Debt

A 7% general obligation bond matures in 1 year. A municipal dealer quoting the bond has just changed his quote from a 7.30 basis to a 7.35 basis. The approximate dollar change in price per $1,000 bond is: A. $.50 B. $5.00 C. $50.00 D. $500.00

The best answer is A. 100 basis points equals 1 point on a bond = 1% of $1,000 par = $10.00 in interest per year. Since this bond has only 1 year to maturity, a 100 basis point change in quote (1 point) will equal a $10.00 change in price. This quote is being changed by 5 basis points (from 7.30 basis to 7.35 basis), so the approximate price change on this 1 year bond 1/20th (5/100) of $10 is $.50.

A customer buys 10M of Allied Corporation 8% debentures, M '35, at 90 on Tuesday, October 8th. The interest payment dates are Feb. 1st and Aug. 1st. The trade settled on Thursday, October 10th. The amount of the next interest payment will be: A. $400 B. $444 C. $800 D. $888

The best answer is A. 10M stands for 10 - $1,000 bonds (M is Latin for $1,000) = $10,000 face amount of bonds. The bonds pay 8% interest annually. 8% of $10,000 is $800 annual interest. Since payments are made semi-annually, $400 is the amount of each payment. Note that the accrued interest paid from buyer to seller on settlement has no effect on the payments made by the issuer to the bondholder of record.

When comparing a CMO Planned Amortization Class (PAC) to a CMO Targeted Amortization Class (TAC), all of the following statements are true EXCEPT: A. Both PACs and TACs offer the same degree of protection against extension risk B. PACs differ from TACs in that TACs do not offer protection against a decrease in prepayment speeds C. PACs are similar to TACs in that both provide call protection against increasing prepayment speeds D. TAC pricing will be more volatile compared to PAC pricing during periods of rising interest rates

The best answer is A. A Targeted Amortization Class (TAC) is a variant of a PAC. A PAC offers protection against both prepayment risk (prepayments go to the Companion class first) and extension risk (later than expected payments are applied to the PAC before payments are made to the Companion class). A TAC bond protects against prepayment risk; but does not offer the same degree of protection against extension risk. A TAC bond is designed to pay a "target" amount of principal each month. If prepayments increase, they are made to the Companion class first. However, if prepayment rates slow, the TAC absorbs the available cash flow, and goes in arrears for the balance. Thus, average life of the TAC is extended until the arrears is paid. Therefore, both PACs and TACs provide "call protection" against prepayments during period of falling interest rates. TACs do not offer the same degree of protection against "extension risk" as do PACs during periods of rising interest rates - hence their prices will be more volatile during such periods.

A municipal revenue bond trust indenture includes an "additional bonds test" covenant. This means that: A. an earnings test must be satisfied before additional bonds can be issued against the same revenue source B. additional bonds can only be issued if they have a subordinated lien on pledged revenues C. additional bonds can only be issued after the original issue is called or advance refunded D. additional bond issues having a lien on the same revenue source are prohibited

The best answer is A. An "additional bonds test" means that the issuer is prohibited from issuing new bonds against the revenues of a facility, unless the facility's revenues are sufficient. Typically, the debt service on the old bonds is added to that of the new bonds. The revenues of the facility must cover, by an adequate margin, the combined debt service before additional bonds can be sold.

Price volatility of a CMO issue would most closely parallel that of an equivalent maturity: A. Treasury bond B. Mortgage backed pass-through certificate C. Treasury STRIP D. Collateral trust certificate

The best answer is A. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower.

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.

Which of the following statements are TRUE regarding a municipal bond issue that is advance refunded? I The security that backs the advance refunded bonds will change after the issue is refinanced II The security that backs the advance refunded bonds will not change after the issue is refinanced III The marketability of the advance refunded bonds will increase after the issue is refinanced IV The marketability of the advance refunded bonds will decrease after the issue is refinanced A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. In an advance refunding, the issuer floats a new bond issue and uses the proceeds to "retire" outstanding bonds that have not yet matured. These funds are deposited to an escrow account and are used to buy U.S. Government securities. The escrowed U.S. Government securities become the pledged revenue source backing the refunded bonds. These bonds no longer have claim to the original revenue source. Since there is a new source of backing for the bonds (and an extremely safe one!), the credit rating on the pre-refunded bonds increases, as does their marketability. The refunded bonds no longer have any claim to the original pledged revenues - and thus have been "defeased" - that is, removed as a liability of the issuer. (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.)

If an issuer defaults on a moral obligation bond, payment can only be made by: A. legislative apportionment B. judicial edict C. legal authorization D. municipal injunction

The best answer is A. Moral obligation bonds are backed by pledged revenues and also by a non-binding pledge to report any revenue deficiencies to the state legislature. The legislature is authorized to apportion the funds necessary to service the debt, but is under no obligation to do so.

Interest income from which of the following bonds is most likely to be considered a "tax preference item" in the Alternative Minimum Tax calculation? A. Airport revenue bond B. Hospital revenue bond C. Water revenue bond D. General obligation bond

The best answer is A. Municipal "Private Activity Bonds" are taxable - the interest income is subject to federal income tax. If the PAB is "qualified," then the interest income is not subject to regular income tax, but it is a tax preference item included in the AMT calculation (which typically only hits higher income taxpayers who take a lot of deductions). Qualified PABs include bonds where the proceeds go to finance the activities of a private entity, including airports, docks, residential rental projects that are privately owned, waste disposal projects, water and sewer facilities that are privately owned and enterprise zones. Note that if any of these activities were being done by public entities, the bonds would be tax-free.

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.

150 basis points are equal to: I $15.00 per $1,000 II $150.00 per $1,000 III 1.5% IV 15% A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. One basis point is .01% of interest. 100 basis points equals 1% of interest. 150 basis points equals 1.50%, which is the same as $15.00 per $1,000 face amount on a bond.

The obligor on a municipal bond issue is the: A. borrower of the bond proceeds B. lender of the bond proceeds C. guarantor of the payment of debt service on the bond issue D. fiduciary acting for the benefit of the bondholders

The best answer is A. The "obligor" on a bond issue is the party having the obligation to pay the debt service on the bonds. This is the "legal" name for the borrower or debtor.

In 2019, a customer buys 1 GE 8%, $1,000 par debenture, M '34, at 110. The interest payment dates are Jan 1st and Jul 1st. The yield to maturity on the bond is: A. 6.98% B. 7.58% C. 8.00% D. 8.24%

The best answer is A. The formula for yield to maturity for a premium bond is: $80 - ($100 premium / 15 years to maturity) ($1,100 + $1,000) / 2 = $80 - $6.67 $1,050 = $73.33 $1,050 = 6.98%

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.

