DEBT

A bank qualified municipal issue is one where: I 80% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted II 100% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted III 80% of the interest income received is not taxable to the bank holding the bonds IV 100% of the interest income received is not taxable to the bank holding the bonds A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. To be bank qualified, a municipal issue must be a public purpose (not private purpose issue). Any bank that buys the issue can deduct 80% of the interest expense it incurs on deposits used to fund the purchase of the bonds, while the interest income from the municipal issue is not taxable to the bank. This is sometimes termed the 80/20 rule. If an issue is not bank qualified, then none of the interest expense that the bank incurs on deposits used to fund the purchase of the bonds can be deducted, which is logical since the interest income from the bonds is exempt from Federal taxation.

Treasury Bills are issued for all of the following initial maturities EXCEPT: A. 4 weeks B. 8 weeks C. 13 weeks D. 26 weeks

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

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 Corporate 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 corporates would not be used because they have too high a level of credit risk (if things get bad, the corporation's credit rating could be downgraded; this is a highly unlikely event for government and agency securities).

An investor is seeking a bond issue offering call protection. An issue having which features would NOT be an appropriate investment? I Low stated interest rates II High stated interest rates III Low stated call premiums IV High stated call premiums A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. An investor seeking call protection does not want the bonds to be called away. Most likely to be called are bonds with low call premiums and high interest rates. After calling the bonds, the issuer can refund the issue at lower rates, given that interest rates have fallen.

The typical purchaser of a Banker's Acceptance is a(n): A. individual investor B. foreign investor C. money fund investor D. bank depositor

The best answer is C. Banker's Acceptances are a money market instrument used to finance imports and exports. The bank agrees to pay a fixed amount at a date in the future, which is the expected date of receipt of the goods. The exporter then has assurance that he will be paid and will ship the goods. Since these are typically issued in minimum $100,000 face amounts, they are too large for individual investors. They are mainly bought by institutions.

When comparing a Variable Rate Demand Obligation (VRDO) to an Auction Rate Security (ARS), which statement is FALSE? A. Both are long-term bonds that have interest rates reset weekly or monthly B. Both are subject to the credit risk of the issuer C. Both have tender options D. Both are marketed by broker-dealers

The best answer is C. Both variable rate demand obligations (VRDOs) and auction rate securities (ARSs) are long-term bonds that have the interest rate reset weekly or monthly, giving the issuer the advantage of lower short-term interest rates on a long-term bond issue. The interest rate on a VRDO is typically set to a market index and the issue can be put back to the issuer at the reset date. With an ARS, the interest rate is reset by Dutch auction, and the owner can only sell at the auction to another buyer - there is no embedded put option. Both are subject to credit risk and both are marketed by broker-dealers.

Commercial Paper: I is a non-exempt security II is an exempt security III has a maximum maturity of 270 days IV has a maximum maturity of 365 days A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Commercial paper is an exempt security under the Securities Act of 1933. It does not have to be registered and sold with a prospectus as long as its maximum maturity is 270 days or less. This makes it much less expensive for an issuer to market the securities, since the regulatory burden is much lower.

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).

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).

A customer buys a new municipal issue from an underwriter on Wednesday, January 14th, with settlement taking place on Monday, January 19th. The bond is dated January 1st. How many days of accrued interest must be paid by the customer to the underwriter? A. 0 B. 13 C. 18 D. 19

The best answer is C. Interest accrues from the dated date on a new issue up to, but not including the date when the first trade settles. Since settlement is on January 19th, interest accrues through the 18th. Counting from the January 1st dated date through the 18th, 18 days of accrued interest are payable from the buyer of the bond to the seller (the underwriter in this case).

A customer buys 10 Allied Corporation 8% debentures, M '38, at 90 on Tuesday, April 18th in a regular way trade. The interest payment dates are March 1st and September 1st. How many days of accrued interest will the buyer pay to the seller? A. 29 B. 30 C. 50 D. 51

The best answer is C. Interest accrues on a 30 day month / 360 day year for corporate bonds. The bonds were purchased on Tuesday, April 18th. Settlement takes place 3 business days after trade date on Friday, Apr 21st. Interest accrues up to, but does not include, settlement date. Thus, 30 days are due for March; and 20 days are due for April; for a total of 50 days.

Which statements are TRUE regarding bonds? I Short term bonds fluctuate more in value than long term bonds due to interest rate movements II Long term bonds fluctuate more in value than short term bonds due to interest rate movements III Short term maturities are more liquid than long term maturities IV Long term maturities are more liquid than short term maturities A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Long term bonds fluctuate more in value than do short term bonds in response to market interest rate changes. Short term bonds do not fluctuate much in value as interest rates move since they will be redeemed shortly at par. There is more active trading of short term debt than long term debt, so short term debt is more liquid.

