Debt

A Repurchase Agreement is effected between two US Government securities dealers. The interest charged under the agreement is the:

"Repo rate, paid by the seller of the security to the buyer. In a repo agreement between 2 government dealers, one dealer sells sercurities to another, with an agreement to buy them back at a later date. The selling dealer obtains cash, and for this, agrees to pay interest to the buying dealer. The interest rate charged is known as the repo rate. The rate fluctuates with and parallels the Federal Funds rate

CMOs are available in what denomination and are quoted in what fraction

1,000 denominations Quoted in 32nds, similar to the underlying pass-through certificates Often CMO tranches are quoted on a "yield spread basis to equivalent maturing Tresury issues.

The minimum denomination for a mortgage backed pass through certificate is

25,000

A municipality would issue a GAN in anticipation of receiving

A grant anticipatory note issued to get immediate access to federal grant monies that are expected to be received months into the future. These are typically used to support mass transit programs.

The primary value of advance refunding a municipal bond issue is that it . . .

Allows the issuer to reduce its interest cost on a non-callable issue when interest rates have fallen

Which of the following are TRUE statements regarding the tax equivalent yield of a municipal bond? I The tax equivalent yield is disclosed on the customer confirmation II The yield will vary depending on the tax bracket of the customer III The tax equivalent yield will change as the market price of the bond varies IV The tax equivalent yield is the complement of the current yield

As the customer's tax bracket increases, so does the tax equivalent yield. In addition, as the market price of the bond moves, its yield changes. This also changes the tax equivalent yield. There is no requirement to disclose the tax equivalent yield on a customer's confirmation. The last choice (IV) is irrelevant.

An investor expects that interest rates will decline over the next five years. Which of the following is an appropriate investment: A) 10 year bond callable at par in 3 years B) 10 year bond puttable at par in 5 years C)Very short term bonds D) Adjustable rate (reset) bonds, with an annual reset period

B - avoid callable issues or issues with adjustable rates. Put options will only be used if interest rates rise. Short term bonds aren't a good choice because at maturity the proceeds will be rolled into a nw, lower coupon issue as rates fall. With declining rates, choose bonds that are non-callable or that have a put option

Which is considered to be a direct obligation of the US Government A) Federal National Mortgage Association Pass Through Certificates B) Government National Mortgage Assosiaction Pass Through Certificate C) Federal National Mortgage Association Bonds D) Federal Home Loan Bank Bonds

B) GNMA

The final responsibility for the debt service on industrial revenue bonds rests with the: A. Issuing municipality B. Corporate lessee of the facility C. Bond trustee D. Bond underwriter

B. The bond is backed by the rental revenues paid by the corporate Essex as well as by the guarantee of the corporate lessee. They therefore taking on the credit rating of the corporation leasing the facility.

A declining rate of inflation does what to interest rates

Cause them to drop

The nominal yield of a bond is also known as

Coupon rate or state yield

Which of the following statements are TRUE regarding the Federal Funds rate? I The rate is charged from one Federal Reserve member bank to another member bank II The rate is charged by the Federal Reserve to member banks who wish to borrow reserves directly from the Fed III The rate is lower than the discount rate IV The rate is higher than the discount rate A I and III B I and IV C II and III D II and IV

Explanation The best answer is A. The Federal Funds rate is the interest rate charged by Federal Reserve member banks for overnight loans to each other. It is lower than the discount rate. The discount rate is charged by the Federal Reserve itself to member banks that wish to borrow reserves directly from the Fed. Review

All of the following are true statements regarding revenue bonds EXCEPT: A issuance of the bonds is dependent on earnings requirements B the bonds may be double barreled with backing by ad valorem taxes C revenue bonds are only suitable for investors willing to assume a high level of risk D yields for revenue bond issues are generally higher than yields for comparable G.O. issues

Explanation The best answer is C. In order to issue revenue bonds, a feasibility study must be prepared and it must show adequate net revenues ("earnings") to service the debt before the bonds can be floated. A revenue bond can be double barreled to improve its safety by additionally backing the issue with the ad valorem taxing power of the issuer. Yields on revenue bonds are higher than that of comparable G.O. bonds because of generally higher risk. Revenue bonds are suitable for investors willing to take on low, medium or high risk. To evaluate credit risk on these issues, look at Moody's or Standard and Poor's ratings.

Which of the following bonds trade "flat"? I Defaulted bonds II Market discount bonds III Adjustment (income) bonds IV Zero coupon bonds A I only B II and IV C I, III, IV D I, II, III, IV

Explanation The best answer is C. Market discount bonds are simply bonds trading at a discount in the secondary market because either interest rates have risen; or the credit quality of that issue has deteriorated. These bonds are meeting their interest payments and trade with accrued interest. Defaulted bonds trade flat; zero coupon bonds trade flat (since no interest payments are made); and adjustment (income) bonds trade flat since interest is only paid if the issuer earns enough income to service the debt. Otherwise, the issuer is not obligated to pay.

During periods when the yield curve is inverted, which statements are TRUE? I Debt defaults are probably at historically high levels II Issuers are likely to sell non-callable bonds III Debt investors expect that interest rates will fall in the future IV Debt investors expect that economic activity will decline A II, III, IV B I, II, III C I, III, IV D I, II, III, IV

Explanation The best answer is C. When the yield curve is inverted, short term rates are higher than long term rates. This typically occurs when the Federal Reserve pursues a "tight money" policy to slow the economy. The tightening of credit raises interest rates overall, slows economic activity, and thus business defaults increase. Long term rates remain lower than short term rates since investors do not expect the tightening to last far into the future. During periods when the yield curve is inverted, interest rates on all maturities tend to shift upwards, with short term rates rising the most. During these periods of high interest rates, issuers are likely to sell callable issues (not non-callable ones). If interest rates decrease in the future (as expected), the issuer can call in the old debt and refinance at lower current interest rates.

If the Federal Reserve enters into REVERSE repurchase agreements with member banks, the Fed funds rate will increase or decrease?

Fed funds rate is likely to increase. This drains member banks of reserves

Interest received from GNMA pass through certificates is taxable at?

Federal and state income levels

Which company securities are directly guaranteed by the US Government: FNMA or GNMA

GNMA. FNMA only carries an "implicit" US backing so its credit rating is lower.

Interest on a corporate bond accrues on a I. 30- day month II. Actual day month III. 360-day year IV. Actual day year

I & III, 30 day month, 360 day year

Which of the following are true of Construction Loan Notes I. The use of CLN's allows the municipal issuer to reduce its interest cost when constructing a new facility II. The maturity of CLN's is usually 2-3 years III. Accrued interest on CLN's is computed on an actual day month/ actual day year basis IV. When the facility is completed, the permanent financing is added to the outstanding balance "basis" of the CLN

I, II, & III

In a period of falling interest rates, a bond dealer would engage in which activities:

In a period of falling interest rates, bond prices will be rising. Therefore, a dealer would Raise his quoted prices in Bloomberg. If the dealer has appreciated bonds that he wishes to sell, he can place "Requests for Bids" for those bonds in Bloomberg. The dealer may bid (buy) bonds that he has previously sold short to limit losses due to rising prices. To hedge existing short positions against rising prices, the dealer would buy call options, not put options. Put options are used to hedge existing long positions from falling prices.

When the Federal Reserve enters into repurchase agreements with member banks it A) Injects cash into banks B) Drains cash from banks C) Drives the Fed Fund rate down D) Drives the Fed Funds rate up

Injects cash into banks, which drives the Fed Funds rate down.

Bond counsels evaluate:

Legal aspects like the trust indenture Enabling legislation and tax statues.

On a customer account statement, long-term negotiable CD's must be shown at

Market Value

Short sales rarely occur in the trading market for: Municipal bonds Corporate Bonds Government Bonds Agency Bonds

Municipal bonds because the trading market is very thin. There is no national trading market. Shorting a security requires the trader to buy back (replace) the EXACT security that was sold. This is hard to do when there are few bonds being sold.

Interest income received from bonds issued by territories or possessions are subject to which taxes

None, they are triple exempt

The nominal yield of a bond will fluctuate in what way according to market interest rates

Not at all. It stays the same because it is the stated rate of interest as a percentage of par value.

What does each part of the following municipal bond offering listing mean CCS District Bond P/R @ 102 4.2.0 6/15/20. M'30. 2.50

P/R = Pre refunded, meaning that the issuer has pre-refunded the bonds by escrowwing US Government securities to retire the bond prior to maturity 102 = The amount the bond holder will receive on the call day (the par of 100 plus the 2 point premium) 4.20 = The coupon rate 6/15/20 = The call date M'30 = maturity date 2.50 = The yield price

PAC tranche

PAC, or Planned Amortization Class Tranche, is buffered by surrounding companion tranches that absorb prepayment and extension risk before these risks affect the PAC tranche. This tranche has the most certain repayment date.

Which type of bond is most likely to be called, premium or discount

Premium

A feasibility study that is prepared prior to the issuance of a revenues bond does what?

Projects revenues and costs for the facility too determine sufficient net revenues.

Federal Home Loan Banks receive funding by

Selling bonds

As a general rule, interest income from agency securities is subject to and exempt from

Subject to Federal and exempt from state and local

Interest income from securities issued BYU the housing agencies that sell pass through certificates is subject to and exempt from

Subject to all taxes and exempt from none. FNMA, GNMA, FHLMC

BABs are: I subject to Federal income tax II exempt from Federal income tax III issued in the taxable bond market IV issued in the tax-exempt bond market A I and III B I and IV C II and III D II and IV

The best answer is A. "BABs" are Build America Bonds. Build America Bonds were issued by municipalities in 2009 and 2010. They are taxable municipal bonds that get a 35% Federal interest rate subsidy and the bond proceeds must be used for capital improvements (this is part of the economic stimulus program after the 2008-2009 "great recession"). These bonds were meant to create jobs and make to it easier for municipalities to access the debt market for needed capital projects.

A municipal bond which is secured by taxes OTHER than ad valorem taxes is a(n): A Special tax bond B Industrial revenue bond C Moral obligation bond D General obligation bond

The best answer is A. A municipal bond which is secured by taxes other than ad valorem taxes is a special tax bond.

Accrued interest on municipal issues is calculated on which basis? A 30/360 B 30/actual C actual/360 D actual/actual

The best answer is A. Accrued interest on municipal bonds is calculated on a 30 day month/360 day year basis.