Which of the following are investment grade bonds? I A-rated II BBB-rated III BB-rated IV CCC-rated A. I and II only B. II and III only C. III and IV only D. I, II, III, IV

The best answer is A. The lowest investment grade is BBB. Any securities below this rating (BB or lower) are considered to be speculative - and are commonly known as "junk" issues.

The nominal yield on a bond is: A. stated interest rate / bond par value B. stated interest rate / bond market value C. market interest rate / bond par value D. market interest rate / bond market value

The best answer is A. The nominal yield is the stated rate of interest on the bond, based on par value.

XYZ Debentures Issue Date: 8-1-XX Payment Dates: J 1 & J 1 Maturity Date: 7-1-XX Some years after issuance, a customer buys 10 debentures in a regular way trade on Friday, October 14th. The customer will owe the seller: A. 107 days of accrued interest B. 108 days of accrued interest C. 109 days of accrued interest D. 110 days of accrued interest

The best answer is A. The purchase on Friday, October 14th will settle on Tuesday, October 18th - 2 business days after trade date. Accrued interest on corporate bonds is based on a 30 day month / 360 day year. And interest starts accruing from the morning of the last interest payment, up to, but not including, settlement. So, 30 days are due for July, 30 days for August, 30 days for September, and 17 days for October (up to but not including settlement) = 107 days total.

As stated in the flow of funds found in a revenue bond issue's trust indenture, before the revenues collected are applied to the operations and maintenance fund, revenues are placed in the: A. Revenue Fund B. Debt Service Reserve Fund C. Sinking Fund D. Reserve Maintenance Fund

The best answer is A. 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 first deposited to a revenue fund. The monies are then applied, in sequence, to the operation and maintenance account; sinking fund; debt service reserve fund; reserve maintenance fund; renewal and replacement fund; and finally to the surplus fund.

Treasury bonds: I are issued in minimum $100 denominations II are issued in minimum $10,000 denominations 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 A. Treasury bonds are issued at par in minimum denominations of $100 each, and pay interest semi-annually. At maturity, the bondholder receives par.

Which of the following statements are TRUE regarding CMO "Planned Amortization Classes" (PAC tranches)? I PAC tranches reduce prepayment risk to holders of that tranche II PAC tranches increase prepayment risk to holders of that tranche III Principal repayments made earlier than expected are applied to the PAC prior to being applied to the Companion tranche IV Principal repayments made later than expected are applied to the PAC prior to being applied to the Companion tranche A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. "Plain vanilla" CMOs are relatively simple - 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. A newer version of a CMO has a more sophisticated scheme for allocating cash flows. 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 made earlier than that required to retire the PAC at its maturity are applied to the Companion class; while principal repayments made later than expected are applied to the PAC maturity before payments are made to the Companion class. Thus, the PAC class is given a more certain maturity date; while the Companion class has a higher level of prepayment risk if interest rates fall; and a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.

Sallie Mae debentures are backed by: A. the full faith and credit of the U.S. Government B. the full faith and credit of the Student Loan Marketing Association C. designated pooled mortgages D. designated pooled student college loans

The best answer is B. "Sallie Mae" is the Student Loan Marketing Association. Sallie Mae raises money to lend to college students. It does this primarily by issuing debentures to the public. These debentures are backed by the faith and credit of this agency. Sallie Mae is another agency that is "privatized." Sallie Mae stock is listed and trades on NASDAQ.

Regarding the allocation of CMO cash flows, which statements are TRUE? I Interest received from the underlying securities is allocated pro-rata to all tranches II Interest received from the underlying securities is allocated sequentially by tranche maturity III Principal repayments received are allocated pro-rata to all tranches IV Principal repayments received are allocated sequentially by tranche maturity A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. 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.

A CMO Z-tranche: A. receives payments prior to all other tranches B. receives payments after all other tranches C. receives payments on a pro-rata basis with other tranches D. does not receive payments

The best answer is B. A Z-tranch is a "Zero" tranche. It gets no payments until all prior tranches are retired. Then it is paid off at par. It acts like a long-term zero-coupon bond, so it is most susceptible to interest rate risk.

Which of the following bond issues would most likely have a mandatory sinking fund? I U.S. Government bond II General Obligation bond III Hospital Revenue bond IV Airport Revenue bond A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is B. A bond issue is likely to have a mandatory sinking fund provision if it is perceived to be somewhat risky causing potential purchasers to demand this additional safeguard. Treasury Bonds are backed by the full faith and credit of the U.S. Government, so these issues have no credit risk. State General Obligation bonds are backed by the unlimited taxing power of the State, and also are perceived to be of low risk. Hospital Revenue bonds and Airport Revenue bonds are backed solely by the facility's revenues and are considered to be somewhat risky. (If there is hospital overbuilding or patient stays are shortened, revenues can fall; if another airport is built nearby that takes away passengers, revenues can fall; etc.)

A municipal bond that has a put option is protected against depreciation due to: I rising interest rates II falling interest rates III rising demand for the issue IV falling demand for the issue A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. A bond with a put option allows the holder to put back the bond to the issuer at par value. Thus, this bond, once the put option is exercisable, is always worth at least par. Therefore, if interest rates rise or if market demand falls, this bond's price cannot fall below par (unlike traditional bonds).

A decreasing market rate of interest 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 market rate of interest means that interest rates are dropping. If market interest rates drop, then bond prices will rise, and the yields on those bonds will fall.

Special assessment bond issues are paid from: A. taxes levied upon all taxable property within the municipality, without limitation as to rate or amount B. taxes levied upon all taxable property within a particular locality, not to exceed the benefit derived from the improvement C. revenues pledged from the operation of a facility built with the proceeds of the issue D. excise taxes placed upon the sale of either alcohol, tobacco, or fuel

The best answer is B. A special assessment bond is one which is used to fund an improvement that benefits only a segment of the population; and only those people are charged taxes to pay for that improvement. Such taxes cannot exceed the value of the benefit received. This makes them totally different from general tax collections, such as ad valorem taxes, which have no such "tie-in".

