Ch.13 Bond Features & Ch.6 Stock Pricing

XYZ Corporation has outstanding a 7% convertible bond currently trading at 102. The bond, which has a conversion price of $50, was issued with an antidilution covenant. If XYZ declares a 10% stock dividend, the new conversion price, as of the ex-date, will be: A) $45.45. B) $55.00. C) $45.00. D) $55.55.

$45.45. To compute a new conversion price, divide the current conversion price by 100% plus the percent increase in shares. $50 / 110% = $45.45.

Which of the following would be considered funded debt? A) Corporate debt maturing in 10 years. B) U.S. Treasury bonds maturing in 20 years. C) Municipal revenue bonds maturing in 10 years. D) Commercial paper maturing in 270 days.

A. Corporate debt maturing in 10 years. Funded debt is simply another name for medium- to long-term corporate debt. If a corporate bond has 5 or more years to maturity, it is said to be funded debt of the issuer

A city waterworks publishes a tombstone offering a $20 million new issue of bonds priced at 100.65%. The bonds are priced above par because the: A) municipality has applied the standard municipal bond servicing charge to the issue price. B) price reflects the fact that the coupon rate for the bonds at issuance is more than the rates of similar newly issued bonds available in the market. C) amount exceeding par represents the underwriter's spread. D) amount exceeding par includes accrued interest.

B

Interest paid on I bonds is: A) Exempt at all levels. B) Exempt from state and local taxation. C) Taxable at all levels. D) Exempt at the federal level only.

B

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

Both must pay principal as it comes due.

Which of the following expressions describes the current yield of a bond? A) Yield to maturity divided by par value. B) Annual interest payment divided by par value. C) Annual interest payment divided by current market price. D) Yield to maturity divided by current market price.

C

Which of the following does NOT issue commercial paper? A) Corporation. B) Commercial bank. C) Broker/dealer. D) Finance company.

Commercial bank.

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) 7.8%. D) 5%.

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.

Treasury STRIPS and Treasury receipts are quoted based on: A) amortization of premiums. B) 0.125. C) 0.03125. D) yield to maturity.

D Noninterest-bearing securities, like zeroes, are quoted based on their yield to maturity. They are sold at a discount and mature at par.

Your customer has listed income and safety of principal as his primary investment objectives. Which of the following might be the least suitable recommendation? A) Preferred shares B) GNMA securities C) US government issued T-bonds D) Sovereign debt securities

D.

All of the following statements regarding Government National Mortgage Association (GNMA) pass-through securities are true EXCEPT A) the minimum investment increment is $1,000 B) GNMAs are considered to be the riskiest of the agency issues C) investors own an undivided interest in a pool of mortgages D) investors receive a monthly check representing both interest and a return of principal

GNMAs are considered to be the riskiest of the agency issues

Which of the following securities trades with accrued interest? A) Commercial paper. B) Treasury bill. C) Banker's acceptance. D) Negotiable certificate of deposit.

Negotiable certificate of deposit. Negotiable CDs are traded with interest. Bankers' acceptances, commercial paper, and T-bills are issued at a discount and traded without accrued interest (flat).

Which of the following is nonnegotiable? A) Series EE bonds. B) Treasury notes. C) Treasury bills. D) Ginnie Mae bonds.

Series EE bonds.

A convertible bond has a conversion price of $40 per share. If the market value of the bond rises to a 12½ point premium over par, which of the following are TRUE? Conversion ratio is 25:1. Conversion ratio is 28:1. Parity price of the common stock is $42. Parity price of the common stock is $45. A) II and IV. B) II and III. C) I and IV. D) I and III.

The conversion ratio is computed by dividing par value by the conversion price ($1,000 par / $40 = 25). Parity price of the common stock is computed by dividing the market price of the convertible bond by the conversion ratio ($1,125 / 25 = $45). Or, 112½% × $40 = $45.

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

The put feature would likely be exercised if interest rates rise. The issuer will likely call bonds if interest rates fall.

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

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 means the bondholder must be able to convert it to more shares, which requires a lower conversion price.

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 A) an equity- or index-linked note (ELN or ILN) B) a collateralized mortgage obligation (CMO) C) a bond fund D) preferred shares

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).

An investor might expect to receive the greatest gain on an investment in a corporate bond by purchasing: A) long-term bonds when interest rates are high. B) short-term bonds when interest rates are low. C) long-term bonds when interest rates are low. D) short-term bonds when interest rates are high.

long-term bonds when interest rates are high. If an investor purchases bonds when market interest rates are high, a drop in interest rates will lead to a corresponding increase in bond value. Long-term debt instruments will fluctuate to a greater degree than those with short-term interest rates. Thus, long-term debt offers the greater chance at gain.