When comparing an ETN to a structured product, which statements are TRUE? I ETNs can be traded at any time while structured products cannot II Structured products can be traded at any time while ETNs cannot III ETN income is taxable at lower rates than income from structured products IV Structured product income is taxable at lower rates than income from ETNs A I and III B I and IV C II and III D II and IV

The best answer is A. An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. ETNs are listed on an exchange and trade, so they have minimal liquidity risk. In comparison, a regular structured product is non-negotiable and, if redeemed prior to maturity, imposes an early-redemption penalty. ETNs make no interest or dividend payments. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to other structured debt products. Review

Bonds quoted on a percentage of par basis are generally: A term bonds B series bonds C serial bonds D short term maturities

The best answer is A. Bonds quoted on a percentage of par basis are term bonds. Municipal bonds quoted in basis points (yield quotes) are serial bonds.

Which of the following statements are TRUE regarding Brokered CDs? I Any call features could affect the maturity of the instrument II How the instrument is titled can determine whether FDIC insurance covers the investment III There may be a penalty for early withdrawal of principal IV The principal amount will remain stable over the life of the instrument A I and II B III and IV C I and IV D II and III

The best answer is A. Brokered CDs, which can have lives of up to 5 years, can be callable. If interest rates drop after issuance, then the issuer can call in the CD, forcing the investor to reinvest the refunded monies at lower current market interest rates. Brokered CDs are sold by brokerage firms that are representing issuing banks. FDIC insurance of $250,000 maximum covers bank deposits - but only if the deposit is titled in the customer's name. If the CD is titled in the brokerage firm's name, then the insurance coverage would not apply! There is no penalty for early withdrawal of funds on brokered CDs - however the amount of interest earned will be pro-rated over the shorter life of the deposit. If interest rates rise after issuance, the value of the CD in the secondary market will fall (though not by much, since this is a short maturity). Review

All of the following statements are true about commercial paper EXCEPT commercial paper: A is a funded debt of the issuer B matures on a pre-set date and at a pre-set price C is quoted on a yield basis D is an unsecured promissory note

The best answer is A. Corporate "funded debt" represents long term debt financing of a corporation with at least 5 years to maturity. Since commercial paper has a maximum maturity of 270 days, it is not a funded debt. Commercial paper is quoted on a yield basis; matures at a pre-set date and price; and is an unsecured promissory note of the issuer. Review

Which of the following can initiate repurchase agreements with government and agency securities as collateral? I Federal Home Loan Banks II Commercial banks III Federal Reserve Banks IV Government securities dealers A II, III, IV B I, II, III C I, III, IV D I, II, III, IV

The best answer is A. Government securities dealers, Commercial banks, and the Federal Reserve through its open market trading desk, all initiate repurchase agreements. Federal Home Loan Banks sell bonds to obtain funding. With the funds, it buys mortgages from Savings and Loans, making a secondary mortgage market and injecting fresh funds into the S&L's.

Wide swings in market interest rates would affect which of the following for holders of collateralized mortgage obligations? I Prepayment Rate II Interest Rate III Market Value IV Credit Rating A I and III B II and IV C I, II, III D I, II, III, IV

The best answer is A. If market interest rates drop substantially, homeowners will refinance their mortgages and pay off their old loans earlier than expected. Thus, the prepayment rate for CMO holders will increase. Furthermore, as interest rates drop, the value of the fixed income stream received from those mortgages increases, so the market value of the security will increase. Market interest rate movements have no effect on the stated interest rate paid by the security; and would not affect the credit rating of the issue.

Interest on a corporate bond accrues on a: A 30/360 basis B 30/actual basis C actual/360 basis D actual/actual basis

The best answer is A. Interest on corporate bonds accrues on an arbitrary 30-day month / 360-day year basis.

Municipal dollar bonds are: I term bonds II serial bonds III quoted on a percentage of par basis IV quoted on a yield basis A I and III B I and IV C II and III D II and IV

The best answer is A. Municipal dollar bonds are quoted on a percentage of par basis and are term bonds. Municipal serial bonds are quoted on a yield to maturity basis.

All of the following are characteristics of municipal secondary market joint accounts EXCEPT: A Good Faith Deposit B Order Period C Concession and Takedown D Account Agreement

The best answer is A. Municipal secondary market joint accounts are formed by two or more municipal dealers to distribute a large block of bonds in the secondary market. One of the participants acts as a manager. Municipal joint accounts are established under a written agreement between the account members; the agreement will specify that the manager has the right to establish concessions and takedowns; and can set an order period, similar to that used in primary market underwritings.During the order period, orders are accumulated and then tallied up at the period's end. The manager then fills the accumulated orders, usually on a "discretionary basis." If the issue is not sold out with these orders, the manager then accepts orders on a priority basis. There is no "good faith deposit" for secondary market joint accounts. Good faith deposits are required in primary market underwritings, since the issuer will not accept a bid without one.

Which securities will trade with accrued interest? A Negotiable Certificates of Deposit B Treasury Bills C Banker's Acceptances D Treasury Receipts

The best answer is A. Negotiable CDs that mature in 1 year or less are issued at par and mature with accrued interest. Those issued for longer periods pay interest semi-annually and trade with accrued interest. The other choices are all original issue discount obligations, which trade flat.

Which of the following information would be found in a municipal bond resolution? I Any restrictive covenants to which the issuer must adhere II Any call provisions providing for redemption prior to maturity as specified in the contract III The credit rating assigned to the issue by a nationally recognized ratings agency IV The compensation received by the underwriters for selling the issue to the public A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is A. The Bond Resolution is the contract between the issuer and the bondholder. In the resolution will be found all covenants made by the issuer, including any call provisions. The credit rating is given by the ratings agencies (e.g., Moody's or Standard and Poor's); and is found in their publications. The underwriter's compensation is disclosed to investors in new negotiated municipal bond offerings in the Official Statement (the disclosure document, similar to a prospectus, for new municipal issues).

Interest income from municipal bonds purchased by a resident of the issuing State is: A exempt from Federal, State and Local tax B exempt from Federal tax and subject to State and Local tax C subject to Federal tax and exempt from State and Local tax D subject to Federal, State and Local tax

The best answer is A. The interest income from municipal bonds is exempt from Federal income tax; but is subject to State and Local tax. However, if a bond is purchased by a State resident, then the State exempts that issue from taxation as well.

A government bond dealer is making good delivery to another government dealer. Payment is to be made in: A 1 business day in federal funds B 1 business day in clearing house funds C 2 business days in federal funds D 2 business days in clearing house funds

The best answer is A. Trades of U.S. Government bonds settle through the Federal Reserve System in Fed Funds. Settlement of government securities trades takes place the business day following trade date. "Non-eligible" securities settle through national clearing houses of which broker/dealers are members. These trades settle in 2 business days in clearing house funds.

Treasury Bills are issued for all of the following initial maturities EXCEPT: A 1 week B 8 weeks C 13 weeks D 26 weeks

The best answer is A. Treasury Bills are issued in initial 4 week (1 month); 8 week (2 month); 13 week (3 month); 26 week (6 month); and 52 week (12 month) maturities.

A government securities dealer quotes a 3 month Treasury Bill at 6.00 Bid - 5.90 Ask. A customer who wishes to buy 1 Treasury Bill will pay: A a dollar price quoted to a 5.90 basis B a dollar price quoted to a 6.00 basis C $5,900 D $6,000

The best answer is A. Treasury Bills are quoted on a yield basis. From the basis quote, the dollar price is computed. A customer who wishes to buy will pay the "Ask" of 5.90. This means that the dollar price will be computed by deducting a discount of 5.90 percent from the par value of $100. This is the discount earned over the life of the instrument.

Variable rate municipal notes avoid which of the following risks? A market risk B default risk C marketability risk D credit risk

The best answer is A. Variable rate municipal notes avoid "interest rate risk," also known as market risk, since a rise in interest rates will not devalue these securities. With a fixed rate note, as interest rates rise or fall, the note's value must decrease or increase proportionately, so that the note gives a yield that approximates the current level of interest rates. Variable rate notes periodically adjust the rate of interest paid to holders, usually based upon an index of government securities. The interest rate on the notes is adjusted up or down, based upon prevailing market interest rates; thus the price of the instrument will stay at, or very close to, par.

A municipal term bond is issued with a mandatory sinking fund. At the first call date, bonds to be called are selected by: A random choice B longest maturity C highest interest rate D yield auction

The best answer is A. When monies are deposited into a sinking fund to retire debt as required under the terms of a bond contract, the issuer has the choice of either calling in bonds at preset dates or buying the bonds in the open market. (The issuer will do whatever is cheaper). The specific bonds to be called are chosen by random lot in a "sinking fund call."

Which statements are TRUE about PO tranches? I When interest rates rise, the price of the tranche falls II When interest rates rise, the price of the tranche rises III When interest rates fall, the price of the tranche falls IV When interest rates fall, the price of the tranche rises A I and III B I and IV C II and III D II and IV

The best answer is B. A PO is a Principal Only tranche. This is a tranche that only receives the principal payments from an underlying mortgage, and it is created with a corresponding IO (Interest Only) tranche that only receives the interest payments from that mortgage. The principal portion of a fixed rate mortgage makes smaller payments in the early years, and larger payments in the later years. Because of this payment structure, it is most similar to a long-term bond, which pays principal at the end of its life. These are issued at a deep discount to face. Its price moves just like a conventional long term deep discount bond. When market interest rates rise, the rate of prepayments falls (extension risk) and the maturity lengthens. Because the principal is being paid back at a later date, the price falls. Conversely, when market interest rates fall, the rate of prepayments rises (prepayment risk) and the maturity shortens. Because the principal is being paid back at an earlier date, the price rises.

Which statement is TRUE about IO tranches? A When interest rates rise, the price of the tranche falls B When interest rates rise, the price of the tranche rises C When interest rates rise, the interest rate on the tranche falls D When interest rates rise, the interest rate on the tranche rises

The best answer is B. An IO is an Interest Only tranche. This is a tranche that only receives the interest payments from an underlying mortgage, and it is created with a corresponding PO (Principal Only) tranche that only receives the principal payments from that mortgage. The interest portion of a fixed rate mortgage makes larger payments in the early years, and smaller payments in the later years. These are issued at a discount to face and each interest payment made brings the "notional principal" of the bond closer to par. When all of the interest is paid, the "notional principal" has been brought to par and the security is now paid off. The price movements of IOs are counterintuitive! Unlike regular bonds, where when interest rates rise, prices fall, with an IO, when interest rates rise, prices rise! This occurs because when market interest rates rise, the rate of prepayments falls (extension risk) and the maturity lengthens. Because interest will now be paid for a longer than expected period, the price rises. Conversely, when interest rates fall (prepayment risk) the principal is being paid back at an earlier than expected date, so less interest is being received and the price falls (if interest rates fall drastically, the holder might get less interest back than what was originally invested).