MBIA insures municipal bonds for the: A. loss of interest only from the time of default B. loss of principal only from the time of default C. loss of both interest and principal from the time of default D. fair market value of the securities at the time of default

The best answer is C. MBIA (Municipal Bond Insurance Association Corporation) insures municipal bonds for loss due to default by the issuer. Both the payment of interest on a timely basis and the repayment of principal (par value at maturity) are insured.

The majority of corporate bond trades take place: A. on the New York Stock Exchange floor B. through Electronic Communications Networks C. dealer-to-dealer in the over-the-counter market D. directly from seller to buyer without the use of a broker

The best answer is C. Most corporate bond and municipal bond trades take place dealer-to-dealer in the OTC market. The municipal market is quite illiquid and the corporate bond market is not very active either. Such illiquid markets are better handled by dealers that will buy bonds into inventory when there are no other buyers; or sell bonds out of inventory to customers when there are no other sellers. There is very little corporate bond trading on the NYSE. ECNs (Electronic Communications Networks) only handle orders for actively traded securities on an agency basis - i.e. NYSE listed and NASDAQ listed stocks, however bond computer trading systems are making more headway into the market.

Under MSRB rules, municipal securities traders that participate in secondary market joint accounts may: I disseminate quotes severally for the securities II not disseminate quotes severally for the securities III indicate that only one market exists for the securities IV not indicate that only one market exists for the securities A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. 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).

Regarding bonds with put options, all of the following statements are true EXCEPT: A. exercise of the put is at the option of the bondholder B. once the option is exercisable, the bond's price will not fall below the option price if interest rates rise C. yields on bonds with put options are higher than similar bonds without this feature D. the put option represents a floor on the market price of the bond

The best answer is C. Put options are exercisable at the option of the bondholder; once the option is exercisable, the bond price cannot fall below the option price, since the bondholder can always "put" the bond to the issuer for this amount. The put price represents a floor on the market price of the bond. Because the put option removes some of the market risk from the bond, this feature is valued by bondholders, who will accept lower yields on bonds having this option.

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.

A convertible debenture is convertible into common at $40 per share. If the market price of the bond rises to a 10 point premium over par, which statements are TRUE? I The conversion ratio is 20:1 II The conversion ratio is 25:1 III The parity price of the stock is $44 IV The parity price of the stock is $50 A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The conversion ratio is established when the bond is issued, and is: par value divided by the conversion price. In this case, the conversion price is set at $40 per share, so the conversion ratio is $1,000 par / $40 conversion price = 25:1 (25 shares per bond). If the bond moves to a 10 point premium over par, its new price will be 110, or $1,100 per bond. For the common stock to be valued at parity to the bond, the price per share must be $1,100 / 25 shares per bond = $44 per share parity price.

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.

Which CMO tranch is LEAST susceptible to interest rate risk? A. Z-tranche B. Floating rate tranche C. PAC tranche D. TAC tranche

The best answer is B. A floating rate CMO tranche has an interest rate that varies, tied to the movements of a recognized interest rate index, like LIBOR. Therefore, an 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.

A workable quotation given by a municipal dealer represents a(n): A. firm bid B. likely bid C. approximate market value, with no bid or offer D. bid or offer for 100 bonds

The best answer is B. A workable quote is one where the dealer indicates a willingness to buy at a stated price. The dealer who solicits the "workable" is usually acting for a customer who wants to sell the bonds. Since there is no active trading market, the customer has no idea what price he can get for the bonds. The selling broker gets the customer a "workable" quote, that is, a likely price at which a dealer will buy, and the customer can then decide whether he wants to sell at that price.

If a corporation reports a loss for a year, it is obligated to make interest payments on all of the following bonds EXCEPT: A. Reset bonds B. Adjustment bonds C. Convertible bonds D. Callable bonds

The best answer is B. Adjustment bonds, also known as income bonds, pay interest only if the corporation hits a predetermined level of earnings. If the income level is not sufficient, there is no obligation to make the interest payment. Reset bonds are obligated to pay interest, however the rate is reset annually. Conversion and call features have no effect on the obligation to pay.

An "unqualified" legal opinion is one which: A. gives a conditional affirmation of the legality of the securities B. gives an unconditional affirmation of the legality of the securities C. is given by an unqualified bond counsel D. disqualifies the issue from legal issuance

The best answer is B. An unqualified legal opinion is a "clean" opinion, where the bond counsel has found no legal problems. Thus, the opinion is an unconditional affirmation of the legality of the issue.

Which of the following are considered to be creditors of a corporation? I Common Shareholders II Preferred Shareholders III Convertible Bondholders IV Warrant Holders A. I and II B. III only C. III and IV D. I, II, III, IV

The best answer is B. Bondholders are creditors of a company. Convertible bondholders are creditors of a company as long as they keep their bonds and do not convert to common shares. Common and preferred shareholders have an equity position. Warrant holders have a long term option to buy the stock. Warrants are considered equity-related securities, but they have neither an equity nor creditor stake in the corporation.