Interest on direct debt issued by the U.S. government is taxable at: A) different levels in different states. B) the federal level and exempt at the state level. C) the state level only. D) the federal and state level.

the federal level and exempt at the state level. Interest on direct debt (T-bills, T-notes, T-bonds, and STRIPS) is taxable by the federal government but not by state or local governments.

ADR owners have all the following rights EXCEPT: A) the right to receive dividends in U.S. dollars. B) the right to receive the underlying foreign security. C) the right to sell in the secondary market. D) the right to sell the ADR in the foreign market.

the right to sell the ADR in the foreign market.

All of the following trade with accrued interest EXCEPT: A) convertible bonds. B) jumbo certificates of deposit. C) Treasury bonds. D) zero-coupon bonds.

zero-coupon bonds.

Which of the following securities is an original issue discount obligation? A) Corporate bonds. B) FNMA bonds. C) GNMA certificates. D) 13-week U.S. Treasury bills.

13-week U.S. Treasury bills.

A quote of 6.20 bid 6.18 offered would most likely be a quote on a: A) Ginnie Mae bond. B) T-bond. C) GO bond. D) T-bill.

D

A 7% convertible debenture is selling at 101. 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 at parity with the debenture, the price of the stock would be: A) $25.00. B) $43.91. C) $40.00. D) $25.25.

To determine the parity price of the common, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 / $25 = 40 shares). Next, divide the current price of the bond by the conversion ratio. The result is the parity price of the common stock. (1010 / 40 = $25.25).

Which of the following bonds would appreciate the most if the interest rates fell? A) 30-year premium. B) 15-year discount. C) 15-year premium. D) 30-year discount.

30-year discount

A May and November Treasury bond is traded the regular way on Wednesday, June 8th. The number of days of accrued interest is: A) 38. B) 44. C) 45. D) 39.

39 Accrued interest on government bonds is based on actual days in a year. Settlement occurs on the next business day. This bond pays interest in May and November, with the most recent payment on May 1st. Interest has accrued on this bond for 31 days in May and 8 days in June, for a total of 39 days. Settlement date is Thursday, June 9th.

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 A) II and III B) II and IV C) I and IV D) I and III

A

A respected analyst reports that last week's T-bill rate at 6% 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 more for T-bills. B) The general level of interest rates is increasing. C) Investors are paying less for T-bills. D) Prices are descending.

A

Each of the following securities are issued with a fixed rate of return EXCEPT: A) common stock. B) preferred stock. C) bonds. D) convertible preferred stock.

A

If all other factors are equal, an investor would expect which type of preferred stock to pay the highest stated dividend rate? A) Callable. B) Cumulative. C) Straight. D) Convertible.

A

The funds used for the retirement of a bond may be deposited into a: A) sinking fund. B) priority capitalization account. C) collateral trust fund. D) level debt service account

A

Which of the following statements regarding Treasury bills (T-bills) are TRUE? The government auctions T-bills at a discount. The difference between the cost of a T-bill and its value at maturity is treated as a capital gain. T-bills have longer maturities than T-notes. The minimum denomination of a T-bill is $100 face amount. A) I and IV. B) I and III. C) II and IV. D) II and III.

A. T-bills are sold at a discount and can be purchased in minimum denominations of $100. The difference between the purchase price and the maturity value is taxed as interest income, not as a capital gain. Treasury bills are short-term investments maturing in 1 year or less. T-notes have maturities of 2 to 10 years. T-bonds have maturities of longer than 10 years.

Ten municipal bonds were purchased with 9% nominal yield for settlement on February 1, 2005. The maturity date of the bonds is July 1, 2020. What is the number of days of accrued interest on the 10-bond trade? A) 31. B) 30. C) 29. D) 37.

B

Which of the following is the most sensitive/volatile short-term interest rate? A) Prime rate. B) Federal funds rate. C) Broker call loan rate. D) Discount rate.

B

One of your clients owns 2 different 6% corporate bonds maturing in 15 years. The first bond is callable in 5 years, while the second has 10 years of call protection. If interest rates begin to fall, which bond is likely to show a greater change in price? A) Both will decrease by the same amount. B) Both will increase by the same amount. C) Bond with the 10-year call. D) Bond with the 5-year call.

Bond with the 10-year call. As interest rates fall, the investor benefits from having the highest interest rate for as long as possible. The price change will not be the same for both bonds. The greater the call protection, the more likely a bond will appreciate if rates fall.

Which of the following is TRUE regarding GNMA? A) Lending institutions apply to GNMA for funds to lend to residential home buyers. B) GNMA approves residential mortgages for home buyers. C) Private lending institutions approved by GNMA originate eligible loans and sell the mortgage-backed securities to investors. D) GNMA originates loans to home buyers and sells the mortgage backed securities to private lending institutions.