A new issue corporate bond has a dated date of September 1st. The bond is assigned by the issuer to the underwriter on August 31st. Accrued interest on the bond will be calculated based on how many days in a year? A. 359 B. 360 C. 364 D. 365

The best answer is B. Accrued interest on a corporate bond is calculated on a 30-day month / 360-day year basis. All of the other information in the question is irrelevant. Note that if the question asked about how many days of interest will be paid in the first interest payment, then the interest accrual starts on the dated date of September 1st (the date of legal issuance of the bonds) and ends when the first interest payment is made (which would be January 1st for most bond issues, since they use a "standard" January 1st and July 1st for the interest payment dates). In this case, the first interest payment would cover the months of September, October, November and December = 120 days.

The Government National Mortgage Association: A. buys conventional mortgages from financial institutions for repackaging as pass through certificates B. buys FHA and VA guaranteed mortgages from financial institutions for repackaging as pass through certificates C. gives its implied backing to the payment of interest and principal on mortgages purchased from financial institutions D. issues mortgages directly on U.S. Government subsidized housing

The best answer is B. Ginnie Mae buys FHA and VA guaranteed mortgages from banks and assembles them into pools. GNMA then sells undivided interests in these pools as pass-through certificates. The monthly mortgage payments are passed through to the certificate holders. GNMA guarantees the payment of interest and principal on the underlying mortgages and has the direct backing of the U.S. Government. The agencies that have an implied U.S. Government backing are Fannie Mae and Freddie Mac.

Two 20-year corporate bonds are issued at par, with stated interest rates of 10%. One issue is puttable at par in 5 years, while the other is puttable at par in 10 years. If interest rates rise by 200 basis points shortly after issuance, which statement is TRUE? A. The bond puttable in 5 years will depreciate more than the bond puttable in 10 years B. The bond puttable in 10 years will depreciate more than the bond puttable in 5 years C. Both bonds will depreciate by equal amounts D. The rate of depreciation depends on the credit rating of the bonds

The best answer is B. If a bond is puttable at par in the near future, any price decline due to rising interest rates will be suppressed since the holder is able to put the bond back to the issuer sooner. Thus, the bond puttable in 10 years will depreciate more than the bond that is puttable in 5 years if interest rates rise.

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: A. $500 B. 103% of $500 C. $1,000 D. 103% of $1,000

The best answer is B. 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.

Which of the following statements are TRUE regarding the effect of market interest rate movements on callable and puttable bond prices? I When interest rates fall, the call price tends to set a ceiling on the market price of the bond II When interest rates fall, the call price tends to set a floor on the market price of the bond III When interest rates rise, the put price tends to set a ceiling on the market price of the bond IV When interest rates rise, the put price tends to set a floor on the market price of the bond A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. If interest rates drop, it is more likely that an issuer will call its bonds. As interest rates drop, bond prices in the market will rise. The price will not rise by as much for a callable issue as that for a non-callable issue. The reason: why would someone pay a premium for an issue that is likely to be called off the market? The price for a puttable bond sets a floor under the market price of the bond during periods of rising interest rates. The price will never drop much below par once the option is exercisable, because if it did, customers would buy as many of the bonds as possible and "put" them to the issuer at par for a capital gain.

A customer purchases a convertible bond at 90, convertible into the common stock at $40. The common stock is currently trading at $36. The company declares a 25% stock dividend. The bond trust indenture includes an anti-dilution clause. After the ex date for the stock dividend, the conversion price for this bond issue will be: A. $30 B. $32 C. $36 D. $40

The best answer is B. If the company issues additional shares, each of the existing shares is worth "less" since the company's earnings are spread over a greater number of shares. Thus, the market price will adjust downward to reflect this. If a company issues 25% more shares (after the dividend, there will be 1.25 times the old number of shares), then the earnings and consequently the share price will drop by a factor of 1/1.25. The bondholder bought the issue based on a conversion price of $40. The market price of the stock is being diluted by the additional shares, reducing or eliminating the value of the bondholder's conversion feature. To protect the bondholder from this occurrence, trust indentures include an anti-dilution covenant. The conversion price of the stock is adjusted downwards by the same factor, so that the convertible bondholder experiences no loss from the issuance of the new shares. $40 1.25 = $32 per share

A customer in the 28% tax bracket is considering the purchase of a municipal bond yielding 11% or a corporate bond yielding 16%. Both bonds have similar maturities and credit ratings. Which statement is TRUE? A. The effective yield on the municipal bond is higher B. The effective yield on the corporate bond is higher C. Both effective yields are equivalent D. The coupon rates for each bond are necessary to determine the effective yield

The best answer is B. In order to compare the tax free municipal yield to the taxable corporate yield, the two must be equalized. 11% (100% - 28%) = 15.3% Since the corporate bond is yielding 16%, the corporate yield is higher.

When a municipal dealer gives a customer a "bond appraisal," he is disclosing: A. a firm price at which the bonds can be sold based on the market prices of similar securities B. a likely price at which the bonds can be sold based on the market prices of similar securities C. his inventory position of similar securities D. the last prices at which trades actually took place of similar bonds

The best answer is B. Municipal dealers are often asked for bond appraisals by customers who wish to sell bonds. Because there is no active trading market for municipal bonds, last trading price information is not available. To get an idea of the value of the bond, the dealer will get prices of similar bonds and then give an estimated price to the customer. This is a likely sale price - not a firm quote.

Municipal variable rate demand notes: I have a market value which will never go below par II have a market value which will never go above par III have a yield which will never fall below the stated rate IV have a yield which will never rise above the stated rate A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Municipal variable rate demand notes are issued by a municipality. The interest rate is reset to the market rate weekly; and at the reset date, the holder can "put" the bonds back to the issuer at par. Here, the minimum value of the bond is par - because of the put feature. Because the price of the bond cannot go below par, these bonds are not subject to market risk and the yield cannot go above the stated rate. However, if interest rates fall, the price can go above par (by a small amount) and the yield can fall below the stated rate until the next reset date.

Which investment does NOT have purchasing power risk? A. STRIPS B. TIPS C. Treasury Bonds D. Treasury Receipts

The best answer is B. Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. "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. If there is inflation, market interest rates are forced upwards, and zero-coupon bonds such as STRIPS fall dramatically in price (Treasury Receipts are broker-created zero-coupon bonds). Long term T-Bonds are also susceptible to purchasing power risk, though not as badly as long-term zero-coupon bonds. The bonds that have the lowest purchasing power risk are short term money market instruments and TIPS.

Current dealer offerings of corporate bonds can be found in: A. Bond Buyer B. Bloomberg C. Moody's D. Fitch's

The best answer is B. Quote providers such as Bloomberg and Reuters give dealer to dealer prices (the "wholesale" market) for corporate bonds daily. The Bond Buyer is the municipal new issue newspaper. Moody's and Fitch's rate bonds - they are not quote providers.

