Unit 4 Qbank Qs
A customer purchased a 5% bond yielding 6%. A year before the bond matures, new bonds of the same quality are being issued at 4%, and the customer sells the 5% bond. The customer probably did which of the following? Bought it at a discount Bought it at a premium Sold it at a discount Sold it at a premium A) I and IV B) II and IV C) II and III D) I and III
A) I and IV 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.
A customer buys a 5% bond at par. The bond is callable in five years at par and matures in 10 years. Which of the following statements is true? A) YTC is the same as YTM. B) YTC is lower than YTM. C) Nominal yield is higher than either YTM or YTC. D) YTC is higher than YTM.
A) YTC is the same as YTM. If a bond is trading at par, the nominal yield (coupon rate) equals current yield equals yield to maturity (YTM) equals yield to call (YTC). YTC is higher than YTM if the bond is trading at a discount to par. YTC is lower than YTM if the bond is trading at a premium over par. Nominal yield is higher than either YTM or YTC if the bond is trading at a premium over par.
Corporate bonds are considered safer than common stock issued by the same company because A) bonds place the issuer under an obligation but stock does not. B) if there is a shortage of cash, dividends are paid before interest. C) the par value of bonds is generally higher than that of stock. D) bonds and similar fixed-rate securities are guaranteed by SIPC.
A) bonds place the issuer under an obligation but stock does not. A bond represents a legal obligation to repay principal and interest by the company. Common stock carries no such obligation.
A bond offered at par has a coupon rate A) equal to its current yield. B) less than its current yield. C) less than its yield to maturity. D) greater than its yield to maturity.
A) equal to its current yield. When a bond is selling at par, its coupon or nominal rate, current yield, and yield to maturity are all the same.
One of your customers calls and asks you about a security with an S&P rating of SP-2. The customer is most likely asking about which of the following? A) A municipal bond B) A municipal note C) Your firm's privacy notice D) Commercial paper
B) A municipal note The three major rating services each have their own rating system for short-term municipal debt (notes). In the case of Standard and Poor's, the ratings are SP-1, SP-2, and SP-3 in declining order of quality. Regulation S-P (with the hyphen between the S and P) deals with privacy notices. Although it is unlikely to be tested, commercial paper is rated A-1, A-2, A-3, and then into the "Bs."
A corporation has $25 million of 5% bonds outstanding. The bonds are callable at 102. Current market interest rates are 6%. If the company would like to retire $10 million of the debt, it might be smart to A) exercise the call provision for $10 million face amount of the bonds. B) make a tender offer to purchase $10 million face amount of the bonds. C) issue $10 million of new bonds at current rates and use the proceeds to call in outstanding ones. D) issue $10 million of treasury stock and use the proceeds to retire the bonds.
B) make a tender offer to purchase $10 million face amount of the bonds. When current market interest rates are 6%, bonds with a 5% coupon are selling at a discount. That means the company could make a public offer to buy the bonds back at a price somewhat below par value. In simple terms, they could retire $10 million of debt for less than $10 million. It would make no sense to call the bonds at 102 ($1,020) when they can be purchased for less than $1,000 each in the open market. Issuing new bonds to retire old ones, a practice known as refunding, is done when interest rates have fallen. In this question, interest rates have gone up making that plan incorrect.
All of the following statements regarding negotiable jumbo certificates of deposit are true except A) they are readily marketable. B) they are fully insured in any denomination by the FDIC. C) they usually have maturities of less than one year. D) they are usually issued in denominations of $100,000 to $1,000,000.
B) they are fully insured in any denomination by the FDIC. The FDIC insures only up to $250,000.
