Unit 2 - Types and Characteristics of Fixed-Income (Debt) Securities

RST debenture is convertible to common at $50. If the common is trading for $45, what is the parity price of the debenture?

Par Value: $1,000 Conversion price: $50 Conversion ratio: 20 The debenture's parity price is found by multiplying 20 x $45 = $900. Here we know that the market price is 10% below that of par, so $50*10% = $5 so $50-$5 = $45. Reducing the debenture price of $1,000 by 10% results in a parity price of the debenture of $900

A debenture is based on a. The general credit of the corporation b. A pledge of real estate c. A pledge of equipment d. The ability to levy taxes

a

Advantages of Brady bonds to an American investor include all of the following except a. Tax-free interest b. Greater liquidity than found in most emerging market securities c. Greater safety than most emerging market debt because of the collateral d. Higher yields than on U.S. Treasury securities

a

In general, among the advantages to investing in Brady bonds over those issued by countries classified as emerging economies is a. Increased liquidity b. Greater risk c. Higher yields d. Shorter maturities

a

The Straight Corporation filed for bankruptcy. One of your clients held a mortgage secured by the corporation's building. When the building is sold, the proceeds were less than the mortgage balance, creating a deficiency balance. Where does this investor's claim stand? a. As a general creditor on a pro rata basis b. After the secured creditors c. After the unsecured creditors d. There is no further claim once the building has been sold

a

Which of the following are characteristics of negotiable jumbo securities? a. Issued in amounts of $100,000 to $1 million b. Typically pay interest on a monthly basis c. Only trade in the primary market d. Always mature in one to two years with a prepayment penalty for early withdrawal

a

Which of the following describes a Yankee bond? a. A U.S. dollar denominated bond issued by a non-U.S. equity inside the United States b. A U.S. dollar-denominated bond issued by a non-U.S. equity outside of the United States c. A U.S. dollar denominated bond issued by a U.S. entity outside the United States d. A U.S. dollar denominated bond issued by a U.S. entity inside the United States

a

Which of the following is a direct obligation of the U.S. government? a. Ginnie maes b. Government bond mutual funds c. Bank for cooperatives bonds d. Fannie maes

a

All of the following debt instruments pay interest semiannually except a. Ginnie mae pass-through certificates b. US T-notes c. Us T-bonds d. TIPS

a Pay monthly, and in addition to interest, investors receive their share of that portion of the mortgage payments that represented principal repayment

If each of the following bonds matures in 10 years and has the same rating, which is the most volatile? a. Zero coupon bond with a 6% yield b. Zero coupon bond with 8% yield c. Corporate bond priced at par with 8% yield d. Corporate bond priced at par with 8% yield

a The most volatile bonds with the lowest yield or coupon rate and the longest time to maturity

Which of the following projects is most likely to be financed by a general obligation rather than a revenue bond? a. Public library b. Expansion of an airport c. Municipal hospital d. Public golf course

a i. All of the others generate revenue.

1. 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 indenture c. The bond coupon d. The bond agreement

b

A bond would be considered speculative below which of the following Moody's ratings? a. A b. Baa c. BBB d. Ba

b

All of the following are advantages of Eurodollar bonds except a. Because they are U.S. dollar denominated, they bear no currency risk to U.S. investors b. greater transparency c. they are rated by U.S. rating agencies, so the risk is clear d. they may offer higher yields than domestic bonds from the same issuer

b

Of the following securities, which is MOST commonly recommended to fund a child's college education? a. Municipal bonds b. Zero-coupon bonds c. Treasury bills d. Investment-grade corporate bonds

b

The price of which of the following will fluctuate most with a change in interest rates a. Common stock b. Long-term bonds c. Short-term bonds d. Money market instruments

b

When a corporation domiciled in the United Kingdom issues U.S. dollar-denominated bonds in the United States, it is issuing a. Eurobonds b. Yankee bonds c. Ameribonds d. ADRs

b

Which of the following statements regarding U.S. government agency securities is TRUE? a. Interest received on agency securities is exempt from federal income tax b. They generally offer higher yields than direct U.S. obligations c. They are direct obligations of the U.S. government d. They generally trade on the major stock exchanges

b

Five percent XYZ debentures are trading for $1,250. Other similarly rated bonds are being offered 4.25%. What is the current yield on the 5% debentures? a. 1.5% b. 4.0% c. 5.0% d. 6.25%

b 5%*1,000 = 50 50/1250 = 4%

When a U.S. resident investor purchases foreign bonds, a. Depreciation of both the bonds and the foreign currency benefits the domestic investor b. Appreciation of both the bonds and the foreign currency benefits the domestic investor c. Appreciation of the bonds and depreciation of the foreign currency benefit the domestic investor d. Depreciation of the bonds and appreciation of the foreign currency benefit the domestic investor

b i. As with any security, if the value goes up (appreciation) that is a benefit to the investor ii. Because the foreign bond is denominated in the local currency, an increase in that currency's value versus the U.S. dollar means the semiannual interest payments will translate into more dollars. iii. At maturity, the return of principal will be higher as well.