Which of the following terms describe a special tax bond issue? A. Self supporting B. Non-self supporting C. General obligation D. Moral obligation

The best answer is B. Special tax bonds are backed by taxes other than an ad valorem tax, such as liquor taxes, gasoline taxes, cigarette taxes or sales taxes. They are considered to be a non-self supporting debt since they are paid from tax collections. Self supporting debts are revenue bond issues that pay their own way from collected revenues. When ratings agencies such as Standard and Poor's look at the Debt Statement of a municipality to assign a credit rating, they will not deduct special tax bonds from Total Bonded Debt when calculating Net Direct Debt (All Bonded Debt Sold - Self Supporting Debt). They say that they treat Special Tax bonds as non-self supporting debt because, to be conservative, they consider ALL types of taxes paid by the population of a town to service its debt when calculating Net Bonded Debt.

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.

The listing of current municipal bond offerings shows the following: Cook County School District Bond P/R @ 102 4.20 6/15/19 M'29 2.50 Which of the following statements are TRUE? I The bonds will be redeemed in 2019 II The bonds will be redeemed in 2029 III The redemption price is par IV The redemption price is 102 A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The School District bonds have a coupon of 4.20% and were scheduled to mature in 2029. However, the issuer has pre-refunded (P/R) the bonds by escrowing U.S. government securities to retire the bonds prior to maturity (at the call date of 6/15/19). At that time, the bondholder will receive 102 (call premium of 2 points). The bonds are currently being offered at a price to yield 2.50%, so they are trading at a premium (coupon is 4.20%). Remember, municipal issuers prerefund their debts when interest rates have fallen, similar to a homeowner refinancing a mortgage when interest rates have dropped. By prerefunding the debt, the issuer "retires" the debt prior to its maturity date because its debt service comes from escrowed government securities (and not tax collections in this case), freeing up the issuer to sell new bonds at lower current market rates.

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.

A customer bought a $1,000 par convertible subordinated debenture at par, convertible into common at $31.25 per share. If the bond's market price increases by 20%, the conversion ratio will be: A. 31.25:1 B. 32.00:1 C. 37.50:1 D. 38.40:1

The best answer is B. The conversion price (and hence the conversion ratio) is fixed when the convertible security is issued and does not change. In this case, the bond is issued with a conversion price of $31.25, based upon converting each bond at par. $1,000 par / $31.25 conversion price = 32:1 conversion ratio. Thus, for every bond that is converted, the holder receives 32 shares.

The current yield on a bond is: A. stated interest rate / bond par value B. stated interest rate / bond market value C. market interest rate / bond par value D. market interest rate / bond market value

The best answer is B. The current yield is the stated rate of interest on the bond, based on current market value.

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.

The nominal yield of a bond will: I increase as bond prices fall II decrease as bond prices rise III remain unchanged as bond prices fall IV remain unchanged as bond prices rise A. I and II B. III and IV C. I and IV D. II and III

The best answer is B. The nominal yield is the stated rate of interest as a percentage of par value. It does not change as bond prices move. However, the current yield and yield to maturity will be affected by changes in bond prices.

The ratio of pledged revenues to debt service requirements would be used to analyze which of the following municipal issues? A. School District Bonds B. Hospital Revenue Bonds C. Special Tax Bonds D. General Obligation Bonds

The best answer is B. The ratio of pledged revenues to debt service requirements applies to revenue bonds. Pledged revenues are those pledged to pay debt service and any other requirements set in the bond contract. The bondholder has a lien on these revenues. The higher this ratio, the safer a revenue bond, since there is a greater ratio of revenues to cover debt service. School district bonds are G.O. issues, paid by unlimited ad valorem taxing power; applicable ratio tests would be debt per capita (How much debt is each citizen of the town responsible for?); debt to assessed valuation (How much debt is there outstanding against the real properties that are assessed taxes to pay for the interest expense on that debt?); and the collection ratio (Of the taxes assessed by the municipality, what percentage is actually collected?)

The most commonly used measure to evaluate the ability of a revenue bond issuer to pay interest and repay principal is the ratio of: A. Gross Revenues / Debt Service B. Net Revenues / Debt Service C. Overall Net Debt / Population D. Overall Net Debt / Assessed Value

The best answer is B. The ratio used to analyze revenue bonds is the Debt Service Coverage Ratio. It is the ratio of Pledged Revenues to Debt Service cost. Almost all revenue bonds have a net revenue pledge, where "net revenues" are pledged to the bondholders (net revenues are gross revenues minus operation and maintenance costs). Thus, the most commonly used ratio to analyze revenue bonds is the ratio of Net Revenues / Debt Service.

Which statements are TRUE regarding Treasury Inflation Protection securities? I In periods of deflation, the amount of each interest payment will decline II In periods of deflation, the amount of each interest payment is unchanged III In periods of deflation, the principal amount received at maturity will decline below par IV In periods of deflation, the principal amount received at maturity is unchanged at par A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. 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. In periods of deflation, the principal amount is adjusted downwards. Even though the interest rate is fixed, the holder receives a lower interest payment, due to the decreased principal amount. In this case, when the bond matures, the holder receives par - not the decreased principal amount.

For bonds trading at a premium, rank the yield measures from lowest to highest? A. Nominal; Current; Yield to Maturity; Yield to Call B. Yield to Call; Yield to Maturity; Current; Nominal C. Current; Nominal; Yield to Call; Yield to Maturity D. Yield to Maturity; Current; Yield to Call; Nominal

The best answer is B. When bonds are trading at a premium, the yield to call will be the lowest measure since the annual return is reduced by the annual amortized portion of the premium that will be "lost" over the life of the bond to the call date. The next highest yield will be the yield to maturity, since the premium will be lost over a longer "life" than if the bond is called early. Current yield will be higher than yield to maturity, since it does not include the annual premium loss. Stated yield will be the highest since it is the return based on par value.