Regarding auction rate securities, a failed auction will result if the: I total par amount of sell orders received by the auction agent exceeds the total par amount of bids II total par amount of buy orders received by the auction agent exceeds the total par amount of offers III bid rates are lower than the Clearing Rate set for the auction IV bid rates are higher than the Clearing Rate set for the auction A I and III B I and IV C II and III D II and IV

The best answer is B. Auction Rate Securities are either preferred stock or bonds that have the dividend rate or interest rate reset at a weekly auction. In order to have a successful auction for anything, there must be bidders (buyers) for the securities offered. A lack of bids (or no bids) will result in no auction, making Choice I correct. The auction is conducted as a "Dutch Auction," where bids are accepted in minimum $25,000 increments to buy the amount of securities offered. The bids are accepted from the lowest interest rate on up to the highest interest rate, and bids are accepted until the total amount offered is sold. The highest interest rate bid that is accepted to complete the sale of the issue is called the "clearing rate" and the entire offering gets this interest rate for the next week. Note that there is usually a maximum interest rate set on bids (otherwise, the issuer could be forced to pay exorbitant interest rates if the only bids received were at excessively high interest rates). If the interest rate bids received are at or below the maximum rate, then the auction is carried out as a Dutch Auction. If the interest rate bids are above the maximum rate (this implies that the issuer's perceived credit quality has deteriorated or that market conditions are excessively volatile and buyers are demanding much higher interest rates), then the auction has "failed" and the sellers (holders) of the securities will carry the positions to the next week, during which they will receive the maximum interest rate on those securities. Then another auction will be attempted. Thus, the risk for the holder of an ARS is not that interest will not be earned; rather it is that the holder may be forced to continue to hold the security when that customer really wants to dispose of the position. This occurs when there is either a lack or bids; or the bids received are at interest rates that are higher than the maximum or clearing rate (which is the same as saying that the clearing rate is below the interest rate bid).

A mortgage backed security that is backed by an underlying pool of 30 year mortgages has an expected life of 10 years. The fact that repayment is expected earlier than the life of the mortgages is based on the mortgage pool's: A standard deviation of returns B prepayment speed assumption C Macaulay duration D loan to value ratio

The best answer is B. Mortgage backed pass-through certificates are "paid off" in a shorter time frame than the full life of the underlying mortgages. For example, 30 year mortgages are now typically paid off in 10 years - because people move. This "prepayment speed assumption" is used to "guesstimate" the expected life of a mortgage backed pass-through certificate. Note, however, that the "PSA" can change over time. If interest rates fall rapidly after the mortgage is issued, prepayment rates speed up; if they rise rapidly after issuance, prepayment rates fall. Duration is a measure of bond price volatility. Standard deviation is a measure of the "risk" based on the expected variation of return on investment. The loan to value ratio is a mortgage risk measure.

What type of bond offers a "pure" interest rate? A Zero coupon bond B U.S. Government bond C Municipal bond D AAA rated bond

The best answer is B. The "pure" interest rate is a theoretical interest rate that will be paid when there is no marketability risk and no credit risk. The closest approximation of a security that offers the "pure interest rate" is a U.S. Government obligation. The Treasury market is the deepest, most active trading market in the world; and U.S. Government securities are considered to be free of credit risk. Also note that a "better" answer that is not given in the question is a T-Bill. This security is considered to be free of credit risk; free of market risk; and is also free of interest rate risk. But you must select the "best" of the choices offered!

Collateralized mortgage obligation issues have: A term structures B serial structures C series structures D combined serial and series structures

The best answer is B. A CMO divides the cash flow from a pool of underlying mortgages into a number of tranches, each with a different maturity. All of the tranches are issued on the same date; but the maturities extend over a sequence of years. This is a serial structure.

All of the following statements are true regarding GNMA "Pass Through" Certificates EXCEPT: A the certificates are quoted on a percentage of par basis in 32nds B the certificates are available in $1,000 minimum denominations C certificates trade "and interest" D accrued interest on the certificates is computed on a 30 day month/360 day year basis

The best answer is B. GNMA certificates are quoted on a percentage of par basis in 32nds, with the minimum denomination of a certificate being $25,000. Unlike Governments on which interest accrues on an actual day month / actual day year basis, accrued interest on "agency" securities is computed on a 30 day month / 360 day year basis. All debt instruments that make periodic interest payments trade "and interest," meaning they trade with accrued interest.

All of the following statements are true about the Government National Mortgage Association Pass-Through Certificates EXCEPT: A GNMA is empowered to borrow from the Treasury to pay interest and principal if necessary B interest payments are exempt from state and local tax C certificates are issued in minimum units of $25,000 D the credit rating is considered the highest of any agency security

The best answer is B. Interest received by the holder of a mortgage backed pass through security is fully taxable by both federal, state, and local government. Ginnie Mae is backed by the guarantee of the U.S. Government, making it the highest credit rated agency security. The other agencies are only implicitly backed. Certificates are issued in minimum $25,000 denominations. For most investors this is too much money to invest, so they buy shares of a Ginnie Mae mutual fund instead.

Municipalities would issue tax exempt commercial paper for all of the following reasons EXCEPT to: A meet a temporary cash shortage due to unforeseen extraordinary expenses B refund an outstanding bond issue C provide construction period financing that will be permanently financed by a future bond sale D smooth out collections of funds that are normally subject to seasonal fluctuations

The best answer is B. Most municipalities finance short term needs through BANs (Bond Anticipation Notes), TANs (Tax Anticipation Notes), RANs (Revenue Anticipation Notes) and TRANs (Tax and Revenue Anticipation Notes). However, commercial paper could be used by a municipality to finance short term cash shortages caused by slow tax collections or unforeseen extraordinary expenses (these could also be financed by tax anticipation notes). Also, commercial paper could be used for an interim construction loan, because when a building is under construction, the long term financing may not yet be in place (of course, the municipality could also finance the construction through a bond anticipation note). Commercial paper cannot be used for long term financing such as a bond refunding.

Under MSRB rules, municipal securities traders that participate in secondary market joint accounts: A can only act as agent in the transactions and cannot carry positions overnight B cannot disseminate quotes severally for the securities; any quote can only indicate that one market exists for the securities C cannot place orders to buy bonds for an accumulation account sponsored by a dealer participating in the joint account D cannot effect customer transactions and can only deal with other municipal broker-dealers

The best answer is B. Municipal secondary market joint accounts are formed by municipal firms to purchase, and subsequently resell, large blocks of bonds. Any quotes disseminated for those bonds must appear as one quote (they are actually grouped and bracketed in Bloomberg to show that they represent a single source for the quote). It cannot appear that there are multiple markets for the bonds when in fact there is only one (the joint account).

A certificate of deposit that changes the rate of interest based on the prevailing market interest rate is known as a: A Market rate CD B Step-up / Step-down CD C Negotiable CD D Renewable CD

The best answer is B. Negotiable CDs that have interest rates that will vary with the market are called Step-Up/Step-Down CDs - since the interest rate steps up as market rates rise; and steps down as market interest rates drop.

Negotiable Certificates of Deposit: I are issued at par II are issued at a discount to par III mature at par IV mature at par plus accrued interest A I and III B I and IV C II and III D II and IV

The best answer is B. Negotiable certificates of deposit (over $100,000 face amount) are issued at par and mature at par plus accrued interest. If they are traded prior to maturity, they trade with the amount of accrued interest due. All other money instruments are issued at a discount to par; and mature at par value. The difference is the interest earned.

The principal difference between a structured product and an ETN is: A investment time horizon B liquidity risk C credit risk D reference index

The best answer is B. Regarding structured products, each bank's version has different features. They are "buy and hold" securities - there is almost no trading market. ETNs are "Exchange Traded Notes." They are an equity index linked structured product, that is listed and trades on an exchange. Because they trade, the liquidity risk aspect of structured products is eliminated.

A customer buys a $1,000 par reverse convertible note with a 1 year maturity and a 6% coupon rate. At the time of purchase, the reference stock is trading at $50 and the knock-in price is set at $40. If, at maturity, the reference stock is trading at $25, the customer will receive: A $1,000 par B 20 shares of the reference stock C 25 shares of the reference stock D 40 shares of the reference stock

The best answer is B. Reverse convertible notes were created for customers looking for enhanced yield in a low interest rate environment. Of course, any enhanced yield comes with higher risk. The note is linked to the price movements of an underlying stock (or very rarely, an underlying index). At maturity, the holder will receive par value, as long as the price of the reference stock is above the "knock-in" price (typically 70-80% of the initial reference price). On the other hand, if at maturity, the reference stock falls below the "knock-in" price, then the holder will receive the shares of stock. In this example, the share price has fallen from $50 to $25, which is below the "$40 knock-in" price. Thus, at maturity, the holder of the note will get the stock - not par value. The original conversion ratio was based on the reference price of $50. $1,000 par / $50 conversion reference price = 20 shares per note. Thus, at maturity, the customer gets 20 shares, currently worth $25 each = $500 worth of stock. This customer has lost $500, partially offset by any interest income received.

All of the following agencies may issue securities EXCEPT: A TVA B FRB C FHLMC D FHLB

The best answer is B. The FRB - Federal Reserve Bank does not issue bonds. It is the nation's central bank. TVA (Tennessee Valley Authority). FHLMC (Federal Home Loan Mortgage Corporation), and FHLB (Federal Home Loan Bank) all issue debt securities.

If a bond is trading at a premium, price volatility is greatest for a bond having: I coupon rates slightly above the market interest rateII coupon rates greatly above the market interest rateIII short term maturitiesIV long term maturities A I and III B I and IV C II and III D II and IV

The best answer is B. The basic truths about bond price volatility are:The lower the coupon rate (the same as saying the lower the price of the bond), the greater the bond price volatility; The longer the maturity, the greater the bond price volatility. Bonds trading at low premiums have a lower price than bonds trading at high premiums. Thus, of the choices given, a bond with a low premium (a coupon only slightly higher than the market interest rate) and a long maturity would have the greatest price volatility.

