Unit 3 - Debt Securities

An investor purchased a corporate bond for 97 3/8. If the bond is sold for 99 3/8, the investor has a profit of: A)$20.00 B)$0.20. C)$2.00 D)$200.

A)$20.00 This investor has a profit of two points, or $20. Remember, one bond point is worth $10.

A customer purchases $50,000 worth of 10% corporate bonds at par. At the end of the day, the bonds close down a half point. The customer has a loss of: A)$250. B)$2,500. C)$5,000. D)$25.

A)$250. The customer holds 50, $1,000 bonds. One bond point equals $10. Therefore, if each bond decreases by a half-point, the loss is $5 per bond; multiplied by 50 bonds, this equals $250.

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

A)$300. 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.

ABC stock is quoted at 67.75 bid 67.85 ask. If an investor wishes to purchase one round lot from the broker-dealer, excluding commissions, the investor would pay: A)$6,785. B)$677.50. C)$6,775. D)$678.50.

A)$6,785. An investor purchases stock at the ask price, or in this case, at $67.85. Because the investor is purchasing a round lot, or 100 shares, the amount payable is $6,785 (100 × $67.85).

Which of the following is a characteristic shared by debentures and equipment trust bonds? A)Both pay principal as it comes due. B)Both are secured by assets of the corporation. C)Both are a type of mortgage bond. D)Both must pay interest annually.

A)Both pay principal as it comes due. Bonds must pay principal when due. Interest is generally paid semiannually. Debentures are unsecured and have no collateral backing the offering.

All of the following statements regarding Government National Mortgage Association (GNMA) pass-through securities are true EXCEPT A)GNMAs are considered to be the riskiest of the agency issues. B)investors own an undivided interest in a pool of mortgages. C)investors receive a monthly check representing both interest and a return of principal. D)interest is taxed at all levels—federal, state, and local.

A)GNMAs are considered to be the riskiest of the agency issues. GNMA securities, which are backed by the full faith and credit of the U.S. government, are considered to be the safest of the agency issues.

Under which of the following circumstances is an investor in a position to acquire stock? I-Buy a call. II-Buy a put. III-Sell a call. IV-Sell a put. A)I and IV. B)II and III. C)II and IV. D)I and III.

A)I and IV. The holder of a call has the right to buy stock at the strike price if exercised. The seller of a put is obligated to buy stock at the strike price if exercised.

A customer believes that ABC's price will go up but does not have the money to buy 100 shares right now. How could the customer use options to profit from an increase in the stock's price? I-Buy calls. II-Write calls. III-Buy puts. IV-Write puts. A)I or IV. B)I or III. C)II or IV. D)II or III

A)I or IV. When an investor anticipates an increase in a stock's price, he is considered to be bullish on the stock. To profit from the anticipated upward movement in the stock price, he could either buy calls or sell (write) puts. Both are bullish option strategies.

With fluctuating interest rates, the price of which of the following will fluctuate most? A)Long-term bonds. B)Convertible debenture maturing in one year. C)Short-term bonds. D)Money-market instruments.

A)Long-term bonds. The longer the term to maturity, the greater the risk to the bondholder, resulting in greater price fluctuation for long-term bonds.

Which of the following is a debt instrument that pays no periodic interest? A)STRIPS. B)Treasury bond. C)GNMA. D)Treasury note.

A)STRIPS. STRIPS are Treasury bonds with the coupons removed. STRIPS do not make regular interest payments. Instead, they are sold at a deep discount and mature at par value.

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)Treasury STRIPS. B)municipal bonds for their tax benefits. C)common stock. D)corporate bonds with high rates of interest.

A)Treasury STRIPS. 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.

DMF Company has convertible bonds (convertible at $50) outstanding. The current market value of DMF's stock is $42. The bond indenture contains an antidilution feature. If DMF declares a 10% stock dividend, the new conversion price will be A)lower than $50 B)$50 C)the stock's current market price D)higher than $50

A)lower than $50 With an antidilution feature, the issuer will increase the number of shares available upon conversion if the company declares a stock split or stock dividend. This is done to keep the bondholder whole. Originally, the bond converts to 20 shares ($1,000 ÷ 50), because of the 10% stock dividend, the bond needs to convert to 22 shares, which means the conversion price is reduced to $45.45 ($1,000 ÷ 22 = $45.45).