A municipality would issue a GAN in anticipation of receiving: A. property tax collections B. proceeds from a long term bond sale C. federal transit funding D. federal highway funding

The best answer is C. A "GAN" is a municipal "Grant Anticipation Note." A GAN would be issued by a municipality to get immediate access to federal grant monies that are expected to be received months into the future. These grant monies typically are used to support mass transit programs, like buses and subways for cities. Note, in contrast, that a "RAN" - Revenue Anticipation Note - is paid from expected revenues to be received in the future, and that this source of funding is usually federal highway funds

A basis quote for a $5,000 municipal bond with one year left to maturity has just been dropped by 20 basis points. The bond's change in price will be: A. $1 increase B. $1 decrease C. $10 increase D. $10 decrease

The best answer is C. A basis point is .01% of par. 20 basis points equals .20% of par. .20% = .002 x $5,000 par = $10. If interest rates drop by 20 basis points, this bond with 1 year to maturity should increase in value by $10. Also note that this type of question can only be asked for a bond with 1 year to maturity. If there are many years to maturity, then discounted cash flow calculations are required, which are not tested.

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

The best answer is C. A floating rate CMO tranche has an interest rate that varies, tied to the movements of a recognized interest rate index, like LIBOR. Therefore, as interest rates move up, the interest rate paid on the tranche goes up as well; and when interest rates drop, the interest rate paid on the tranche goes down as well. There is usually a cap on how high the rate can go and a floor on how low the rate can drop. Because the interest rate moves with the market, the price stays close to par - as is the case with any variable rate security.

In a municipal bond contract, a "covenant of defeasance" would be invoked if: I interest rates have risen subsequent to bond issuance II interest rates have dropped subsequent to bond issuance III call premiums on the issue are low IV call premiums on the issue are high A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A municipal "covenant of defeasance" allows the issuer to "advance refund" or "pre-refund" the bond issue under the terms specified in the bond contract. When a bond is advance refunded, the issuer places Treasury securities in escrow that will mature when the outstanding bonds mature, so this becomes the bond issue's backing, freeing up the issuer to sell new bonds at lower current market rates. An issue is "pre-refunded" if the bond is callable, and Treasury securities are placed in escrow with a maturity that matches the call date. An issuer will take advantage of the defeasance covenant if interest rates have dropped and the issue is not currently callable. If the issue was callable, instead of pre-refunding the issue, the issuer would just call in the bonds and issue new ones at the lower current interest rate. An issuer will be more likely to call bonds with low call premiums (lower cost to the issuer to call in the issue) than those with high call premiums (higher cost to the issuer to call in the issue). (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.)

A municipal variable rate demand note is: I a short term issue II a long term issue III issued at short-term interest rates IV issued at long-term interest rates A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A municipal variable rate demand note is a long-term municipal security because it has no stated maturity, but it is issued at short-term (lower) interest rates, because the holder has the right to "put" the bond to the issuer at par at each interest payment date. The interest rate is reset, usually weekly at the interest payment date, to an indexed rate for the next week. Thus, the interest rate will vary. With any variable rate note, the interest rate varies as market rates move; therefore the market price remains at, or very close to, par. Thus, these instruments have almost no market risk.

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.)

Nominal quotes for municipal bonds are: A. a firm price at which a transaction would take place B. a likely price at which a transaction would take place C. an indication of a price given for informational purposes only D. prohibited to be disseminated to municipal market participants

The best answer is C. A nominal quote is an approximation of a market price for a bond, given for informational purposes only. The dealer giving such a quote is under no obligation to trade at that price; or even near to that price.

A nominal quotation given by a municipal dealer represents a(n): A. firm bid or offer B. likely bid or offer C. approximate market value, with no bid or offer D. bid or offer limited to round lots of 100 bonds

The best answer is C. A nominal quote is really no quote - it is simply an approximate price. The dealer is not obligated to trade at this quote and must identify it as a nominal quote.

The income source backing a special tax bond issue could be: I Cigarette taxes II Sales taxes III Ad valorem taxes IV Business taxes A. I only B. II only C. I, II, IV D. I, II, III, IV

The best answer is C. Ad valorem taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales, business or income taxes).

Which characteristic is NOT common to both Treasury STRIPS and Treasury Notes? A. Minimum $100 denominations B. Quoted as a percent of par in 32nds C. Pay interest at maturity D. Guaranteed by the U.S. Government

The best answer is C. All T-Notes and T-STRIPS have a minimum $100 par value; are quoted in 32nds; and are directly backed by the U.S. Government. T-Notes pay interest semi-annually. Treasury STRIPS are notes or bonds "stripped" of coupons, meaning all that is left is the principal repayment portion of the note or bond (sometimes called the "corpus" or body). STRIPS are zero coupon original issue discount obligations that do not have a stated interest rate. The accretion of the discount over the note's or bond's life represents the interest earned, which is paid at maturity.

A municipal revenue bond trust indenture includes an "additional bonds test" covenant. This prohibits the issuer from doing all the following EXCEPT: A. issuing parity bonds unless the facility's revenues are sufficient to pay for existing and proposed debt B. issuing senior lien bonds unless the facility's revenues are sufficient to pay for existing and proposed debt C. issuing junior lien bonds unless the facility's revenues are sufficient to pay for existing and proposed debt D. issuing bonds with the same lien on pledged revenues unless the facility's revenues are sufficient to pay for existing and proposed debt

The best answer is C. An "additional bonds test" means that the issuer is prohibited from issuing new bonds against the revenues of a facility that have the same lien ("parity lien") against pledged revenues, unless the facility's revenues are sufficient. There is no prohibition on selling bonds that have a junior claim (meaning they are paid after) the existing bonds. In all bond issues, there is a prohibition on selling debt that has a senior claim to that of the existing bondholders. To perform an additional bonds test, typically, the debt service on the old bonds is added to that of the new bonds. The revenues of the facility must cover, by an adequate margin, the combined debt service before additional bonds can be sold.

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.

When comparing CMOs to their underlying pass-through certificates, which of the following statements are TRUE? I CMOs receive a higher credit rating than the underlying mortgage backed pass-through certificate II CMOs receive the same credit rating as the underlying mortgage backed pass-through certificate III CMOs are subject to a lower degree of prepayment risk than the underlying pass-through certificate IV CMOs are subject to the same degree of prepayment risk as the underlying pass-through certificate A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. CMOs receive the same credit rating (AAA or AA) as the underlying mortgage backed pass-through certificates held in trust. CMOs are subject to a lower degree of prepayment risk than the underlying pass-through certificates. During periods of falling interest rates, prepayments of mortgages in a pool are applied pro-rata to all holders of pass-through certificates. CMOs divide the cash flows into "tranches" of varying maturities; and apply prepayments sequentially to the tranches in order of maturity. Thus, prepayments are applied to earlier tranches first, so the actual date of repayment of the tranche is known with more certainty.