BFJ Corp's 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 plus cash for fractional shares b. 20 shares c. 24 shares d. 2.4 shares

b i. Conversion ratio always uses par value, never market price. ii. Par value of 1000/conversion price of 50 = 20

Richard purchased a 30-year bond for 103 ½ 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. 8.5% d. 9.36%

b i. No calculation needed, this bond was bought at a premium so the YTM must be less than the nominal coupon rate

Which of the following would you NOT expect to see issued at a discount? a. Commercial paper b. Bank jumbo CD c. Treasury bill d. Zero-coupon bond

b i. These are always interest bearing and issued at par or face value

1. The most common collateral securing a Brady bond is a. The credit standing of the sovereign nation issuing the Brady bond b. The credit standing of the banking institution acquiring the Brady bond c. U.S. Treasury zero-coupon bonds with a maturity corresponding to the maturity of the individual Brady bond d. An asset or group of assets, pledged by the borrowing entity

c

When a bond with a 6% coupon is selling for 90, each of the following statements is correct except: a. The current yield is approximately 6.67% b. The bond is selling at a discount c. The bondholder will receive two semiannual interest payments of $27 each d. The yield to maturity is slightly higher than the current yield

c

Which of the following debt instruments generally present the least amount of default risk? a. High-yield corporate bonds b. Convertible senior debentures c. Municipal general obligation bonds d. Municipal revenue bond

c

Which of the following statements about jumbo CDs is NOT correct? a. Negotiable CDs do not have a prepayment penalty b. FDIC insurance applies up to $250,000 c. They are secured by pledged assets of the insuring bank d. Jumbo CDs pay interest semiannually

c

A 4.67% convertible debenture is selling at 102. It is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. If the stock were trading parity with the debenture, the price of the stock would be a. $25.00 b. $25.25 c. $25.50 d. $44.35

c (102-100)/100 = 0.02 or 2% 2% of 25 = 0.5

If an investor in the 27% federal income tax bracket invests in municipal general obligation bonds selling at par with a coupon of 4.5%, what is the tax-equivalent yield a. 3.29% b. 5.72% c. 6.16% d. 16.67%

c 4.5/73 = 0.0616

One of your customers is a new parent. The customer wishes to deposit a lump sum into an investment offering a guaranteed return in 18 years, just in time for college. Which of the following bonds maturing in 18 years would offer the greatest safety? a. A corporate zero coupon bond with a AAA rating b. A municipal zero coupon bond with a AAA rating c. An unrated Treasury STRIPS d. A high-yield corporate bond

c Separate trading of registered interest and principal of securities

A risk-adverse investor, who had only invested in bank CDs, was informed by his investment adviser representative that higher returns with safety could be achieved by investing in U.S. Treasury notes with a 10-year maturity. The adviser representative assured the client that investment in federal government-backed securities is riskless. In this situation, the representative acted a. Properly because Treasury notes carry no risk of principal default b. Property because Treasury notes are suitable for a risk-adverse customer c. Unethically because the agent failed to disclose that the customer retains investment rate risk d. Unethically because Treasury notes are unsuitable for a risk-adverse customer

c The prices of treasury securities will decline if interest rates rise, subjecting the client to loss of principal if he sells them prior to maturity

Which of the following choices offers the highest tax-equivalent yield? a. 5.8% municipal bond to an individual in the 25% tax bracket b. 5.0% municipal bond to an individual in the 35% tax bracket c. 6.2% municipal bond to a corporation in the 21% tax bracket d. 5.5% municipal bond to an individual in the 28% tax bracket

c a. 5.8% municipal bond to an individual in the 25% tax bracket i. 7.73% b. 5.0% municipal bond to an individual in the 35% tax bracket i. 7.69% c. 6.2% municipal bond to a corporation in the 21% tax bracket i. 7.85% d. 5.5% municipal bond to an individual in the 28% tax bracket i. 7.63%

Which type of risk is a mortgage-backed security most likely to experience? a. Business b. Exchange-rate risk c. Reinvestment risk d. Market risk

c i. As mortgages are paid off early and refinanced in the event of declining interest rates, the interim cash flows received from the obligation must be reinvested in lower-yielding securities.