C

Two registered representatives (RRs) are discussing a collateralized debt obligation (CDO) backed by cash flow from credit card payments. All of their statements during the discussion are true EXCEPT A) CDOs are securitized products where pooling or repackaging of individual loans has occurred B) CDOs always represent pools of assets that individually are very liquid, and that is why the CDOs themselves are very liquid C) CDOs are not considered suitable for all customers D) a customer would have to choose a tranche that has the right risk characteristics for him, in terms of suitability

CDOs always represent pools of assets that individually are very liquid, and that is why the CDOs themselves are very liquid In most cases, the assets comprising the CDO portfolio are small and individually not very liquid. Generally, individual investors would not have an opportunity to purchase these assets separately. Repackaging the assets, however, facilitates them being sold to individual investors in the secondary markets.

Which of the following debt securities does NOT have a fixed maturity date? A) Collateralized mortgage obligation. B) Subordinated debenture. C) Treasury STRIPS. D) General obligation bond.

Collateralized mortgage obligation. 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.

A money market mutual fund would be least likely to invest in which of the following assets? A) Repurchase agreements. B) U.S. Treasury bills. C) Bank certificates of deposit. D) U.S. Treasury notes.

D 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.

Which of the following statements regarding corporate zero-coupon bonds are TRUE? Interest is paid semiannually. The discount is in lieu of periodic interest payments. The discount must be accreted and is taxed annually. The discount must be accreted annually with taxation deferred until maturity. A) II and IV. B) I and III. C) II and III. D) I and IV.

II and III. The investor in a corporate zero-coupon bond receives the return in the form of growth of the principal amount over the bond's life. The bond is purchased at a deep discount and redeemed at par at maturity. That discount from par represents the interest that will be earned at maturity date. However, the discount is accreted annually and the investor pays taxes yearly on the imputed interest.

Twenty-five basis points on a par bond with 1 year to maturity are equal to: $.25 per $1,000. $2.50 per $1,000. 0.25%. 2.5%.

If 1 basis point equals .01%, 25 basis points equal .25%. .25% of $10 (which is the value of one full point for a bond) = $2.50.

ABC, Inc. will issue new stock through a rights offering. Terms of the offering are 10 rights plus $10 to purchase one new share of stock, with any fractional shares to be considered whole shares. ABC is currently trading at $13. If your customer owns 85 shares of ABC and wishes to subscribe to the new offering, how many shares can she purchase at the subscription price and how much money will be required? A) 8 shares; $80. B) 9 shares; $90. C) 9 shares; $80. D) 8 shares; $90.

Owning 85 shares, the customer would receive 85 rights allowing the purchase of 8.5 shares. Because fractional shares are rounded up, a total of 9 shares could be purchased. Each share requires an additional $10 to purchase, therefore if the customer wants to buy the 9 shares the customer must pay a total of $90.

All of the following will affect the marketability of a block of corporate bonds EXCEPT: A) block size. B) rating. C) maturity. D) bond denominations.

bond denominations.

Corporate bonds are considered safer than common stock issued by the same company because: A) if there is a shortage of cash, dividends are paid before interest. B) bonds place the issuer under an obligation but stock does not. C) bonds and similar fixed-rate securities are guaranteed by SIPC. D) the par value of bonds is generally higher than that of stock.

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 customer purchases an ABC 6-½% convertible preferred stock at $80. The conversion price is $20. If the common stock is trading 2 points below parity, the price of ABC common is: A) $18. B) $12. C) $16. D) $14.

he conversion ratio is computed by dividing par value by the conversion price ($100 par / $20 = 5). Parity price of the common stock is computed by dividing the market price of the convertible by the conversion ratio ($80 / 5 = $16). $16 − 2 = $14.

A client of your broker/dealer is interested in collateralized mortgage obligations (CMOs). While determining suitability for the client all of the following should be discussed EXCEPT A) the tax consequences of CMOs B) how changing interest rates may affect the prepayment rates C) the relationship between mortgage loans and mortgage securities D) how currency exchange rates may affect the value of the securities

how currency exchange rates may affect the value of the securities

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

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 means the bondholder must be able to convert it to more shares, which requires a lower conversion price.

An investor purchases an ABC Corporation convertible bond at 98 on June 18, 1997. The bond is convertible at $25 and the investor converts his bond into the stock on June 19, 1998, when the common stock is trading at $26 per share. For tax purposes, these transactions will result in: A) a $60 capital gain. B) a $40 capital gain. C) a $40 capital loss. D) neither gain nor loss.

neither gain nor loss. Converting a bond into shares of common stock does not result in tax consequences. For a taxable gain or loss to exist, the shares received as a result of the conversion must be sold.

A company that has issued cumulative preferred stock: A) pays past and current preferred dividends before paying dividends on common stock. B) forces conversion of the preferred that is trading at a discount to par, thereby eliminating the need to pay past-due dividends. C) pays the current dividends on the preferred, but not the past dividends on the preferred, before paying a dividend on the common. D) pays the preferred dividend before paying the coupons due on its outstanding bonds.

pays past and current preferred dividends before paying dividends on common stock.