A calamity call covenant would be activated for which of the following reasons? I Earthquake damage has incapacitated a facility II Flooding has inundated a facility III Fire has incinerated a facility IV Obsolescence has caused the mothballing of a facility A. II and III only B. I and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Catastrophes are "sudden" occurrences, such as flooding, hurricanes, fires, earthquakes, etc. Damage from all of these could activate a calamity call covenant. Obsolescence does not factor into this definition.

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

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.

Construction Loan Notes are repaid from: A. rents received from the housing project built with the proceeds of the offering B. rent subsidies received from the U.S. Government C. monies received from a permanent take-out financing D. monies received from the issuance of the Construction Loan Note

The best answer is C. Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing).

Which of the following statements are true regarding Construction Loan Notes ("CLNs")? I The use of CLNs allows the municipal issuer to reduce its interest cost when constructing a new facility II The maturity of CLNs is generally 2 - 3 years III Accrued interest on CLNs 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 CLNs A. I only B. II and III only C. I, II, III D. I, II, III, IV

The best answer is C. Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing). CLNs allow an issuer to reduce its interest cost, since the interest rate that must be paid on short term notes is lower than that for long term bond issues. CLNs typically have a maturity of 2 to 3 years, to coincide with the projected construction period of the building. Accrued interest on all municipal short term notes is computed in a manner similar to other money market instruments - an actual day month / actual day year basis. Please note that this is not true for long term municipal bonds, which accrue interest on a 30 day month / 360 day year. Finally, the last statement is false. When the long term financing is completed, the proceeds are used to retire the CLNs. The proceeds of the long term bond issue are not added to the original debt outstanding.

Which of the following debt securities may be issued by a corporation? I Mortgage Bonds II Collateral Trust Certificates III Revenue Bonds IV Income Bonds A. I and IV only B. II and III only C. I, II, IV D. I, II, III, IV

The best answer is C. Corporations do not issue revenue bonds - rather, these are a type of municipal bond. Corporations can issue mortgage bonds (backed by real property), collateral trust certificates (backed by a portfolio of marketable securities), and income or adjustment bonds (that obligate the issuer to pay only if there are sufficient earnings).

General obligation bond analysis would consider which of the following? I Protective covenants in the trust indenture II Trend of assessed valuation of property III Ratio of overall debt per capita IV Record of tax collections A. I and III only B. II and IV only C. II, III, IV D. I, II, III, IV

The best answer is C. G.O. bonds are typically issued without a trust indenture - revenue bonds have trust indentures. The specific protections of an indenture are not needed since the municipality's taxing power is unconditionally pledged to pay off the bonds. Trust indentures are found in revenue bond issues, where only the revenues are pledged to pay off the debt, and purchasers of the bonds demand additional protections that are spelled out in the trust indenture, such as rate, insurance, and maintenance covenants. To assess whether taxes are likely to be sufficient to pay off the debt, G.O. bond analysis includes evaluation of the tax collection record; trend of assessed valuation of property in the area; and debt to population ratios.

Which of the following are TRUE statements regarding revenue bonds? I Yields for revenue bond issues are generally higher than yields for comparable G.O. issues II Revenue bonds are only suitable for investors willing to assume a high level of risk III The bonds may be double barreled with backing by ad valorem taxes IV Issuance of the bonds is dependent on earnings requirements A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

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.

An investor purchases a bond, which pays interest on January 1st and July 1st. The trade settles on May 1st. How many months of interest will the buyer receive from the issuer in the next interest payment? A. 1 month B. 3 months C. 6 months D. 12 months

The best answer is C. Issuers make fixed semi-annual interest payments to bondholders covering the preceding 6-month period. If the bond is traded in-between interest payment dates, the payment of accrued interest from buyer to seller ensures that each party gets the correct amount of interest. In this example, the buyer will receive the 6 month interest payment from the issuer; but will have paid 4 months of accrued interest to the seller on settlement. Thus, the buyer correctly only "earns" the net amount of 2 months of interest corresponding to the period that he or she held the bond.

Short sale transactions are typical for which of the following? I Listed options II Common stock III Municipal bonds IV Treasury bonds A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is C. Municipal bonds are generally not sold short because the trading market in each maturity is very thin, making short covering difficult, if not impossible. Short selling (the sale of borrowed securities, with the purchase and replacement of the borrowed securities occurring later) is a strategy that allows the investor to profit in a falling market. Short selling can only be performed with actively traded securities (since ultimately the borrowed securities that were sold must be repurchased and replaced). Common stocks, listed options, and U.S. Government securities are all actively traded; and short selling of these securities is common.

A municipal "broker's broker" does which of the following? I Executes trades as agent for institutional clients II Executes trades as agent for other dealers III Trades for the firm's own account IV Obtains quotes from other dealers A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is C. Municipal broker's brokers act as agents handling large municipal orders, usually for institutions. These firms do not act as market makers and do not take inventory positions.

Net Direct Debt and Overlapping Debt equals: A. Debt per Capita B. Debt to Assessed Valuation C. Net Overall Debt D. Overlapping Debt

The best answer is C. Net Overall Debt of a municipality is used as the numerator in Debt Per Capita ratios and Debt to Assessed Value ratios. These ratios measure the relative size of the municipality's debt level. Net Overall Debt is: Net Direct Debt + Overlapping Debt.

Which of the following municipal issues would be exempt from taxation of interest by the Federal Government? I San Francisco, California - Convention Center Revenue Bond II Miami, Florida - Sewer and Water Revenue Bond III Nassau County, New York - Pollution Control Bond IV Des Moines, Iowa - Baseball Stadium Revenue Bond A. I only B. I and IV C. II and III D. I, II, III, IV

The best answer is C. Non-essential use, private purpose municipal issues are subject to Federal Income tax, via the Alternative Minimum Tax computation (AMT). The building of a convention center constitutes such a use, as does the building of a baseball stadium. Sewers, water, pollution control, and schools are all essential public uses and these issues qualify for the Federal Income Tax exemption on interest.

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 city has a total assessed value of property of $1,700,000,000 and a tax rate of 10 mills. For the year, the city collects $14,000,000 of taxes. The city's collection ratio is: A. $14,000,000 / $1,700,000,000 B. $1,700,000,000 / $14,000,000 C. $14,000,000 / $17,000,000 D. $17,000,000 / $14,000,000

The best answer is C. The "mill" rate is the tax rate in the city. 1 "mill" = 1/1,000 = .001. = $1 per $1,000 of assessed value. Since the city has a tax rate of 10 mills, the tax is $10 per $1,000 of assessed value. The total assessed value of $1,700,000,000 means that taxes assessed equal $10 x 1,700,000 = $17,000,000. Since the city only collected $14,000,000 of the assessed taxes, its collection ratio is $14,000,000 / $17,000,000 = 82%

The municipal bond counsel opines on all of the following EXCEPT: A. validity B. legality C. feasibility D. tax exempt status

The best answer is C. The bond counsel examines new municipal issues for legal or tax problems and renders an opinion on the validity, legality and tax exempt status of the issue. Bond counsels do not render economic opinions, which is the same as rendering an opinion on feasibility of an issue.