A corporation has issued 7% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 8%. Which of the following are TRUE statements about the outstanding 7% issue? I The current yield will be higher than the nominal yield II The current yield will be lower than the nominal yield III The dollar price of the bond will be at a premium to par IV The dollar price of the bond will be at a discount to par A I and III B I and IV C II and III D II and IV

The best answer is B. The bond was issued with a coupon of 7%. Currently, the yield for a similar issue is 8%. Therefore, interest rates have risen subsequent to the issuance of the bond; or the credit quality of the bond has deteriorated. When interest rates rise, yields on bonds already trading must also rise. What causes this is a drop in the dollar price of the issue - the bond now trades at a discount.

As interest rates rise, which of the following statements are TRUE? I Bonds trading at large discounts fall faster in price than bonds trading at small discounts. II Bonds trading at small discounts fall faster in price than bonds trading at large discounts. III Bonds trading at large premiums fall faster in price than bonds trading at small premiums. IV Bonds trading at small premiums fall faster in price than bonds trading at large premiums. A I and III B I and IV C II and III D II and IV

The best answer is B. The general rule is the lower the price of the bond, the faster that bond's price will move as market interest rates change. Deep discount bonds have a lower price than small discount bonds, hence their prices move faster. Small premium bonds have a lower price than large premium bonds, hence their prices move faster as well.

A customer has a discretionary account at a brokerage firm. The customer calls the registered representative handling the account and states "Buy $50,000 of lower medium investment grade corporate bonds" with at least 5 years to maturity and a minimum 8% yield. To comply with the customer's instructions, the registered representative must choose bonds that are rated, at a minimum: A Aaa B A C Baa D Ba

The best answer is B. The investment grades and highest speculative grade published by Moody's are: AaaHighest Investment GradeAaUpper Medium Investment GradeALower Medium Investment GradeBaaLowest Investment GradeBaHighest Speculative Grade To comply with the customer's requirement that the bonds be lower medium investment grade, an A rated bond is appropriate.

If investors expect an economic expansion, the best investment strategy would be to: I sell U.S. Government bonds II sell corporate bonds III buy U.S. Government bonds IV buy corporate bonds A I and III B I and IV C II and III D II and IV

The best answer is B. When an economic expansion is expected, there is a "flight from quality" to higher yielding corporate instruments. Investors liquidate holdings that are giving a lower yield (high grade government bonds) and put the money into higher yielding instruments such as corporate bonds. An excess of investors are thus buying corporates, pushing their yields down; and selling higher grade government bonds, pushing their yields up. This causes the spread between the government and corporate yields to narrow. Review

When the yield curve is inverted: I short term rates are higher than long term ratesII long term rates are higher than short term ratesIII the Federal Reserve is loosening creditIV the Federal Reserve is tightening credit A I and III B I and IV C II and III D II and IV

The best answer is B. When short term rates are higher than long term rates, this is an inverted or descending yield curve. If the Federal Reserve sharply tightens credit, it exerts its influence at the short end of the yield curve, driving up short term rates. If the Fed really "tightens," then short term rates can be driven above long term rates. Long term rates are indirectly influenced by Fed actions - what drives long term rates are long term expectations about economic growth and inflation.

Of the choices offered, which municipal bond would have the greatest credit risk? A Prerefunded bond B Escrowed To Maturity bond C Parity bond D Double Barreled bond

The best answer is C. A municipal "parity" bond is one that has an equal claim on tax collections or revenues as other obligations of that issuer. For example, 2 issues of revenue bonds of the same issuer are on parity with each other if the same pledged revenues are the security for each bond issue. Because additional bonds are issued against the same revenue, these bonds will have greater credit risk. In contrast, a double barreled revenue bond is a revenue bond that is additionally backed by that municipality's ad valorem taxing power if there is a revenue shortfall. Thus, aside from the revenue pledge, these are additionally backed by a general obligation pledge of "full faith, credit and taxing power." Thus, these are safer. Municipal bonds which have been escrowed to maturity are now backed by escrowed U.S. Government or Agency securities with the same maturity as the municipal debt, rather than by tax collections or a revenue pledge. This frees up the issuer to sell new bonds when rates have dropped. The interest earned on the escrowed Treasuries/Agencies is used to pay the interest on the outstanding debt, and when these mature, the principal is used to retire the outstanding debt. These are rated AAA because they are secured by top-rated U.S. Government issues. A pre-refunded municipal bond is the same idea, except that it will be redeemed at the first call date, using escrowed Treasury securities as the backing for the issue.

A municipality would defease its debt with all of the following EXCEPT: A U.S. Government securities B U.S. Government agency securities C AAA Municipal securities D Bank certificates of deposit

The best answer is C. A municipality will defease its debt with securities of the highest credit rating, that provide the highest interest income to the municipality (since this interest income will be used to pay the interest expenses on the municipality's outstanding bonds that have been defeased). Acceptable securities to the bondholders are U.S. Governments, Agencies, and sometimes (rarely) bank certificates of deposit. AAA municipals would not be used because their yield is lower than governments (since the interest is exempt from Federal income tax, while the others are taxable). (Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)

Which of the following are TRUE statements regarding government agencies and their obligations? I Ginnie Mae is a publicly traded company II Fannie Mae is a publicly traded company III Ginnie Mae issues are directly backed by the U.S. Government IV Fannie Mae issues are directly backed by the U.S. Government A I and III B I and IV C II and III D II and IV

The best answer is C. Ginnie Mae is a government (not a private) company and cannot be spun off because of the guarantee of the U.S. Government that its securities carry. GNMA obligations trade over the counter. Fannie Mae was "spun off" by the government as a public company listed on the NYSE (so was Freddie Mac). Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets.

Which bond portfolio with a 20-year life would be expected to give the highest long-term return? A Portfolio #1 with an expected rate of return of 6% and a default risk of 5% over the portfolio life B Portfolio #2 with an expected rate of return of 8% and a default risk of 10% over the portfolio life C Portfolio #3 with an expected rate of return of 10% and a default risk of 20% over the portfolio life D Portfolio #4 with an expected rate of return of 12% and a default risk of 40% over the portfolio life

The best answer is C. The "default risk" represents the loss of return that is likely due to making higher risk investments. If Portfolio #1 has an expected annual rate of return of 6% over 20 years; but there is the probability that 5% of those bonds will default, so the net return will be 95% of 6% = 5.7%. If Portfolio #2 has an expected annual rate of return of 8% over 20 years; but there is the probability that 10% of those bonds will default, so the net return will be 90% of 8% = 7.2%. If Portfolio #3 has an expected annual rate of return of 10% over 20 years; but there is the probability that 20% of those bonds will default, so the net return will be 80% of 10% = 8.0%. If Portfolio #4 has an expected annual rate of return of 12% over 20 years; but there is the probability that 40% of those bonds will default, so the net return will be 60% of 12% = 7.2%.

A municipal dealer quotes a 2 year, 6% term revenue bond at 99. The yield to maturity is: A 5.92% B 6.00% C 6.53% D 6.85%

The best answer is C. The formula for yield to maturity is: This bond has a coupon rate of 6% = 6% of $1,000 par = $60 of annual income. The bond is purchased at 99% of $1,000 par = $990; and will mature at $1,000 in 2 years, Thus, the $10 capital gain is earned over 2 years for an annual gain of $10 / 2 = $5 per year. The bond is purchased at $990 and matures at $1,000, for an average value of $990 + $1,000 / 2 = $995. The YTM is: ($60 + $5)/ $995= 6.53%

An investor buys an 4.25% Treasury Bond, paying interest on February 1st and August 1st, on Friday, May 18th, in a cash settlement. How many days of accrued interest are due from buyer to seller? (This is not a leap year.) A 104 B 105 C 106 D 107

The best answer is C. Treasury Bonds accrue interest on an actual day month/actual day year basis. The last interest payment was made on February 1st. Interest accrues up to, but not including settlement. Since this is a cash settlement on Friday, May 18th, the trade settles that day. The accrued interest due is: February:28 daysMarch:31 daysApril:30 daysMay:17 days 106 days Total Accrued Interest Due

Principal repayments on a CMO are made: A all at once at maturity date of the tranche purchased B in constant dollar amounts every month C in varying dollar amounts every month D according to the amortization schedule of the underlying mortgages

The best answer is C. CMOs are Collateralized Mortgage Obligations. Each CMO tranche has an expected maturity, but the actual repayments are based on the rate of principal repayments that come in from the underlying mortgages - and this rate can vary. If interest rates start dropping, homeowners refinance and prepay their mortgages, and these prepayments are passed-through to pay off the tranches. On the other hand, if market interest rates rise, homeowners stay in their existing homes longer than expected and the rate of expected principal repayments slows, extending the maturity of the tranches. Thus, the rate of principal repayments varies, depending on market interest rate movements.

All of the following are sources of income that can be used for debt service on municipal revenue bonds EXCEPT: A User Fees B Special Taxes C Capitalized Interest D Lease Rentals

The best answer is C. A revenue bond is defined as a debt where payment of interest and principal is derived from a source other than ad valorem taxes. Thus, revenue bonds can be paid off by lease rental fees, user fees, and special taxes (such as excise taxes). Capitalized interest is not an income source; rather it is part of the cost of a construction project that is included in the total financing needs when building a facility.

A new issue corporate bond with dated date of March 1st is bought from the underwriter with settlement occurring on Wednesday, March 28th. How many days of accrued interest is owed the underwriter? A 0 B 26 C 27 D 28

The best answer is C. Accrued interest on a new issue is calculated from the dated date up until, but not including settlement date. This new issue is bought from the underwriter. The customer pays the underwriter the price of the bond plus any accrued interest. This interest accrues from March 1st (the dated date) until the 27th (up to, but not including, settlement date of the 28th), so there are 27 days of accrued interest owed to the underwriter.

Which statements are TRUE about a Certificate of Participation (COP)? I COPs are considered to be a general obligation of the issuer II COPs are considered to be backed by a revenue pledge III Payments to security holders are contingent on the governing body making an annual appropriation from budgeted funds IV Payments to security holders are not contingent on the governing body making an annual appropriation from budgeted funds A I and III B I and IV C II and III D II and IV

The best answer is C. As municipalities reached their debt limits with G.O. bond issuance, they found it harder and harder to get voter approval to raise limits to sell additional G.O. bonds (think of Proposition 13 in California that capped property taxes to almost no increase unless the property was sold). To get around this, the COP - Certificate of Participation - was invented and COP issuance is now greater than G.O. bond issuance in many states.A COP is issued by a state entity where lease revenues are pledged to back the issue. The lease payments are received from a project such as a university dormitory, prison, municipal office building, municipal transit system, etc. The "difference" is that the lease payment is made based on the governing body making an annual appropriation from tax collections, and it is not "legally" obligated to do so, hence it is not really a bond. Rather, it is a security that gives the holder a share of "revenue" if the appropriation is made (which it will be, otherwise that issuer's credit rating would be trashed). COP issuance has increased greatly over the years because they are easier to issue than G.O. debt (no pesky debt limits or voter approval to deal with) - but they are sold at a slightly higher yield, because they have more credit risk.