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. Above $1,000 c. Above $1,200 d. Below $1,200

c i. Convertible securities generally sell at a slight premium over the parity price ii. (48-40)/40 = 0.2 * 1000 = 200 so 1000+200=1200

Although bond 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. Price movement that is inverse to interest rates b. A stated interest rate c. Safety of principal d. A stated maturity date

c i. Depends on the issuer

A TIPS bond is issued in the principal amount of $1,000, paying 3.5%. Over the security's five year term, the annual inflation rate is 6%. What is the principal value of the bond at the end of 4 years? a. $1,240 b. $1,300 c. $1,267 d. $1,344

c i. Inflation rate (6%=$60) for four years ($240) added to the $1,000 face value to get $1,240. The correct answer will always be the next highest number, in this case $1,267 ii. Or the math is 1,000*1.03^8

1. The DERP corporation has an outstanding convertible bond issue with a conversion price of $125 per share. If the current market price of the bond is 80, the parity price of the stock is a. $156.25 b. $125.00 c. $100.00 d. $64.00

c i. The bond is currently valued at $800 (80% of par) ii. 80% of 125 is $100

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. 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 d. Interest rates have fallen since the debenture was issued

c i. With a conversion price of $40, the bond is convertible into 25 shares (1,000/40) ii. Convertible securities generally sell at a slight premium to their parity price which, at $1,260, would be $50.40 per share (1260/25)

A bond selling for $20 above par would be quoted at a. 120 b. 1,200 c. 1,020 d. 102

d

Securities issued by which of the following agencies offer direct government backing? a. Federal national mortgage association b. Federal intermediate credit bank c. Federal home loan mortgage corporation d. Government national mortgage association

d

Which of the following has no interest rate risk? a. Negotiable CDs b. Commercial paper c. U.S. Treasury Bonds d. Time deposits at your local bank

d

Which of the following investments gives the investor the LEAST exposure to reinvestment risk? a. Treasury notes b. Common stock in an electric utility c. Preferred stock in a growth company d. Treasury STRIPS/zero-coupon bonds

d

Which of the following would be MOST likely to increase a bonds liquidity a. A lower rating b. No call protection c. A longer maturity d. A higher rating

d

Disregarding commissions, an investor selling a U.S. Treasury bond for a price of: 104:16 will receive a. $104.16 b. $104.50 c. $1,041.60 d. $1045.00

d 104*1,000 = $1,040 and 16/32 (1/2)*$10 = $5

All of the following statements regarding Government National Mortgage Association (GNMA) pass-through securities are true EXCEPT a. Investors own an undivided interest in a pool or mortgages b. Investors receive a monthly check representing both interest and a return of principal c. The minimum initial investment is $25,000 d. GNMAs are considered to be the riskiest of the agency issues

d Backed by the full faith and credit of the U.S. government, considered to be the safest

Which of the following statements is NOT true? a. A country wishing to restructure its debt using Brady Bonds would do so to save on debt servicing costs b. One of the benefits of holding convertible debentures is the option to convert into the corporation's common stock c. U.S. Treasury securities are backed by full faith and credit of the U.S. Government d. A resident of France purchasing Eurodollar bonds does not incur currency risk

d Only U.S. residents have no currency risk with Eurodollar bonds

Your client with $100,000 to invest is looking for maximum current income. Which of the following would offer the highest current return? a. $200,000 of utility common stock paying a current dividend of 3.5% b. $100,000 AA rated corporate bonds trading at par with a 6% coupon rate c. $100,000 of zero coupon bonds with a YTM of 6% d. $100,000 market value of corporate bonds selling at a premium and yielding 6% to maturity

d i. Cant be A, we only have $100,000 ii. Maximizing current income excludes zero-coupon bonds because there is no current income iii. Why does a bond sell at premium over par? Because the coupon rate is higher than the current market interest rate. Therefore, with a higher coupon rate, the current income will always be higher for a bond selling at a premium.

MNO is planning to raise capital through an offering of 30-year bonds. Which call price would be the MOST beneficial to MNO? a. 106 b. 104 c. 110 d. 102

d i. MNO would seek to benefit from the ability to call bonds at the lowest possible price. The call feature enables MNO to buy the bonds before maturity to reduce their fixed interest costs.