A corporation has issued 8% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 7%. Which are TRUE statements about the outstanding 8% 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 C. The bond was issued with a coupon of 8%. Currently, yield for a similar issue is 7%. Therefore, interest rates have fallen subsequent to the issuance of the bond; or the credit quality of the bond has improved. When interest rates fall, yields on bonds already trading must also fall. What causes this is a rise in the dollar price of the issue - the bond now trades at a premium.

Which of the following measures would be evaluated when analyzing a General Obligation Bond? I Debt to assessed valuation ratio II Debt per capita ratio III Tax collection ratio IV Debt service coverage ratio A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. The debt service coverage ratio is used for revenue bond analysis - not G.O. bond analysis. The debt service coverage ratio is Net Revenues From the Facility / Debt Service Requirements. G.O. bonds are paid off from property tax collections, not collected revenues. Therefore, the relevant measures for G.O. bond analysis are Debt / Assessed Valuation of Property; Debt / Population; and Taxes Collected / Taxes Assessed.

The yield to maturity for a premium bond is: A. stated interest rate - annual capital loss / bond par value B. stated interest rate + annual capital gain / bond par value C. stated interest rate - annual capital loss / bond average value D. stated interest rate + annual capital gain / bond average value

The best answer is C. The formula for yield to maturity for a premium bond is:

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 = 6.53% $995

The interest income earned on which of the following municipal bonds would be included in the alternative minimum tax computation? A. School District Bond B. Turnpike Revenue Bond C. Industrial Revenue Bond D. Water District Revenue Bond

The best answer is C. The interest income derived from "non-essential use" private purpose revenue bonds is included in the alternative minimum tax computation. Industrial Revenue Bonds fall into this category. Public purpose bonds, such as G.O.'s, and public facility revenue issues are not subject to the alternative minimum tax (AMT).

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 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. B

The best answer is C. The investment grades published by Moody's are: Aaa Highest Investment Grade Aa Upper Medium Investment Grade A Lower Medium Investment Grade Baa Lowest Investment Grade Any bond with a rating below Baa is considered to be speculative. To comply with the customer's requirement that the bonds be investment grade, a Baa rated bond is the lowest that could be purchased.

When analyzing municipal general obligation bonds of different issuers, it is difficult to use the ratio of Overall Debt / Assessed Valuation because: A. the ratio does not consider a municipality's ability to collect the taxes levied on all real property B. municipalities differ in their method of computing overall debt C. municipalities differ in their method of computing assessed value of properties D. the ratio does not consider the management capabilities of municipal government

The best answer is C. The ratio of Overall Debt to Assessed Value of Property is a more difficult measure to use when comparing municipal issuers for safety because municipalities have differing methods of computing assessed values of properties, and such assessments tend to be quite subjective. The computation of Overall Debt is consistent across municipalities, so this is not a problem. The other choices do not address the characteristics of the components of the ratio.

A 10 year 7% municipal bond, quoted on a 5.00 basis, is priced at 104. A 10 year 6% municipal bond, quoted on a 5.00 basis, is priced at 101. What is the price of a 10 year, 6.30% municipal bond, quoted on a 5.00 basis? A. 100.60 B. 100.80 C. 101.90 D. 104.50

The best answer is C. This question is asking for the following: 7% Coupon 5.00 Basis 104 6.3% Coupon 5.00 Basis ? 6% Coupon 5.00 Basis 101 The difference in price between the 6% and 7% bonds is 3 points. The 6.30% bond is 30% of the way from 6% to 7%. 30% x 3 points = .90 point price increment from the 6% price. 101 + .90 = 101.90 price for the 6.30% bond.

Which statements are always TRUE about Treasury Bonds? I Treasury Bonds are traded in 32nds II Treasury Bonds are quoted at a discount to par value III Treasury Bonds are issued in either bearer or registered form IV Treasury Bonds have minimum maturity of more than 10 years A. I and II only B. II and IV only C. I and IV only D. I, III and IV

The best answer is C. Treasury Notes have maturities of 10 years or less. Treasury Bonds have maturities that are greater than 10 years - currently they are issued with 30 year maturities. Both are quoted on a percentage of par basis in 32nds. All Treasury issues are available only in book entry form. There are no bearer or registered issues.

Which of the following are required to calculate the yield to maturity of a bond? I Maturity Date II Coupon III Purchase Price IV Redemption Price (Par) A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. The coupon rate x par value gives the annual interest. The annual capital gain or loss is the difference between the purchase price and the redemption price divided by the number of years to maturity. Therefore, all of the items listed are required to calculate the YTM of a bond. questi

A yield quote change of 5 basis points on municipal bonds with a 6.25% nominal yield will result in the greatest dollar price change for bonds quoted at: A. 8.20% with 3 years to maturity B. 8.30% with 3 1/2 years to maturity C. 8.40% with 4 years to maturity D. 8.50% with 4 1/2 years to maturity

The best answer is D. All of the bonds listed are discount bonds. As a general rule, the deeper the discount, the more volatile the bond's price movements in response to market interest rate changes. Also, the longer the maturity, the more volatile the bond's price movements in response to market interest rate changes. The 6.25% bond quoted on an 8.50% yield with 4 1/2 years to maturity has both the longest maturity and deepest discount. This bond's price will move the farthest in response to market interest rate changes.

Which of the following statements are TRUE about CMOs? I CMO issues have a serial structure II CMO issues are rated AAA III CMO issues are more accessible to individual investors than regular pass-through certificates IV CMO issues have a lower level of market risk than regular pass-through certificates A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. All of the statements are true about CMOs. CMOs have a lower level of market risk (risk of price volatility due to movements in market interest rates) than do mortgage backed pass-through certificates. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower. CMOs have a serial structure since they are divided into 15 - 30 maturities known as tranches; CMOs are rated AAA; and CMOs are more accessible to individual investors since they have $1,000 minimum denominations as compared to $25,000 for pass-through certificates.