Which statement about Auction Rate Securities is FALSE? A Auction Rate Securities are long-term instruments B The interest rate on an Auction Rate Security is reset weekly or monthly C Auction Rate Securities can be put back to the issuer at the reset date D Auction Rate Securities are available from corporate and municipal issuers

The best answer is C. Auction Rate Securities are long-term debt issues where the interest rate is reset weekly (or monthly) via Dutch auction. This gives the issuer the advantage of paying a short-term market interest rate on a long-term security. However, unlike a variable rate demand note (VRDO), they have no embedded put option - meaning that the issuer is not obligated to buy them back at the reset date. ARSs are available from both corporate and municipal issuers. The failure of the weekly auctions in 2008 created a situation where holders could not sell these securities to get out of them.

Which of the following securities can be margined? I Treasury bills II Commercial paper III Bankers' acceptances IV Structured products

The best answer is C. Because money market instruments are "safe," they can be margined - meaning that the brokerage firm can lend money against these securities held as collateral for the loan. Government securities, agency securities, investment grade money market instruments, investment grade corporate bonds, and listed stocks are the marginable securities. As a general rule, structured products cannot be margined because they are not readily transferable.

Which statement is FALSE about CMBs? A CMBs are used to smooth out cash flow B CMBs are sold at a discount to par C CMBs are sold at a slightly lower yield than T-Bills D CMBs are direct obligations of the U.S. government

The best answer is C. CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. Because they are sold on an irregular basis, they sell at slightly higher yields than equivalent maturity T-Bills. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.

Which of the following ratings applies to commercial paper? I MIG 1II P1III P3IV NP A I and IV only B II and III only C II, III, IV D I, II, III, IV

The best answer is C. Commercial paper is rated P1, P2, P3, NP (highest to lowest) by Moody's. P stands for prime. NP means "not prime" and is the lowest rating. MIG (Moody's Investment Grade) is the ratings scale used for municipal notes.

When comparing a PAC tranch to a TAC tranche: I TAC tranches have the same level of prepayment risk II TAC tranches have the same level of extension risk III TAC tranches have a higher level of prepayment risk IV TAC tranches have a higher level of extension risk

The best answer is C. Companion classes are "split off" from the Planned Amortization Class (PAC) and act as buffers absorbing prepayment and extension risk prior to this risk being applied to the PAC tranche. The PAC, which is relieved of these risks, is given the most certain repayment date. The Companion, which absorbs these risks first, has the least certain repayment date. A Targeted Amortization Class (TAC) is like a PAC, but is only buffered for prepayment risk by the Companion; it is not buffered for extension risk. Thus, A TAC has the same level of prepayment risk as the PAC; but the TAC has a higher level of extension risk than the PAC.

Which CMO tranche will be offered at the lowest yield? A Plain vanilla B Targeted amortization class C Planned amortization class D Companion

The best answer is C. Companion tranches are the "shock absorber" tranches, that absorb prepayment risk out of a TAC (Targeted Amortization Class) tranche; or both prepayment risk and extension risk out of a PAC (Planned Amortization Class) tranche. Because the companion absorbs both of these risks, it has the greatest risk and trades at the highest yield. Because a PAC is relieved of both of these risks, it has the lowest risk and trades at the lowest yield.

Which of the following would be considered when evaluating the credit risk of a municipal revenue bond? I Management experience II The effect of competing facilities III Coverage ratios IV Collection ratios A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is C. Credit risk is the risk that the bond will default. To evaluate this risk for a revenue bond issue, one would examine coverage ratios; the effect of competing facilities; and the management of the facility. Collection ratios are only used to analyze G.O. bonds. The collection ratio shows the percentage of property taxes assessed that are actually collected by the municipality.

Which statements are TRUE regarding Government National Mortgage Association pass-through certificates? I GNMA securities are insured by the FDICII Dealers typically quote GNMA securities at 50 basis points over equivalent maturity U.S. Government BondsIII Credit risk for GNMAs is the same as for equivalent maturity U.S. Government BondsIV Reinvestment risk for GNMAs is the same as for equivalent maturity U.S. Government Bonds A I and II only B III and IV only C II and III only D I, II, III, IV

The best answer is C. GNMA securities are not insured by the Federal Deposit Insurance Corporation (making Choice I incorrect) - they are guaranteed by the U.S. Government (making Choice III correct). Dealers typically quote agency securities, including Ginnie Maes, on a basis point differential to equivalent maturing U.S. Governments. A typical quote is 50 basis points above the yield on the same maturity U.S. Government issue. Please note, that dealers also quote agency securities on a percentage of par basis in 32nds, but this is not given as a choice in the question. Reinvestment risk is greater for Ginnie Maes than for U.S. Government bonds. Ginnie Mae holders receive monthly payments that must be continuously reinvested while T-Bond holders only receive payments every 6 months that must be reinvested. The greater the frequency of receipt of payments that must be reinvested, the greater the reinvestment risk.

An analysis of general obligation bonds would include: I examination of collection ratios II evaluation of engineer's reports III analysis of debt to value ratios IV analysis of debt service coverage ratios A I and II only B III and IV only C I and III only D I, II, III, IV

The best answer is C. General obligation bonds are backed by faith, credit, and taxing power of the issuer. To analyze these bonds, it is important to examine the issuer's collection ratio (taxes collected / taxes assessed) to ascertain if the issuer is truly collecting all the taxes necessary to service the debt. The ratio of debt to assessed value of property would also be examined, since most G.O. bonds are backed by ad-valorem (property) tax collections. Engineer's reports are examined when evaluating a revenue bond issue (e.g., is that bridge feasible?) and are not relevant to G.O. bonds. Similarly, the ratio of pledged revenues to debt service requirements (debt service coverage ratio) is used to evaluate a revenue bond issue - not G.O. bonds.

An "in whole call" is a(n): A mandatory call B extraordinary mandatory call C optional call D extraordinary optional call

The best answer is C. In the bond contract, the issuer may have the right to call in the entire issue at preset dates and prices (a normal call schedule, usually with at least 10 years of call protection given to the bondholder). The issuer has the option of calling in the bonds at those dates and prices; and will only do so if it is advantageous to the issuer (meaning that interest rates have dropped since the bonds were issued).

All of the following securities are quoted on a yield basis EXCEPT: A Commercial Paper B Treasury Bills C American Depositary Receipts D Banker's Acceptances

The best answer is C. Money market instruments are original issue discount obligations quoted on a yield basis that are priced at a discount to par (with the exception of negotiable certificate of deposit that are priced at par plus accrued interest). The discount from par is the interest earned. American Depositary Receipts are not a money market instrument. They are essentially shares of a foreign company, traded domestically similar to equity securities. They are dollar price quoted in 1/8ths.

A Moody's MIG rating is used for: A Corporate short term debt B Corporate long term debt C Municipal short term debt D Municipal long term debt

The best answer is C. Moody's MIG ("Moody's Investment Grade") ratings are used for short term municipal paper; P (Prime) ratings are used for short term corporate commercial paper. "A-B-C" ratings are used to rate both long term corporate and municipal bonds.

Which investment gives the greatest protection against purchasing power risk? A 10 year Double Barreled Bonds B 10 year Guaranteed Bonds C 10 year TIPS D 10 year STRIPS

The best answer is C. Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. Since all of the choices have the same maturity, this is not a factor. "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher total payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. STRIPS are zero-coupon Treasury obligations - these have the highest level of purchasing power risk.

Which of the following rate commercial paper? I Standard and Poor's II Fitch's III Best's IV Moody's A I and II only B III and IV only C I, II and IV D I, II, III, IV

The best answer is C. The 3 major debt ratings agencies are Moody's, Standard and Poor's and Fitch's. Best's is an insurance rating agency. All three rate commercial paper.

Which of the following issue agency securities? I FNMA II FHLMC III FRB IV FHLB A I and II only B III and IV only C I, II, IV D I, II, III, IV

The best answer is C. The Federal Reserve Bank does not issue bonds. Fannie Mae (FNMA) and Freddie Mac (FHLMC) issue mortgage-backed pass through certificates. The Federal Home Loan Banks (FHLB) issues short term and long term bonds.

A municipal dealer who wishes to buy bonds has received a quote which is "out firm for 1/2 hour with a 5 minute recall." This means that the: I buying dealer can buy the bonds at the stated price during the next half hour II selling dealer can call during the next half hour and demand a purchase decision be made in the next 5 minutes III buying dealer is free to sell the bonds before actually making the purchase IV buying dealer can renegotiate the price during the next half hour, but the deal can be canceled by giving 5 minutes' notice A: I and III B: II and IV C: I, II, III D: I, II, IV

The best answer is C. The buying dealer has been given a firm quote, good for 1/2 hour. During this time, the buying dealer is free to sell the bonds before making the actual purchase, since he has been guaranteed a firm price. The "5 minute recall" means that the selling dealer can call at any time during the 1/2 hour and demand that a decision to buy be made within 5 minutes, or the quote is invalid.

The interest income earned from which of the following is subject to state and local tax? I Federal Farm Credit Funding Corporation Note II Real Estate Investment Trust III Ginnie Mae Certificate IV Fannie Mae Certificate A I only B III and IV only C II, III, IV D I, II, III, IV

The best answer is C. The interest income on U.S. Government obligations and most agency obligations is subject to Federal income tax but is exempt from state and local tax. This is the tax status for Federal Farm Credit Funding Corporation notes. However, the interest income on mortgage pass through certificates issued by Fannie Mae and Ginnie Mae is fully taxable. Income from REITs, since they are corporate securities, is fully taxable as well.

