, (3) call premiums.

Which of the following statements regarding the federal funds rate is NOT true? A) It tends to fluctuate more than long-term interest rates. B) It is the rate at which member banks of the Federal Reserve System lend money to each other. C) It tends to fluctuate in response to the prime rate. D) It tends to lead the upward and downward moves of other interest rates

C The federal funds rate is charged by banks with excess reserves on overnight loans made to meet reserve requirements. It is determined by supply and demand of federal funds between Federal Reserve member banks. It is considered the most volatile rate in the economy and generally fluctuates on a daily basis. The federal funds rate is set by the market, not the banks.

An investor's portfolio includes 10 bonds and 200 shares of common stock. If both positions increase by one point, what is the appreciation? A) $100 B) $210 C) $300 D) $220

C The gain would be $100 for the bonds (one point for one bond is $10 × 10 bonds) and $200 for the common stock (one point is $1 × 200 shares). The total portfolio gain is $300.

You observe that a yield curve that was previously flat is moving toward having short- term interest rates lower than long-term interest rates. This new yield curve is considered to be: A) adverse B) breaking out C) normal D) inverted

C When short-term interest rates are lower than long-term interest rates, the yield curve is considered to be normal.

Which of the following bonds trade flat? A) GO bonds B) Mortgage bonds C) Revenue bonds D) Income bonds

D Bonds that trade flat do not trade with accrued interest. These include income bonds (also known as adjustment bonds), zeroes, bonds in default, and bonds that settle on an interest payment date.

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

D Money market securities have a maximum maturity of 1 year. Treasury notes are issued with maturities of 2 to 10 years. Treasury bills are money market instruments with maturities of 6 months or less. Jumbo CDs are issued by banks and have maturities of 1 year or less. Commercial paper (issued by corporations) is unsecured short-term debt with maturities of 270 days or less.

All of the following statements regarding CMOs are true EXCEPT: A) PACs provide protection against prepayment risk B) TACs provide protection against prepayment risk C) PACs provide protection against extension risk D) TACs provide protection against extension risk

D PACs provide protection against both prepayment and extension risk while TACs provide protection against prepayment risk only.

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

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

Accrued interest on a bond confirmation is: (choose 2) I) added to the buyer's contract price II) added to the seller's contract price III) subtracted from the buyer's contract price IV) subtracted from the seller's contract price

I and II The accrued interest calculation is made to determine the seller's share of the upcoming interest payment. It is added to the buyer's contract price (the buyer pays), and it is added to the seller's contract price (the seller receives).

In treasury auctions a bidding system known as a Dutch auction is used. With this auction process the winning bid is the: (choose 2) I) lowest yield at which all of the securities can be sold II) highest yield at which all of the securities can be sold III) the price paid by bidders who bid at or below the winning yield bid IV) the price paid by bidders who bid at or above the winning yield bid

I and III When a Dutch auction is used for treasury securities the winning bid is the lowest yield at which all of the securities can be sold. This is known as the "stop out price" and once established is the rate that all bidders who bid at or below that yield will pay.

The federal funds rate is which of the following? (choose 2) I) Computed daily II) Generally higher than the discount rate III) Set by the Federal Reserve IV) The rate charged in bank-to-bank lending

I and IV The federal funds rate is computed daily, is lower than the discount rate, and is the rate charged in bank-to-bank lending. The only interest rate the Federal Reserve directly sets is the discount rate. It does not set the federal funds rate, although it heavily influences its level.

When the U.S. dollar is devalued against other currencies: (choose 2) I) U.S. products become more competitive abroad II) U.S. products become less competitive abroad III) foreign products become more competitive in the U.S. IV) foreign products become less competitive in the U.S.

I and IV When the U.S. dollar is devalued, U.S. products become more competitive abroad since the foreign currency is stronger. Of course, the exact opposite happens to foreign products in the United States as they become less competitive. In other words, since the American dollar is worth less, it takes more American dollars to purchase those foreign products.

Which of the following statements regarding put and call features of bonds are TRUE? (choose 2) I) The put feature would likely be exercised if interest rates fall. II) The put feature would likely be exercised if interest rates rise. III) The issuer will likely call bonds if interest rates fall. IV) The issuer will likely call bonds if interest rates rise.

II and III A put feature on a bond benefits the bondholder. Once the bond becomes puttable, its holder has the right to put it back to the issuer at par. At this point, the bondholder is insulated from rate risk (the risk that rates will rise, putting downward pressure on bond prices). Once puttable, the bond will not trade below par. Issuers will likely call bonds if rates fall. The issuer can issue new bonds at a lower rate and use the proceeds to call in the original bond.

Which of the following scenarios would be TRUE about a step-down CD? (choose 2) I) When initially purchased, the CD pays a lower rate II) When initially purchased, the CD pays a higher rate III) Later the interest rate adjusts to a lower rate than when it was purchased IV) Later the interest rate adjusts to a higher rate than when it was purchased

II and III With a step-down CD the interest rate will pay a higher rate in the earlier months and adjust downward in later months to pay a lower rate than when it was initially purchased.

When a customer purchases a newly issued municipal bond or corporate bond, the accrued interest is calculated: (choose 2) I) from the trade date II) from the dated date III) up to the interest payment date IV) up to, but not including, the settlement date

II and IV Interest accrues from the bond's dated date up to, but not including the settlement date.

Which of the following characteristics describe Treasury bills? (choose 2) I) Issued at face value II) Issued at a discount III) Pay semiannual interest IV) Pay all interest on maturity

II and IV Treasury bills are issued at a discount and pay all interest at maturity.