Which of the following bonds is most affected by interest rate risk? A) 7.3s of '37 B) 7.5s of '39 C) 7.6s of '45 D) 7.8s of '42
C) 7.6s of '45 To begin with, let's be sure you understand the nomenclature used here. Each of the choices has two numbers. The first is the coupon rate of the bond and the second is the year the bond matures. For example, the 7.3s of '37 pay interest at a rate of 7.3% of the $1,000 par value per year and mature in 2037. The s is just to separate the two numbers. Interest rate risk is the loss in value due to a rise in interest rates. Because there is little difference in coupon rates, the bond with the longest maturity (highest duration) will experience the greatest fall in a rising interest rate market.
The SEC recognizes all of the following under the Credit Rating Agency Reform Act as being registered with the commission to rate debt instruments. Which of them historically has specialized in ratings for the insurance sector? A) Fitch Ratings B) Standard & Poor's C) A.M. Best D) Moody's
C) A.M. Best 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.
The industry term "junk bond" applies to a bond with a Standard and Poor's rating no higher than A) BBB. B) B. C) BB. D) C.
C) BB. Once a bond's rating has fallen below the top four grades (AAA, AA, A, and BBB), it is no longer considered investment grade. At that point, BB (or Moody's Ba) or lower, it is considered a high-yield or junk bond.
Which of the following choices is least similar to the others? A) Standard & Poor's. B) Moody's. C) Financial Guaranty Insurance Corp. D) Fitch.
C) Financial Guaranty Insurance Corp. Standard & Poor's, Fitch, and Moody's are all agencies that rate debt securities, including municipals and equity securities. The Financial Guaranty Insurance Corp. is one of several entities that insure municipal bonds.
If a U.S. corporation wishes to issue eurodollar bonds, which of the following statements are true? The corporation will be subject to currency risk. The corporation will not be subject to currency risk. The issue must be filed with the SEC. The issue need not be filed with the SEC. A) I and IV B) I and III C) II and IV D) II and III
C) II and IV Because eurodollar bonds are denominated in U.S. dollars, a U.S. corporate issuer will not be subject to foreign exchange risk, regardless of the country of issuance. In addition, because the bonds are issued outside the United States, the issue is not registered with the SEC.
A respected analyst reports that last week's T-bill rate at 1% is lower than the rate for the preceding week and lower than the average for the past month. Which of the following is true? A) Investors are paying less for T-bills. B) Prices are descending. C) Investors are paying more for T-bills. D) The general level of interest rates is increasing.
C) Investors are paying more for T-bills. When the rate is lower, the price has gone up. This means investors are paying more as interest rates are going down.
A bond you are recommending to a customer has call protection. What does that mean? A) The issuer records the phone number of investors and puts it on the do-not-call list. B) The issuer has set up a sinking fund to provide funds for the call. C) It is the number of years into the issue before the issuer may exercise the call privilege. D) It is the number of years into the issue before the investor may exercise the call privilege.
C) It is the number of years into the issue before the issuer may exercise the call privilege. The definition of call protection is the length of time an investor is protected against the issuer exercising the right to call the bonds in. What is the maximum possible call protection? A noncallable bond. In many cases, the issuer sets up a sinking fund to use for the call, but that is not the definition of call protection.
Debt normally issued by big corporations with reliable credit ratings that seek to finance short-term needs best describes A) T-bills. B) revenue anticipation notes. C) commercial paper. D) certificates of deposit.
C) commercial paper. This is the definition of commercial paper, as known as promissory notes. They are short-term corporate-issued instruments sold at a discount and maturing at par.
If the dollar price of a municipal bond is 101 and, at that price, the basis is 6.10, the nominal yield is A) less than 6.10%. B) less than the coupon rate. C) greater than 6.10%. D) exactly 6.10%.
C) greater than 6.10%. Basis is a common synonym for yield to maturity, especially for municipal bonds. For any bonds trading at a premium, the nominal yield (or coupon) is higher than the basis (YTM). For bonds at a premium, yields from lowest to highest are as follows: yield to call, yield to maturity, current yield, and nominal yield.