A customer residing in California that is in the 30% Federal tax bracket and the 10% State tax bracket wishes to make a bond investment with a minimum 10-year life. The customer also wants a high level of safety. The following 10-year bonds are available: Yield AAA Corporate Bond 6.50 U.S. Treasury Bond 4.50 AAA Federal Home Loan Bank Bond 5.00 AAA California Bond 4.00 The best recommendation for the customer is the: A U.S. Treasury bond B AAA Corporate bond C AAA California bond D AAA Federal Home Loan Bank bond

The best answer is C. The rules on taxation of interest income received, generally, are: Treasury/Agency Issues: Interest is subject to Federal Income tax, but is exempt from State and Local tax Municipal Issues: Interest is exempt from Federal Income tax, and exempt from State and Local tax when purchased by a resident of that state Corporate Issues: Interest is subject to Federal Income tax, and to State and Local tax If the customer buys the Treasury bond yielding 4.5%, 30% of the yield will go to the Federal Government, so the after-tax yield is (.7 x 4.50%) = 3.15% . If the customer buys the Federal Home Loan Bank bond yielding 5%, 30% of the yield will go to the Federal Government, so the after-tax yield is (.7 x 5.00%) = 3.50%. If the customer buys the Corporate bond yielding 6.50%, 30% of the yield will go to the Federal Government and 10% to the State Government, so the after-tax yield is (.6 x 6.50%) = 3.90%. If the customer buys the Municipal bond yielding 4.00%, there is no tax on the income received at either the Federal or State level, so the after-tax yield is 4.00%.

Which statement is FALSE regarding Treasury Inflation Protection securities? A In periods of inflation, the coupon rate remains unchanged B In periods of inflation, the amount of each interest payment will increase C In periods of inflation, the principal amount received at maturity will be par D In periods of inflation, the principal amount received at maturity is more than par

The best answer is C. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount.

The investment performance of an ELN (Equity Linked Note) is determined by all of the following EXCEPT: A cap on the investment return B floor on the investment return C participation rate in the investment return D interest rate credit set by weekly auction

The best answer is D. An Equity Linked Note (ELN) or Exchange Traded Note (ETN) is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. The annual return is not going to be the actual return of the reference index, because there is a participation rate (usually 80%), where the note is only credited with 80% of the return of the reference index. So if the reference index increases by 10%, the note will only be credited with 8% interest. Furthermore, the annual interest credit is capped to a maximum rate; and in return for this, there is a minimum floor on the annual interest credit. This is not an auction rate security, so there is no weekly setting of an interest rate return via auction.

Arrange the following CMO tranches from lowest to highest yield: I Plain vanilla II Targeted amortization class III Planned amortization class IV Companion A I, II, III, IV B IV, III, II, I C IV, I, II, III D III, II, I, IV \

The best answer is D. Companion tranches are the "shock absorber" tranches, that absorb prepayment risk out of a TAC (Targeted Amortization Class) tranche; or both prepayment risk and extension risk out of a PAC (Planned Amortization Class) tranche. Because the companion absorbs both of these risks, it has the greatest risk and trades at the highest yield. The PAC, because it is relieved of both of these risks, has the lowest risk and trades and the lowest yield. A Plain Vanilla tranche is not relieved of either extension risk or prepayment risk, so it will offer a yield that is higher than a PAC or a TAC, but lower than the yield on a companion. A TAC is only relieved of prepayment risk, so its yield will be lower than a Plain Vanilla tranche. However, the TAC yield will be higher than the yield on a PAC, which is relieved of both extension and prepayment risk, while the TAC is only relieved of prepayment risk.

A customer purchases 10M of City of Los Angeles 7% G.O. bonds, maturing in 2041 at 90. Interest payments are Jan. 1st and Jul. 1st. The trade took place on Friday, May 2nd. How much accrued interest will the customer be required to pay the seller? A $0 B $24.31 C $231.38 D $243.05

The best answer is D. Interest accrues on municipal bonds on a 30 day month/360 day year basis, with interest accruing up to, but not including settlement date. The trade took place on Friday, May 2nd. Settlement occurs 2 business days after trade date. Therefore, settlement takes place on Tuesday, May 6th. The last interest payment was made on January 1st, so the buyer owes the seller: January30 daysFebruary30 daysMarch30 daysApril30 daysMay5 days (up to, not including settlement) 125 days 125 days interest x $70 x 10 bonds360= $243.05 Note that "10M" stands for $10,000 face amount of bonds (M is Latin for $1,000).

Which statements are TRUE regarding market index linked certificates of deposit? I Early redemption can result in the imposition of a penalty of 3-5% of the principal amount invested II The CD can only be redeemed on a specified date during each calendar quarter III The rate of return may be capped to a limit that is lower than the return of the reference stock index IV Market index linked CDs typically have a minimum life of 3 years A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is D. Market Index Linked CDs are a type of "structured product" that consists of a "zero-coupon" synthetic bond component that grows based on the returns of an equity index; and that has a maturity established by an embedded option, typically 3 years from issuance. Market Index Linked Certificates of Deposit tie their investment return to an equity index, usually the Standard and Poor's 500 Index. This can give a potentially better rate of return than that of a traditional CD. If held to maturity, there is no penalty imposed on any CD. For an early withdrawal, traditional CDs may reduce the interest earned, but there is no loss of principal. In contrast, market index linked CDs typically impose a 3-5% principal penalty for early withdrawal. This "early withdrawal" penalty is imposed because the embedded option that established the maturity of the instrument was paid for and now is not being used. Both regular and market index linked CDs qualify for FDIC insurance. Finally, the minimum life for market index linked CDs is typically 3 years; whereas traditional bank CDs can have lives as short as 3 months.

Which statement is TRUE about private CMOs? A The CMO is issued by Ginnie Mae, Fannie Mae or Freddie Mac B The CMO is backed by only by non-conforming mortgages C The CMO is suitable for investors seeking the highest level of safety D The CMO is rated dependent on the credit quality of the mortgages underlying mortgage backed pass through securities held in trust

The best answer is D. Private CMOs (Collateralized Mortgage Obligations) are also called "private label" CMOs. They are created by bank issuers, using a mix of mortgage-backed securities as collateral. The "mix" includes both mortgage-backed securities issued by agencies (Fannie, Freddie, Ginnie) and "private label" mortgages - meaning mortgages that do not qualify for sale to these agencies (either because the dollar amount of the mortgage is above their purchase limit or they do not meet Fannie, Freddie or Ginnie's underwriting standards). If the bank issuer wants to offer a CMO with a higher yield, it will increase the proportion of "private label" mortgages included in the CMO. Of course, along with a higher yield comes higher risk. Whereas CMOs backed solely by Fannie, Freddie or Ginnie mortgage-backed securities are rated AAA, the rating of "private label" CMOs is dependent on the credit quality of the underlying mortgages.

Series EE bonds: I are negotiable II are non-negotiable III pay interest semi-annually IV pay interest at redemption A I and III B I and IV C II and III D II and IV

The best answer is D. Series EE bonds are "savings bonds" issued by the U.S. Government with a minimum purchase amount of $25 (or more). The interest rate is set at the date of issuance. Interest is "earned" monthly and credited to the principal amount every 6 months. The bonds have no stated maturity - the holder can redeem at any time, however interest is only credited to the bonds for 30 years. Savings bonds do not trade - they are issued by the Treasury and are redeemed with the Treasury (a bank can act as agent for the Treasury issuing and redeeming Series EE bonds). No physical certificates are issued - the bonds are issued in electronic form.

A municipal dealer who solicits a "Bid Wanted": I must accept the first bid received II need not accept the first bid received III must have purchased the bonds prior to soliciting the bids IV need not have purchased the bonds prior to soliciting the bids A I and III B I and IV C II and III D II and IV

The best answer is D. A municipal dealer can trade without physically having the position. If a dealer is requesting bids (that is, the dealer wishes to sell bonds), the dealer must simply intend to deliver those bonds by settlement. There is no requirement that the dealer must have the bonds, or must have purchased the bonds, prior to soliciting bids. Furthermore, there is no requirement that the dealer accept the first bid. The dealer will accept the highest bid received (if the bid amount is acceptable).

Which statements are TRUE about Bloomberg? I Bloomberg is published daily II Bloomberg lists dealer offerings of municipal bonds in the secondary market III Bloomberg shows quotes for any size IV Bloomberg quotes are subject to prior sale or change in price A I and II only B III and IV only C I, II, IV D I, II, III, IV

The best answer is D. All of the statements are true. Bloomberg is published electronically every day, and lists dealer offerings of municipal bonds in the secondary market. All quotes are "firm;" nominal (approximate) quotes cannot be given unless it is clearly stated that the quote is nominal. Quotes can be for any amount (any "size") of bonds; it is not required that they be for round lots only. The MSRB requires that all quotes that are disseminated be "bona fide." This means that, at the time that the quote was placed, the firm giving the quote is willing to trade at that price for the size quoted. However, all quotes are subject to prior sale or change in price.

Quotes for which of the following are found in Bloomberg? I General obligation bonds II Revenue bonds III Industrial development bonds IV Corporate bonds A I only B II and III C I, II, III D I, II, III, IV

The best answer is D. Aside from listing dealer offerings of all municipal bonds, Bloomberg also lists dealer offerings of corporate bonds.

Which of the following securities cannot be margined? A Treasury bills B Commercial paper C Bankers' acceptances D Structured products

The best answer is D. Because money market instruments are "safe," they can be margined - meaning that the brokerage firm can lend money against these securities held as collateral for the loan. Government securities, agency securities, investment grade money market instruments, investment grade corporate bonds and listed stocks are the marginable securities. As a general rule, structured products cannot be margined because they are not readily transferable.

CMO Targeted Amortization Classes (TACs) have: A lower prepayment risk, but the same extension risk as a Planned Amortization Class B higher prepayment risk, but the same extension risk as a Planned Amortization Class C the same level of prepayment risk but a lower level of extension risk than a Planned Amortization Class D the same level of prepayment risk but a higher level of extension risk than a Planned Amortization Class

The best answer is D. Companion classes are "split off" from the Planned Amortization Class (PAC) and act as buffers absorbing prepayment and extension risk prior to this risk being applied to the PAC tranche. The PAC, which is relieved of these risks, is given the most certain repayment date. The Companion, which absorbs these risks first, has the least certain repayment date. A Targeted Amortization Class (TAC) is like a PAC, but is only buffered for prepayment risk by the Companion; it is not buffered for extension risk. Thus, a TAC has the same level of prepayment risk as the PAC; but the TAC has a higher level of extension risk than the PAC.