Ginnie Mae pass-throughs will pay back both principal and interest: A)monthly. B)semiannually. C)annually. D)quarterly.

A)monthly. Ginnie Mae (GNMA) securities are called pass-through certificates because the monthly home mortgage payments, which consist of both principal and interest, pass through to the GNMA investor monthly.

All of the following would be sources of revenue for debt service payment to revenue bond holders EXCEPT: A)real estate taxes. B)water and sewer usage fees. C)tolls paid to use the turnpike. D)airport parking lot charges.

A)real estate taxes. Real estate taxes are used to pay debt service to general obligation (GO) bond holders. The other answer choices describe user fees which are used to make principal and interest payments to revenue bond holders.

All of the following statements about put sellers are true EXCEPT: A)they are bearish on the underlying stock. B)they receive money from the option transaction. C)they have taken on an obligation. D)they hope the underlying stock holds steady or goes up in value.

A)they are bearish on the underlying stock. Put sellers are paid the premium, in exchange for which they take on the obligation to buy stock at a fixed price, called the strike price. Whenever buying something (obligation to buy), the investor is bullish, not bearish.

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

B)$1,200 If a bond is convertible at $25, each $1,000 bond will convert to 40 shares.

If your customer holds ten KLP 6% bonds, how much money will he receive in total at the debenture's maturity? A)$10,000. B)$10,300. C)$10,600. D)$10,200.

B)$10,300. The holder of 10 bonds will receive $10,000 in principal at maturity. Each bond pays 6% annual interest, or $60. Thus, ten bonds pay a total of $600 per year in two semiannual payments of $300. At maturity, the bondholder will receive the $10,000 face amount plus the final semiannual payment ($10,000 + $300 = $10,300).

What is the conversion ratio of a convertible bond purchased at par value and convertible at $50? A)5:1 B)20:1 C)50:1:0 D)2:1

B)20:1 The $1,000 par value divided by the $50 conversion price equals 20 shares per bond.

TIPS offer which of the following benefits to an investor? I-Semiannual adjustments to principal based on the CPI. II-A Guarantee of profit upon sale. III-The interest payments will keep pace with inflation. IV-TIPS provide investors with an income they can't outlive. A)I and II B)I and III C)II and III D)III and IV

B)I and III Treasury Inflation Protection Securities (TIPS), are issued by the government and designed to offer investors inflation protection by adjusting the principal of the TIPS semiannually based on the Consumer Price Index (CPI). No security guarantees a profit upon sale and only an annuity can guarantee an income for life.

T-bills are direct obligation of the US government and I-are issued at par II-trade in the secondary market. III-are redeemable IV-are issued at a discount A)III and IV B)II and IV C)I and II D)I and III

B)II and IV T-bills are short-term obligations and, unlike most other debt securities, are issued at a discount from par. Once they are issued, T-bills trade in the secondary market.

T-bills are direct obligation of the US government and I-are issued at par II-trade in the secondary market. III-are redeemable IV-are issued at a discount A)I and II B)II and IV C)III and IV D)I and III

B)II and IV T-bills are short-term obligations and, unlike most other debt securities, are issued at a discount from par. Once they are issued, T-bills trade in the secondary market.

Which of the following securities is issued at par? A)Treasury STRIPS B)Treasury notes C)Zero coupon bond D)Treasury bills

B)Treasury notes Of the securities shown, only treasury notes issue at par and pay semiannual interest. The others issue at a discount, pay no interim interest, and are redeemed at par.

If the RST Corporation has issued several different debt securities, an investor would expect the lowest income stream from RST's: A)ordinary debentures. B)convertible debentures. C)speculative bonds. D)subordinated debentures.

B)convertible debentures. Although convertible debentures have many positive features for the investor, the major negative is that, in exchange for those benefits, the investor accepts a lower rate of interest.