In recent years, much publicity has surrounded the rapid growth of start-up businesses. In most cases, the early financing was done privately. When private debt is used at the intermediate stage of a company's development, it is called A) middle-risk debt. B) intermediate debt. C) mezzanine debt. D) mid-term debt.
C) mezzanine debt. Just as the mezzanine in a theater is between the balcony and the orchestra levels, mezzanine debt represents financing supplied at the intermediate point in a new company's development. The funds are provided on a private basis and the investment carries a high degree of risk. As an alternative investment, it will be suitable for a very narrow range of customers.
A term used to define certain alternative forms of debt financing, such as equity-linked notes (ELNs) and exchange-traded notes (ETNs), is A) high-risk investments. B) principal protected products. C) structured products. D) combination products.
C) structured products. The most important thing for you to know for the exam is that these generally carry higher risk than other debt securities. These should be recommended only when the registered representative has a thorough understanding of the product and believes it is suitable for the specific investor. Yes, these are high-risk investments, but that is not the term used to describe them.
When a bond is selling at a discount A) the yield to maturity will always be lower than the current yield. B) the yield to call will always be lower than the yield to maturity. C) the nominal yield will always be lower than the current yield. D) the current yield will always be higher than the yield to call.
C) the nominal yield will always be lower than the current yield. When a bond is selling at a discount, all of the yields are higher than the nominal (coupon) yield. The sequence in ascending order of yield is NY, CY, YTM, YTC.
Your customer is interested in long-term corporate bonds. Which of the following interest rate environments makes a call protection feature most valuable to your customer? A) Rising interest rates B) Volatile interest rates C) Stable interest rates D) Declining interest rates
D) Declining interest rates A call protection feature is an advantage to bondholders in periods of declining interest rates. When interest rates are falling, issuers are more likely to call in bonds previously issued at higher interest rates. For bondholders, calling bonds creates reinvestment risk, as they are unlikely to be able to reinvest at the rate they had been earning. Call protection gives the bond holder a specified length of time during which the bond cannot be called.
Which of the following is a money market instrument? A) Preferred stock B) Common stock C) Long-term debt D) Short-term debt
D) Short-term debt A money market instrument is short-term debt with one year or less to maturity.
Three 3% bonds are listed in the newspaper. One bond will mature in one year, another bond will mature in 10 years, and the third bond will mature in 20 years. If interest rates are going up, which bond will have the greatest decrease in value? A) None, as they will all have the same decrease in value B) The bond with the 1-year maturity C) The bond with the 10-year maturity D) The bond with the 20-year maturity
D) The bond with the 20-year maturity Long-term bonds have the greatest interest rate risk. A bond with only one year to maturity will trade very close to par.
What happens to outstanding fixed-income securities when market interest rates drop? A) The coupon rates increase. B) The yields increase. C) Short-term fixed-income securities are affected most. D) The prices increase.
D) The prices increase. When interest rates drop, the price of outstanding bonds rises to adjust to the lower yields on bonds of comparable quality.
The XYZ Corporation has issued some 4% callable bonds maturing in 20 years. The bonds are callable at 102 commencing in 10 years. Regarding these bonds, which of the following statements is not correct? A) XYZ will most probably call these bonds when it can refund the issuer at a lower interest rate. B) The bonds will likely be called in a declining interest rate market, forcing the bondholders to reinvest at lower rates. C) The call premium generally will not compensate the bondholder for the loss of interest if the bond is called. D) These bonds will appreciate faster in declining interest rate markets than comparable bonds without a call feature.
D) These bonds will appreciate faster in declining interest rate markets than comparable bonds without a call feature. All things being equal, callable bonds will not show as much appreciation in a declining interest rate market as bonds without a call feature. Logically, as interest rates fall, those bonds will be called making them less attractive than bonds where the higher interest rate payments will continue until maturity. It is correct that the premium ($20 in this question) is generally not going to equal the amount of interest that the investor would have been able to earn on the bond. It is some compensation, but not full. The bonds will be called when interest rates have declined, and the investor will now have the cash but faces the reinvestment risk of having to put the money to work at those lower interest rates.