All of the following statements are true regarding Government National Mortgage Association pass-through certificates EXCEPT: A GNMA securities are guaranteed by the U.S. Government B Dealers typically quoted GNMA securities at 50 basis points over equivalent maturity U.S. Government Bonds C Credit risk for GNMAs is the same as for equivalent maturity U.S. Government Bonds D Reinvestment risk for GNMAs is the same as for equivalent maturity U.S. Government Bonds

The best answer is D. GNMA securities are guaranteed by the U.S. Government. Dealers typically quote agency securities, including Ginnie Maes, on a basis point differential to equivalent maturing U.S. Governments. Reinvestment risk is greater for Ginnie Maes than for U.S. Governments. If the mortgages backing a Ginnie Mae Pass Through Certificate are prepaid (if interest rates have dropped), the certificate holder receives payments that are a return of principal, and that, when reinvested at lower current rates, produce a lower return (this is reinvestment risk). There is little reinvestment risk with U.S. Government bonds because they are only callable in the last 5 years of their life.

A municipality issues a zero-coupon bond that is callable at 104. If the municipality calls the bonds prior to maturity, the bondholder will receive: A par B 104% of par C current accreted value D 104% of current accreted value

The best answer is D. If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract.

100 Basis Points equal: A $.01 B $.10 C $1.00 D $10.00

The best answer is D. One basis point = .01% in interest, or .01% of $1,000 par in annual interest = $.10. 100 basis points equal 1% of annual interest on a $1,000 per bond = $10.00.

All of the following would be purchasers of Eurodollar bonds EXCEPT: A British investors B French investors C Japanese investors D United States investors

The best answer is D. Since Eurodollar bonds are not registered with the SEC, and they are not exempt from these registration requirements, they cannot be offered within the United States.

Repo Rate

The interest rate on a repurchase agreement.

The bond call premium is

The price above par at which the issuer has the right to call in the bonds from the bond holders. If bonds are callable at 103, then the premium is 3% or 3 points above par

Regarding the flow of funds set forth in a municipal bond contract, collected monies would be deposited in the following order

The trust indenture of a revenue bond issue includes a "flow of funds" - meaning how revenues will be applied by the issuer. As revenues are collected, they are deposited to a revenue fund, also called a general collection account. The monies are then applied, in sequence, to the O: operation and maintenance account; S: sinking fund; D: debt service reserve fund; R: reserve maintenance fund; R: renewal and replacement fund; and finally to the S: surplus fund.

Commercial paper is quoted on

Yield Basis (as is all money market debt)

Eurodollar bonds

bonds issued outside the United States whose principal and interest will be paid in dollars. The bonds can be issued by an American or European corporations, and by sovereign governments and municipal governments. (see Eurodollar)

Trust Indenture

legal contract between the bond issuer and a trustee representing bondholders

Conversion price formula of convertible bonds

par/ conversion ratio 1000/ 20 or 40 or 60, etc. . .

Accretion

the annual earning, taken as income, of a portion of the discount on a bond purchased below par, as that bond's value increases towards par as it approaches maturity. Each year, the accretion amount is shown as interest income earned; and the bond's cost basis is adjusted upwards towards par by that accretion amount. Note that there is both accretion for tax purposes, as defined by IRS rules; and accretion for book purposes, as defined by FASB (Financial Accounting Standards Board rules).

A basis quote is the same thing as a . . .

yield-to-maturity quote. (see Yield to maturity)

The minimum dollar amount of a negotiable certificate of deposit is usually:

100,000 Negotiable certificates of deposit are issued in minimum units of $100,000. They are designed for institutional investment - not for individual purchasers. They are also not FDIC insured for any deposit amount that exceeds FDIC limits (currently $250,000).

A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive:

103% x $500 If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract.

A corporation has posted a large financial loss for this year. It has a legal obligation to pay interest on all of the following bonds EXCEPT: A debentures B subordinated debentures C adjustment bonds D equipment trust certificates

The best answer is C. Adjustment (also known as "income") bonds obligate the issuer to pay interest only if the company meets a specified earnings test. If the earnings are not sufficient, no interest payment is legally required. All other bonds obligate the issuer to pay interest, regardless of events. Review

All of the following callable municipal bonds are trading at an 8% basis. Which is MOST likely to be called? A 6 3/4% coupon rate callable at 103 in 2020 B 7 1/2% coupon rate callable at 103 in 2020 C 8 3/4% coupon rate callable at 100 in 2020 D 8 3/4% coupon rate callable at 105 in 2020

The best answer is C. An issuer is most likely to call bonds which have high interest rates (high financing cost to the issuer) and low call premiums (the least expensive for the issuer to call in these bonds).

As a general rule, interest income from US government securities is subject to and exempt from which taxes:

Subject to federal and exempt from state and local tax

TAC tranche

Targeted Amortization Class is a CMO tranche that is buffered against prepayment risk by an associated companion tranche, but is not buffered against extension risk.

Formula for tax equivalent yield or Equivalent Taxable yield =

Tax Free Yield/ 100% - Tax Bracket

Mandatory sinking funds for municipal issues are: I found in revenue bond issues II not found in revenue bond issues III found in general obligation bond issues IV not found in general obligation bond issues A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. A bond issue is likely to have a mandatory sinking fund if it is perceived as a risky issue, causing prospective purchasers to demand additional safeguards on their investment. Since G.O. bonds are backed by unlimited taxing power of the State, they are perceived as low risk (not needing a sinking fund). Revenue bonds are backed by the facility's revenues and are considered somewhat risky. These are the issues that are likely to have a mandatory sinking fund requirement.

A declining rate of inflation would lead to: A higher bond prices and higher bond yields B higher bond prices and lower bond yields C lower bond prices and lower bond yields D lower bond prices and higher bond yields

The best answer is B. A declining rate of inflation will lead to lower interest rates. If interest rates drop, then bond prices will rise.

Regarding Ginnie Mae Pass Through Certificates: I The certificates pay holders on a monthly basis II The certificates pay holders on a semi-annual basis III Each payment consists of interest only IV Each payment consists of a combination of interest and principal A I and III B I and IV C II and III D II and IV

The best answer is B. Ginnie Mae Pass Through Certificates "pass through" monthly mortgage payments to the certificate holders. Each payment is a combination of both interest and principal paid from the underlying mortgage pool.

A facility built with a revenue bond issue has been condemned. Which of the protective covenants found in the trust indenture would be activated? A defeasance covenant B catastrophe call covenant C maintenance covenant D sinking fund covenant

The best answer is B. If a facility is condemned, it can no longer generate revenues. Though the question is not clear as to why it was condemned, the best choice is that a catastrophe call provision would be activated. This requires the issuer to call in the bonds, repaying the bondholders if a disaster occurs. Of the other choices, sinking fund covenants and defeasance covenants have no bearing. A maintenance covenant requires the issuer to maintain the facility in good repair. This covenant is not "activated" by a condemnation, as is a catastrophe call covenant.

Yield curve analysis is useful for an investor in debt securities because: I the curve shows market expectations for interest ratesII investors can compare rates of return relative to changing maturitiesIII the yield of a specific security can be compared to the market expectation for similar securitiesIV the curve can show relative demand for differing maturities by comparing the change in yield to the change in maturity A I, II only B II, III only C I, III, IV D I, II, III, IV

The best answer is D. All of the statements are true regarding yield curve analysis. The curve shows market expectations for interest rates. Because it shows all the rates for all maturities, investors can compare rates against differing maturities. The yield curve is an average for securities of a given risk class. An investor can compare the yield on a specific security to the curve for the risk class to evaluate the attractiveness of that investment. If there is a great demand for a specific maturity, the price will be pushed up and the yield lowered. One can pick this out in a yield curve since the curve would drop for that specific maturity.

Which of the following can issue Eurodollar bonds? I Domestic CorporationsII Foreign CorporationsIII U.S. GovernmentIV Foreign Governments A I only B II only C II and III D I, II, IV

The best answer is D. Eurodollar bonds are issued by U.S. corporations, foreign corporations, and foreign governments. The bonds are issued in foreign countries but are payable in dollars. The bonds give U.S. corporations access to foreign capital markets without having to assume foreign currency risk. The bonds give foreign corporations and governments access to investors who want to buy dollar denominated instruments, who might not normally buy the debt if it were payable in that country's currency.

Which of the following statements are TRUE regarding Eurodollar bonds? I Eurodollar bonds are issued by both domestic and foreign corporations II Eurodollar bonds are denominated in U.S. dollars only III Trading does not take place in the United States IV The securities are not registered with the SEC A I and III only B II and IV only C II, III, IV D I, II, III, IV

The best answer is D. Eurodollar bonds are issued by both domestic and foreign corporations outside of the U.S. markets to take advantage of lower interest rates. These bonds are denominated only in dollars and are payable only in dollars. Since trading does not take place in the U.S., these securities are not registered with the SEC.

Which of the following ratings are considered "investment grade"? I AAAII AAIII AIV BBB A I only B II and III only C I, II, III only D I, II, III, IV

The best answer is D. The top 4 ratings are "investment grade" - AAA, AA, A, and BBB. Any rating below BBB is considered speculative.

All of the following are true statements about Treasury STRIPS EXCEPT: A the investor's interest rate is locked in at purchase, eliminating any reinvestment risk B at maturity, there is no capital gain C the income is accreted and taxed annually D these are suitable investments for individuals seeking current income and a high level of safety

The best answer is D. Treasury STRIPS are government bonds that are "stripped" of coupons. They do not provide current income. The discount on the bonds must be accreted annually, with the annual accretion amount being taxable as interest income. As the bond is accreted, its cost basis is adjusted upwards so that at maturity, the bond has an adjusted cost basis of par. Therefore, no taxable capital gain is realized at maturity. This is a zero coupon obligation with a "locked in" rate of return over the life of the bond.

All of the following statements are true about Treasury Receipts EXCEPT: A the full faith and credit of the U.S. Government backs the securities underlying the issue B they are "packaged" by broker-dealers C the interest coupons are sold off separately from the principal portion of the obligation D the securities are purchased at par

Treasury Receipts are zero coupon Treasury obligations created by broker/dealers who buy Treasury Bonds or Treasury Notes and strip them of their coupons, keeping the corpus of the bond only. The bonds are put into a trust, and "units" of the trust are sold to investors. Treasury Receipts are purchased at a discount and mature at par. The discount earned over the life of the bond is the "interest income." Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, this market evaporated. However, you still must know the basics of these securities for the exam.