All of the following statements regarding bonds registered as to principal only are true EXCEPT: A)coupons are attached. B)interest payments are sent directly to the owner twice a year. C)the registered owner may sell the bonds before maturity. D)such bonds can be purchased today in the secondary market.

B)interest payments are sent directly to the owner twice a year. A bond registered as to principal only has a certificate registered in the owner's name and has bearer coupons attached to the bond certificate. Only the person to whom the bond is registered may sell the securities. Interest is not sent directly to the owner but is paid only if the interest coupons are presented to the bond's paying agent.

All of the following statements regarding Treasury STRIPs are true EXCEPT: A)there are no semiannual interest payments. B)the interest is taxed as a capital gain. C)the rate of return is locked in. D)the interest is realized at maturity.

B)the interest is taxed as a capital gain. The interest on the bond is paid at maturity but it is taxed as interest income over the life of the bond, not as a capital gain.

All of the following are characteristics of an investment in Treasury notes EXCEPT: A)interest is paid semiannually. B)they are short-term issues. C)they are issued in a variety of denominations. D)they are issued with a variety of maturities.

B)they are short-term issues. Treasury notes sell at par and pay semiannual interest. Their maturities vary from 2 to 10 years, and are therefore intermediate term, not short-term.

If your client wants to accumulate $50,000 over the next ten years for her daughter's college education, to achieve this investment objective you would recommend a(n): A)high-yield corporate bond fund. B)zero-coupon bonds maturing in ten years. C)aggressive growth fund. D)large-cap fund.

B)zero-coupon bonds maturing in ten years. Zero-coupon bonds are well-suited for achieving investment goals of a stated sum within a fixed period of time. They are purchased at a discount and mature to their face value. Investors do not receive current income.

An investor's portfolio includes an ABC 6% bond maturing in 2020 and 100 Shares of XYZ common stock. At market close, if the stock closed at $45.45 compared to yesterday's $44.95, and the bond moved from 95 to 95½ , the portfolio increased in value by: A)$100 B)$110 C)$55 D)$50

C)$55

Which of the following is NOT a characteristic of GNMA securities? A)Interest income received on GNMA's is fully taxable at both the state and federal level. B)The usual minimum purchase amount is $25,000. C)Distributions are made annually. D)These securities are directly backed by the U.S. Treasury.

C)Distributions are made annually. GNMA securities (Ginnie Mae's) make interest-plus-principal payments monthly.

If interest rates increase, the interest payable on outstanding corporate bonds will: A)increase. B)change according to the inverse payout theory. C)remain unchanged. D)decrease.

C)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, that responds inversely to changes in interest rates.

The best time to purchase shares in a long-term bond fund is: A)when long-term interest rates are rising after a period of low interest rates. B)when short-term interest rates are stable. C)when long-term interest rates are falling after a period of high interest rates. D)when short term interest rates are fluctuating.

C)when long-term interest rates are falling after a period of high interest rates. The best time to purchase shares in a long-term bond fund is when interest rates are falling after a period of high rates. The bonds already in the fund will continue to pay a high rate of return, and if rates continue to fall, the market value of the fund's portfolio will rise.

Which of the following statements describing the federal taxation of municipal bond fund distributions is TRUE? A)Both dividend distributions and capital gains distributions are tax free. B)Dividend distributions are taxable; capital gains distributions are tax free. C)Both dividend distributions and capital gains distributions are taxable. D)Dividend distributions are tax free; capital gains distributions are taxable.

D)Dividend distributions are tax free; capital gains distributions are taxable. Interest income from municipal bonds is exempt from federal taxation and remains so when a bond fund distributes it as dividends. Capital gains on municipal bonds, however, are taxable. Therefore, capital gains distributions made by the fund to shareholders are taxable distributions.

An investor is considering purchasing a bond. He has settled on either a 6% municipal bond offered by the state in which he lives or an 8% corporate bond offered by a company with headquarters in his state. He would like you to help him decide which bond will get him the greatest return for his investment. Which of the following items of information must you obtain before you can make a specific recommendation? A)How long he has been a resident of his state. B)What other securities he owns. C)His county of residence. D)His tax bracket.