A corporate bond with a nominal yield of 6% is currently trading at a yield to maturity (YTM) of 5.8%. It would be accurate to state that this bond is trading at A) a discount. B) parity. C) par. D) a premium.
D) a premium. If YTM is less than the nominal or coupon yield, the bond is trading at a premium.
Transactions in all of the following are affected in the money market, as opposed to the capital market, except A) U.S. Treasury bills. B) commercial paper. C) jumbo CDs. D) municipal revenue bonds.
D) 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.
If interest rates increase, the interest payable on outstanding corporate bonds will A) increase. B) decrease. C) change according to the inverse payout theory. D) remain unchanged.
D) 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.
It would be expected that your firm would employ heightened suitability standards when evaluating recommendations for A) sovereign debt. B) cumulative preferred stock. C) nonvoting common stock. D) structured products.
D) structured products. The higher the risk of the investment, the greater the need for checking suitability. Structured products, such as equity-linked notes and exchange-traded notes, are considered complex products. In many cases, FINRA has discovered that registered representatives had inadequate understanding of the investment, leading to their making unsuitable recommendations.
The legal contract stating the issuer's obligation to pay back a specific amount of money on a specific date to its bondholders is best described as A) the official notice of sale. B) the prospectus. C) the official statement. D) the trust indenture.
D) the trust indenture. A trust indenture delineates the covenants or promises made by an issuer to its bondholders. Those would include the amount of the debt, the maturity date, and the rate of interest. A trustee would also be identified in the indenture who would act on behalf of the bondholders in the event of default on any of the indenture's provisions.
The minimum face amount of a negotiable CD is A) $100,000. B) $50,000. C) $10,000. D) $25,000.
A) $100,000. Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are traded in blocks of $1 million.
The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 115 is approximately A) 3.95%. B) 4.35%. C) 4.65%. D) 5.75%.
A) 3.95%. A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $1,150 current market price. That is about 4.35%. The YTM must be lower than that because it includes the eventual loss realized when the bond matures at par.
Which of the following debt instruments would likely be suitable for sophisticated investors only? A) Equity-linked notes B) First mortgage bonds C) Debentures D) Jumbo CDs
A) Equity-linked notes Despite the misleading name, ELNs are debt instruments. When traded on an exchange, they are exchange-traded notes (ETNs). In either case, these are considered alternative products with unique risks, and therefore, not suitable for most investors. Although debentures are corporate debt without any pledged collateral, some of the financially strongest companies in the country issue them and receive high ratings. Even though Jumbo CDs require a minimum of $100,000, it does not require any sophistication to understand the product.
All of the following are money market instruments except A) options. B) commercial paper. C) bankers' acceptances. D) reverse repurchase agreements.
A) options. Money market instruments are short-term (one year or less to maturity) liquid debt instruments. Reverse repurchase agreements, repurchase agreements, commercial paper, CDs, and bankers' acceptances are examples. Options are not money market instruments.
A 5% bond is trading at a premium. Which of the following would be the bond's highest yield? A) Dividend yield B) Yield to maturity C) Coupon yield D) Current yield
C) Coupon yield
Nickelplate Manufacturing Corporation (NMC) is capitalized with 1 million shares of a 6% $50 par callable preferred stock and 10 million shares of $1 par common stock. Your customer's required rate of return on fixed income investments is 8%. The NMC preferred stock would be an appropriate addition to this customer's portfolio only if the stock was not priced in excess of A) $37.50. B) $75.00. C) $66.66. D) $40.00.
A) $37.50. How does a 6% preferred stock return 8%? Remember the inverse relationship between interest rates and fixed income security prices. As one goes up, the other goes down. An increased return results from a decreased price. The math is basic algebra. We know the annual dividend is $3 per share (6% of $50 = $3); that is fixed. What number results in a payment of $3 providing an 8% return? Divide 3.00 by $8 and the answer is $37.50. You could also do this question by working backwards. Multiply each of the choices by 8% and the one where the product is $3 is correct.