Which of the following are TRUE statements about the trading of bonds and their prices? I Bonds trading at a premium are more likely to be called than bonds trading at a discount II A bond trading at a discount can indicate that the issuer's rating has deteriorated III Discount bonds will appreciate more rapidly as interest rates fall than will similar premium bonds IV A bond trading at a discount can indicate that interest rates have risen 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 regarding bonds. If a bond issued at par is trading at a discount, it can indicate that the issuer's rating has deteriorated or that market interest rates have risen. As interest rates fall, discount bonds will appreciate at a faster rate than will premium bonds. The change in value of the bond's price is a result of an increased "present value" of the remaining interest payments to be received. This increase in the "value" of the remaining interest payments is a larger percentage of a discount bond's price than of a premium bond's price. Thus, as interest rates drop, discount bonds rise faster than premium bonds. Similarly, as interest rates rise, discount bond prices fall faster than premium bond prices. If the bond is trading at a discount and is then called, then the issuer will have to pay par for the bonds. Why not, instead of paying par, purchase the bonds at the current market price? It would be better to pay the discount than the full market value. Furthermore, a bond trading at a discount indicates that market interest rates have risen - why would an issuer call in such an issue, when it has a bargain interest rate? The only bonds that are likely to be called are those trading at premiums - meaning that market interest rates have fallen. The issuer can call in the premium bonds at a price close to par, and refund at lower current market interest rates.

All of the following statements are true about the Federal National Mortgage Association Pass-Through Certificates EXCEPT: A. FNMA is a publicly traded company B. interest payments are subject to 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 D. FNMA is a publicly traded company. 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. Unlike GNMA, whose securities are directly U.S. Government guaranteed; FNMA only carries an "implicit" U.S. Government backing, so its credit rating is lower than that of GNMA. Interest received by the holder of a mortgage backed pass through security is fully taxable by both federal, state, and local government. Certificates are issued in minimum $25,000 denominations. For most investors this is too much money to invest, so they buy shares of a mutual fund that invests in these instruments instead.

Which of the following statements are TRUE regarding a 5% municipal bond purchased at par that has a put option at par? I The yield on the bond can fall below 5% II The put would be exercised if interest rates rise III The holder can receive 100% of par for the bond if he or she exercises the put option IV The investor can exercise the put at his or her discretion A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is D. If a bond has a put option at par, the holder can always exercise the put and "put" the bond back to the issuer, receiving 100% of par for that bond. Thus, as market interest rates rise, this bond's price will not fall, because it must always be worth par. Thus, such a bond is not susceptible to market risk. The yield on such a bond with a 5% coupon rate cannot rise above this level, because the price will not fall below par. However, the yield can drop below this level, because if interest rates fall, the bond's price will go to a premium and the put option would be worthless.

Municipal broker's brokers: I deal with the general public II do not deal with the general public III take inventory positions IV do not take inventory positions A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Municipal broker's brokers perform specialized trades for institutional investors on an agency basis only - they do not carry inventory positions nor do they deal with the general public.

Which statements are TRUE about private CMOs? I The CMO is backed by mortgage backed securities issued by Ginnie Mae, Fannie Mae or Freddie Mac II The CMO is backed by mortgage backed securities created by a bank-issuer III The CMO is rated AAA IV The CMO is rated dependent on the credit quality of the mortgages underlying mortgage backed pass through securities held in trust A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Private CMOs (Collateralized Mortgage Obligations) are also called "private label" CMOs. Instead of being backed by mortgages guaranteed by Fannie, Freddie or Ginnie, they are backed by "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). Bank issuers make non-conforming mortgages that cannot be sold to Fannie, Freddie or Ginnie and rather than hold them as investments, they can pool them into mortgage backed securities which are then placed into trust and sold as private label CMOs. Whereas CMOs backed 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.

Interest income from which municipal bond is LEAST likely to be included as a tax preference item under the Alternative Minimum Tax (AMT)? A. Airport revenue bond B. Convention center revenue bond C. Private utility revenue bond D. Water revenue bond

The best answer is D. Private purpose revenue bonds are taxable municipal bonds. They can either be subject to regular income tax, or If they are "qualified private purpose bonds," they are subject to AMT. Choices A, B and C are private uses. Choice D is an essential public use and the interest income would be federally tax-free.

Dealer offerings of corporate bonds found in Bloomberg are: I retail quotes II wholesale quotes III new issue offerings sold under a prospectus IV 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.

A corporation has issued 10%, $1,000 par convertible debentures, convertible at $31.25. The common stock is currently trading at $35. If the bond and the common are trading at parity, a customer purchasing 5M of the bonds will pay: A. $3,500 B. $4,800 C. $5,000 D. $5,600

The best answer is D. The bonds are convertible at $31.25, based on $1,000 par value. Therefore each bond converts into 32 shares ($1,000 par / $31.25 conversion price). If the common is trading at $35, the bond must be trading at 32 times this to be at parity. $35 x 32 = $1,120 parity price of one bond. The parity price of "5M" ($5,000 face amount, "M" is Latin for $1,000) is $1,120 x 5 = $5,600.

A municipal bond dealer buys 100M of 30 year non-callable 9% General Obligation bonds at par less 1 1/2 points. After holding the bonds in inventory for a week, the dealer reoffers the bonds on a 9.10 basis. The dealer's approximate profit or loss on this transaction is: A. loss of $150 B. loss of $400 C. gain of $150 D. gain of $400

The best answer is D. The dealer purchases these bonds at par less 1 1/2 points, so the bonds were purchased at 98.5. Since these 9% coupon bonds were reoffered on a 9.10 basis, they must have been reoffered at a discount price. Since these are long term bonds (30 years), we can approximate the reoffering price by dividing 9% (nominal yield) by the 9.10 reoffering yield. 9/9.10 = .989. Thus, the bonds were reoffered at an approximate price of .989% of par (note, this only works for long term maturities - not short term maturities). The bonds were reoffered at a price that is .004% higher than the cost to the dealer (.985 cost versus .989 reoffer price). .004% x $100,000 face amount = $400 gain on the transaction. Note that "100M" of bonds is $100,000 face amount, where M = $1,000.

A municipal bond dealer quotes 15 year 3% Revenue bonds at 97 3/4 - 99. The dealer's spread per $1,000 is: I $1.25 II $12.50 III 12.5 basis points IV 125 basis points A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. The spread is 1.25 points, which is 1 1/4% of $1,000 par, which equals $12.50. $12.50 is the same as 125 basis points, since each basis point equals $.10.