D)His tax bracket. To make the recommendation, you must do a tax-equivalent yield or tax-free equivalent yield calculation, for which you need the investor's tax bracket. The other items listed do not have a bearing.

Which of the following statements regarding a corporate bond quoted as QRS Zr 20 is TRUE? A)The bond pays $200 interest annually. B)The bond pays $20 interest annually. C)The interest payable is tax free. D)The bond pays no interest until maturity.

D)The bond pays no interest until maturity. QRS Zr 20 represents a zero-coupon bond issued by the QRS Company maturing in 2020. Zero-coupon bonds are bought at a discount and mature at face value. If a bond is held to maturity, the difference between the purchase price and the maturity price is considered interest, though it is taxed on a yearly basis.

Ginnie Mae issues pass-through certificates. What does this mean? A)The issuer receives principal and interest passed through from the Treasury. B)The investor receives principal and interest passed through after taxes and interest. C)The issuer will pass through all losses. D)The investor receives principal and interest after the homeowner has made his monthly mortgage payment.

D)The investor receives principal and interest after the homeowner has made his monthly mortgage payment. The term pass-through means that Ginnie Mae has received money from the homeowner and passed it through to the investor.

The difference between par and a lower market price on a bond is called the: A)premium. B)spread. C)reallowance. D)discount.

D)discount. The difference between a bond's par (or face) value and a market price lower than par is known as the bond's discount from par.

An investor purchasing a convertible debenture would most likely NOT be seeking to: A)diversify an equity portfolio. B)take advantage of a possible increase in stock prices. C)have the safety of a debt security. D)maximize current income.

D)maximize current income.

An investor has secured bonds maturing in two weeks. He plans to purchase some unsecured bonds he has identified on the secondary market that have a 6% coupon rate. If interest rates decline before the investor can purchase the new bonds, he can expect the income he will receive from the new bonds to: A)decline to less than $60 per year. B)pay no interest. C)increase to more than $60 per year. D)remain at $60 per year.

D)remain at $60 per year. Fluctuations in interest rates will affect a bond's price, but will not affect the bond's payable interest. The percentage interest payable for use of money is stated on the face of a bond and is part of the bond indenture, a legal obligation on the part of the issuing company.

When an option is trading, all of the following are fixed EXCEPT A)the strike price B)the underlying security. C)the expiration date D)the premium

D)the premium While the option is trading, the premium is variable - determined by supply and demand in the market. The other choices are characteristics of the option when issued.

All of the following statements regarding government and agency securities are true EXCEPT: A)they are authorized by Congress. B)interest paid is always subject to federal income tax. C)they are considered safer than corporate debt securities. D)they are always directly backed by the federal government.

D)they are always directly backed by the federal government. Only GNMAs are directly backed by the federal government. FNMAs and FHLMCs are only indirectly backed but are still considered less risky than corporate debt. Income from all three are taxable at federal, state, and local levels, and all were authorized by Congress.

The best time to purchase shares in a long-term bond fund is: A)when short term interest rates are fluctuating. B)when long-term interest rates are rising after a period of low interest rates. C)when short-term interest rates are stable. D)when long-term interest rates are falling after a period of high interest rates.

D)when long-term interest rates are falling after a period of high interest rates The best time to purchase shares in a long-term bond fund is when interest rates are falling after a period of high rates. The bonds already in the fund will continue to pay a high rate of return, and if rates continue to fall, the market value of the fund's portfolio will rise.

Mr. and Mrs. Smith, both nearing retirement, want to maximize their income. They want to reallocate $100,000 of their $400,000 portfolio of securities for this purpose. Of the possible investment choices below, which would be the LEAST suitable recommendation given their investment objective? A)Preferred shares of stock B)GNMA certificates c) AAA convertible corporate bonds D)CMOs

c) AAA convertible corporate bonds Convertible bonds offer a lower coupon in exchange for the conversion feature, therefore is not a good choice for maximizing income.