The ELLA Distributing Company issued a bond with a nominal yield of 5%. The bond matures in 12 years and is currently trading at 94. The bond's yield to maturity is closest to A) 5.67%. B) 5.32%. C) 5.00%. D) 4.64%.
A) 5.67%. The first point to notice is that the bond is trading at a discount. When bonds trade at a discount, our yield chart and example tells us that the yields, in ascending order, are nominal yield, current yield, yield to maturity, and yield to call. Therefore, we know that the yield to maturity must be greater than the nominal (coupon) yield of 5% The yield to maturity computation is tricky, but current yield is not. It is simply the coupon divided by the current market price. In our question, that is 5% divided by 94 equals 5.32% (or $50 divided by $940). We know the yield to maturity for a bond selling at a discount is higher than its current yield. That means the correct answer must be greater than 5.32%.
Which of the following are characteristics of commercial paper? It is registered with the SEC. It is a short-term debt instrument. It is issued by commercial banks. It is unsecured debt. A) II and IV B) I and III C) III and IV D) I and II
A) II and IV Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Because commercial paper is issued with maturities of less than 270 days, it is exempt from SEC registration under the Securities Act of 1933.
In a discussion with one of your customers, the topic of alternative debt instruments is brought up. It seems that the customer was competing in a duplicate bridge tournament in town and one of the other competitors mentioned that they have been obtaining higher income returns from ELNs. When the customer asks you for the meaning of that abbreviation, you would reply A) equity-linked notes. B) exchange-leveraged notes. C) equity-leveraged notes. D) exchange-linked notes.
A) equity-linked notes. An ELN is an equity-linked note. That is a strange name for a debt product. The equity refers to the specific stock, a basket of stocks, or an equity index upon which the return is based. Therefore, the return is not fixed and can be higher or lower than anticipated depending on the selected equity's performance. There are foreign exchange-linked notes where the performance is based on currency rates, but that is unlikely to ever be a topic covered on the exam. There are no such products as exchange or equity-leveraged notes.
During a period of sustained low interest rates, many investors, particularly institutions, look to increase their return through alternative debt investments. Examples of those would include all of the following except A) leveraged ETFs. B) private placement debt. C) exchange-traded notes. D) equity-linked notes.
A) leveraged ETFs. Although leveraged ETFs (exchange-traded funds) are certainly an alternative investment, they represent an equity investment rather than debt. Despite the misleading name, equity-linked notes are, in fact, debt instruments.
The LLAW Manufacturing Company issued a 6.25% debenture 5 years ago. The bond is callable in seven years at 102 and matures in 15 years. The bond's current yield is 4.23%. If one of your customers decided to purchase this bond, they would have to understand they would be A) paying a premium for the bond. B) receiving a yield to maturity in excess of 4.23%. C) buying the bond at a price below par. D) required to pay the call price.
A) paying a premium for the bond. The first thing to notice is that the current yield is below the nominal (coupon) rate. That automatically tell us the bond is selling at a premium. Whenever a bond is selling at a premium, in increasing order, the order of the yields is yield to call, yield to maturity, current yield, and nominal yield. Therefore, if the current yield is 4.23%, the yield to mature cannot be higher than that; it must be less. As we say in the LEM, "if you pay more, you get less" and "if you pay less, you get more." The issuer pays the call price when, and if, the bond is called.
The following is taken from the S&P Bond Guide: FLB Zr 37 87 87½. What is the coupon rate on this bond? A) 8.70% B) 0% C) 0.37% D) 8.75%
B) 0% FLB is the issuer, Zr means zero coupon, 37 indicates the year of maturity (2037), 87 is the bid price ($870), and 87½ is the asked price ($875).