Defeasance

this is the legal "shifting" of a municipal bondholder's claim on an issuer's taxing power or revenues onto another acceptable form of collateral. The municipal issuer will buy U.S. Government securities, Agency securities, or sometimes bank certificates of deposit; escrow them with a trustee; and use the income stream from the escrowed securities to pay the debt service on the outstanding bonds. This effectively removes all bondholder claims against the revenue source backing the original issue and enables the municipality to remove the debt from its balance sheet. The outstanding municipal bonds are now backed by the U.S. Government securities that are held in trust. If a bond issue is defeased until maturity it is said to be "escrowed to maturity" (ETM) and is known as an advance refunded issue. If a bond is defeased until its call date, it is "escrowed to call" (ETC) and is known as a pre-refunded issue. (see Advance refunding, Pre-refunding)

Advance refunding

when interest rates have dropped, a municipal issuer who has sold bonds that are non-callable, can issue new bonds with a lower coupon rate and use the proceeds to buy other bonds (usually U.S. Government securities) which are placed in escrow. The income from the escrowed U.S. Governments pays the interest on the older high rate outstanding municipal debt and when the U.S. Government securities mature, the proceeds are used to retire the old, outstanding municipal issue. In effect, the issuer is prepaying both interest and principal on the old bonds with the escrowed U.S. Government securities - thus these bonds are "advance refunded" and no longer have a claim on the issuer's taxing power or revenues.

All of the following statements are true regarding collateralized mortgage obligations EXCEPT: A CMOs are issued by the U.S. Treasury B CMOs are backed by agency pass-through securities held in trust C CMOs have the highest investment grade credit ratings D CMOs give the holder a limited form of call protection that is not present in regular pass-through obligations

The best answer is A. The last 3 statements are true. Collateralized mortgage obligations are backed by mortgage pass-through certificates that are held in trust. The underlying mortgage backed pass-through certificates are issued by agencies such as FNMA, GNMA and FHLMC, all of whom have an "AAA" (Moody's or Fitch's) or "AA" (Standard and Poor's) credit rating. The CMO takes on the credit rating of the underlying collateral. CMOs take the payment flow from the underlying pass-through certificates and allocate them to so-called "tranches." A CMO backed by 30 year mortgages might be divided into 15-30 separate tranches. As payments are received from the underlying mortgages, interest is paid pro-rata to all tranches; but principal repayments are paid sequentially to the first, then second, then third tranche, etc. Thus, the earlier tranches are retired first. The CMO purchaser buys a specific tranche. Because of the sequencing of principal repayments from the underlying mortgages, the holder has a more definite maturity date on the issue, as compared to actually buying a mortgage backed pass-through certificate. This is true because prepayments on pass-through certificates are allocated pro-rata. During periods of falling rates, all certificate holders receive their share of those repayments pro-rata. The holder of a specific tranche of a CMO will only receive prepayments after all earlier tranche holders are repaid. Thus, CMOs give holders a form of "call protection" not available in regular pass-through certificates. CMOs are created by banks from the mortgages they underwrite and are issued by government agencies such as Ginnie Mae, Fannie Mae and Freddie Mac.

During a period when the yield curve is normal: A short term rates are more volatile than long term rates B long term rates are more volatile than short term rates C short term and long term rates are equally volatile D no relationship exists between short term and long term rate volatility

The best answer is A. Whether the yield curve is ascending (normal), flat or descending, the true statement always is that short term rates are more volatile than long term rates. Short term rates are susceptible to Federal Reserve influence, and move much faster than do long term rates. Long term rates respond more slowly; and reflect longer term expectations for inflation and economic growth, among other factors. Please note that if the question referred to bond price movements, long term bond prices always move faster than short term bond prices, as interest rates change. This is due to the compounding effect on the bond's price that occurs, which increases with longer maturities.

Which of the following statements are TRUE regarding repurchase agreements? I Repurchase agreements are used by dealers to reduce the carrying cost of Government securities held in their inventory II Repurchase agreements are initiated by the Federal Reserve to loosen the money supply III If a repurchase agreement specifies a date and price at which time the trade will be reversed, the agreement is known as a "Reverse" repurchase agreement IV If a repurchase agreement extends for longer than overnight, the agreement is known as a "Due Bill" repurchase agreement

The best answer is A. Under a "repurchase agreement," a government securities dealer sells some of its inventory to another dealer or to the Federal Reserve, with an agreement to buy back the securities at a later date for a pre-established price. In this manner, the dealer gets a temporary inflow of cash. Since government dealers finance their inventory, by reducing the amount of inventory on hand, they are reducing inventory finance charges when such an agreement is employed. Thus, Choices I and II are true. Choice III is false. Under a "reverse repurchase agreement," the dealer is buying securities from the Federal Reserve (instead of selling), draining the dealer of cash. Choice IV is also false. Under any repurchase agreement, the underlying government securities are the collateral. The collateral that underlies the agreement must be transferred from seller to buyer to support the transaction. In the "good old days," dealers could do repurchase agreements that were backed by a promise to deliver the underlying securities (a "due bill" for the securities) instead of making physical delivery. Due bill repurchase agreements are no longer permitted.

A municipal issuer would call an issue for all of the following reasons EXCEPT: A substantial funds have accumulated in the issuer's surplus account B interest rates have risen sharply since the issuance of the bonds C the facility built with the proceeds of the issue has been destroyed in a flood D the proceeds of the issue were never expended due to legal obstacles

The best answer is B. If substantial funds have accumulated in the surplus account, the issuer would use the monies to retire debt and reduce the annual interest cost. If a facility is destroyed by a flood, a catastrophe call covenant would be activated, requiring the issuer to call in the bonds. This is done since the facility can no longer generate the revenues to service the debt. If a bond issue is floated and the monies collected are never used for their intended purpose, most bond contracts require that the issuer refund the money to the bondholders. This would be accomplished by calling in the bonds. An issuer would only call in bonds when interest rates have fallen, since the debt could be replaced with lower interest rate financing. An issuer would never refund its debt if interest rates have risen. (Would you go out and refinance your mortgage at a higher interest rate?)

Series EE bonds: A. are issued at a discount to face B. are redeemed at par plus interest earned C. pay interest semi-annually D. are actively traded in the secondary market

The best answer is B. Series EE bonds are "savings bonds" issued by the U.S. Government with a minimum purchase amount of $25 (or more). This is the face value of the bond, and any interest earned is added to the bond's value. The interest rate is set at the date of issuance. Interest is "earned" monthly and credited to the principal amount every 6 months. The bonds have no stated maturity - the holder can redeem at any time, however interest is only credited to the bonds for 30 years. Savings bonds do not trade - they are issued by the Treasury and are redeemed with the Treasury (a bank can act as agent for the Treasury issuing and redeeming Series EE bonds). No physical certificates are issued - the bonds are issued in electronic form.

Reports of corporate bond trades are made to: I TRACEII RTRSIII within 10 seconds of executionIV as soon as practicable but no later than 15 minutes after execution A I and III B I and IV C II and III D II and IV

The best answer is B. TRACE is FINRA's Trade Reporting and Compliance Engine. It reports trades of corporate, government and agency bonds. Any OTC dealers trading these bonds must report each trade to TRACE "as soon as practicable," but no later than 15 minutes after execution. TRACE disseminates the trade report immediately. RTRS stands for Real Time Reporting System. It reports trades of municipal bonds.

The interest expense on monies used to buy bank qualified municipal bonds is: A 20% deductible for bank investors B 80% deductible for bank investors C 20% deductible for individual investors D 80% deductible for individual investors

The best answer is B. A bank is allowed to deduct 80% of any interest expense that it must pay on monies borrowed to buy bank qualified municipal bonds. (The bank "borrows" the monies from its depositors and pays them interest on their deposits). If an individual were to buy municipal bonds, the interest expense on monies used to buy the bonds is non-deductible.

During a period when the yield curve is normal: A short term bond prices are more volatile than long term bond prices B long term bond prices are more volatile than short term bond prices C short term and long term bond prices are equally volatile D no relationship exists between short term and long term bond price changes

The best answer is B. Whether the yield curve is ascending (normal), flat or descending, long term bond prices always move faster than short term bond prices, as interest rates change. This is due to the compounding effect on the bond's price that occurs, which increases with longer maturities.

Which of the following statements are TRUE about PAC tranches? I PAC tranche holders have lower prepayment risk than companion tranche holdersII PAC tranche holders have lower extension risk than companion tranche holdersIII If prepayment rates slow down, the PAC tranche will receive its sinking fund payment prior to its companion tranchesIV If prepayment rates rise, the PAC tranche will receive its sinking fund payment after its companion tranches A I and II only B III and IV only Incorrect answer C. You did not choose this answer. C I, II, IV D I, II, III, IV

The best answer is D. Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a "Planned Amortization Class." Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments that are made earlier than the PAC maturity are made to the Companion classes before being applied to the PAC (this would occur if interest rates drop); while principal repayments made later than anticipated are applied to the PAC maturity before payments are made to the Companion class (this would occur if interest rates rise). Thus, the PAC class is given a more certain maturity date and hence lower prepayment risk; while the Companion classes have a higher level of prepayment risk if interest rates drop; and they have a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.

Dealer offerings of corporate bonds found in Bloomberg are: I retail quotesII wholesale quotesIII new issue offerings sold under a prospectusIV secondary market offerings A I and III B I and IV C II and III D II and IV

The best answer is D. Quote providers such as Bloomberg and Reuters give dealer to dealer prices (the "wholesale" market) for corporate bonds daily. These are bonds that are trading in the secondary market.

Which of the following investments has the lowest level of reinvestment risk? A Preferred Stock B Municipal Bond C Collateralized Mortgage Obligation D Treasury Bill

The best answer is D. Reinvestment risk is an issue for investments that make periodic payments held over long time horizons. If interest rates drop during the investment time horizon, the periodic payments received from these long-term securities must be reinvested at lower and lower current market rates, reducing the overall rate of return on the portfolio. Short-term investments have minimal reinvestment risk; and zero-coupon obligations have no reinvestment risk.

Which of the following ratings are used for long term corporate and municipal bonds? I AII AaaIII BIV Caa A I and III only B II and IV only C I, II, III D I, II, III, IV

The best answer is D. The "ABC" ratings are used for long term corporate and municipal bonds. The Aaa and the Caa are Moody's ratings. The equivalent Standard and Poor's ratings would be AAA and CCC, respectively.

In order to render an opinion on a new municipal bond issue, the bond counsel will examine: I Municipal statutes II State constitution and amendments III Tax code and interpretive regulations IV Judicial edicts

The best answer is D. The bond counsel renders an opinion as to the legality, validity, and tax exempt status of a new municipal issue. To do this, he examines municipal statutes, state laws, judicial edicts, and tax regulations.