Which of the following callable municipal bonds trading on a 7% basis is most likely to be called? A) 6.5% coupon, callable at 105 in 2030 B) 7.5% coupon, callable at 100 in 2030 C) 7.5% coupon, callable at 105 in 2030 D) 6.5% coupon, callable at 100 in 2030
B) 7.5% coupon, callable at 100 in 2030 An issuer will call the higher coupon bonds before calling the lower coupon bonds. Of the two bonds with coupons of 7.5%, the one with the lower call price will likely be called first.
Which of the following are characteristics of commercial paper? It represents a loan by the holder to the issuer. It is a certificate of ownership in the corporation. It is commonly issued to raise working capital for a corporation. It is junior in preference to convertible preferred stock. A) II and III B) I and III C) I and IV D) II and IV
B) I and III 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.
Two conservative customers in their 50s are interested in preserving principal and high-current income from their investments. From first to last, in which order are the following bonds ranked in meeting your customer's needs? Fort Worth Gas 5¼s of 35, rated A1 San Antonio Transit 5¼s of 35, rated AA+ Texas Telecom 5¼s of 35, rated AAA Dallas Electric 5¼s of 35, rated AA- A) I, II, III, IV B) III, II, IV, I C) IV, III, I, II D) III, IV, II, I
B) III, II, IV, I Because the maturity and coupon rates are all the same, we can rank the bonds by rating. Based on the ratings given, the highest-quality bond is the Texas Telecom, rated AAA, followed in order by the bonds rated AA+, AA-, and A1.
Most rating services rate which of the following? A) Durability B) Quality C) Reinvestment risk D) Marketability
B) Quality The rating services are concerned with quality, which is defined as the ability of the issuer or guarantor to pay (default risk).
A bond investor who is looking for capital gains should invest in bonds when interest rates are A) low and expected to rise. B) high and expected to decline. C) low and expected to decline. D) high and expected to rise.
B) high and expected to decline. This is about the inverse relationship between interest rates and bond prices. As interest rates rise, bond prices fall. Conversely, when interest rates decline, bond prices increase. If an investor buys bonds when the current interest rates are high, a future decline in those interest rates will cause the price of the bonds to increase.
A corporate bond is quoted at 102⅝. A customer buying 10 bonds would pay A) $10,025.80. B) $10,258.00. C) $10,262.50. D) $10,285.00.
C) $10,262.50. Par ($1,000) × 102% = $1,020. Five-eighths of one bond point ($10) equals 0.625 times $10 equals $6.25. Therefore, the quote reading 102⅝ equals $1,026.25 per bond ($1,020 + $6.25). Because we are told the customer is buying 10 bonds, we multiply $1,026.25 by 10 bonds, which equals the amount the customer will need to pay to make the entire purchase: $10,262.50.
Six percent XYZ debentures are trading for $1,200. Other similarly rated bonds are offered at 4.5%. What is the current yield on the 6% XYZ debentures? A) 7.5% B) 1.5% C) 5% D) 6%
C) 5% Current yield is defined as the annual income (or coupon rate) from a bond divided by the bond's current market price. Accordingly, $60 / $1,200 = 0.05 × 100 = 5%. The current yield will be lower than the coupon rate when the bond is trading at a premium.
The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 85 is approximately A) 4.59%. B) 5.75%. C) 5.88%. D) 6.22%.
D) 6.22%. A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $850 current market price. That is about 5.88%. The YTM must be higher than that because it includes the eventual profit realized when the bond matures at par.
A bond issued by a Swiss company, sold outside the United States and the issuer's country, but for which the principal and interest are stated and paid in U.S. dollars, is the definition of a A) Eurobond. B) Francodollar bond. C) Matterhornbond. D) Eurodollar bond.
D) Eurodollar bond. The key to a Eurodollar bond is that everything is in U.S. dollars. The issuer is either a non-U.S. corporation or government, and the security is not issued in the United States.