If a bond is trading at a discount, price volatility is greatest for a bond having: I low interest rates II high interest rates III short term maturities IV 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. Thus, the most volatile bonds are deep discount, long maturity bonds.

On March 1, 2016, a corporation has published a Notice of Redemption, calling all of its 6 1/2% Debentures, maturing in 2026. The corporation plans to refund the issue with new bonds at a lower interest rate. A bondholder can: I tender the bonds on the call II sell the bonds at the current market price III retain the bonds and continue to receive the 6 1/2% stated interest rate IV retain the bonds and receive the lower interest rate of the refunding bonds A. I only B. I and II C. II and III D. I, II, III, IV

The best answer is B. The bondholder can either tender the bonds and receive the call price; or can sell the bonds at the current market price. When bonds are called, interest payments cease, so Choices III and IV are incorrect.

A customer buys 5M of 3 3/4% Treasury Bonds at 96-5. The current yield of the Treasury Bond is: A. 3.75% B. 3.90% C. 4.05% D. 4.25%

The best answer is B. The customer buys the bonds at 96 and 5/32s = 96.15625% of $1,000 = $961.5625 (the fact that $5,000 face amount of bonds were purchased is irrelevant, since the formula is a percentage). The formula for current yield is: $37.50 (per $1,000 face amount) $961.5625 (per $1,000 face amount) = 3.90%

Which statements are TRUE regarding bond price volatility? I High coupon bonds have the lowest price volatility II Low coupon bonds have the lowest price volatility III Long maturity bonds have the lowest price volatility IV Short maturity bonds have the lowest price volatility A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The shorter the maturity, the lower the bond's price volatility in response to interest rate movements. The longer the maturity, the greater the bond's price volatility in response to interest rate movements. Bonds with low coupon rates exhibit greater price volatility than ones with high coupon rates.

Four revenue bonds have the same maturity. Which of the following will cost the greatest amount? A. 5% bond quoted on a 5.25 basis B. 5 1/4% bond quoted on a 5.00 basis C. 5 1/2% bond quoted on a 5.50 basis D. 5 1/4% bond quoted on a 5.50 basis

The best answer is B. This choice is the only one where the nominal yield is higher than the basis. To lower the effective yield (basis) on the bond, the price must rise - this is the only premium bond of the four choices given. The other choices are either priced at par; or at a discount.

All of the following are used to evaluate a general obligation bond issue EXCEPT: A. mill rate trend of the issuer B. collection ratio of the issuer C. pledged revenues to debt service requirements ratio D. debt to assessed valuation ratio

The best answer is C. The ratio of pledged revenues to debt service requirements is used to evaluate the creditworthiness of a revenue bond issue. (Are there enough pledged revenues to cover annual debt service payments?) In order to evaluate a general obligation bond issue, one would look for a trend of increasing assessed property valuation; a consistently high collection ratio - meaning that most of the taxes assessed are actually being collected; a low ratio of debt to assessed valuation and low ratio of debt per capita; as well as a consistent mill rate - meaning that property tax rates are not being raised too quickly, causing people to flee from the area.

A customer purchases 5M of New York 3% G.O.'s, maturing in 2042 at 90. The interest payment dates are Jan 1st and Jul 1st. The trade took place on Tuesday, Feb 1st. How much will the customer pay for the bonds, excluding commissions and accrued interest? A. $850 B. $1,000 C. $4,500 D. $5,000

The best answer is C. These bonds are quoted at 90 meaning 90% of par value. "5M" means that $5,000 face amount of bonds are being purchased (M is Latin for $1,000). Municipal bonds that are quoted this way are called dollar bonds and are usually term issues. Serial bonds are quoted on a yield to maturity basis. 90% of $5,000 par = $4,500

A sewage treatment plant has been financed through a revenue bond issue containing a Net Revenue Pledge. Prior to paying Debt Service, which of the following expenses would be deducted by the issuer? I Sewage transport costs II Sewage treatment costs III General and administrative expenses IV Depreciation and amortization A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Under a Net Revenue Pledge, operation and maintenance is funded before Debt Service is paid. This is accounted for on a cash basis. Thus, operating costs such as sewage transport, sewage treatment, and general and administrative costs are funded before monies go to pay Debt Service. Depreciation and amortization are non-cash expenses and are not counted.

In order to construct a diversified municipal bond portfolio, which of the following would be considered? I The geographic location of the issuers II The credit rating of each issue III The denominations available of each issue IV The revenue source backing each issue A. I, III B. II, IV C. I, II, IV D. I, II, III, IV

The best answer is C. When constructing a diversified municipal bond portfolio, one is trying to diversify away as much risk as possible. It would be logical to make sure that the portfolio is geographically diversified since having too great a concentration in one state or region is unwise if the local economy goes bad. A mix of credit ratings also helps to diversify the portfolio. Lower credit rated bonds give higher yields and make sense in a large portfolio, as long as the concentration is not too great. A mix of revenue sources also helps diversify away risk. The denominations of the bonds in the portfolio have no bearing on the risks inherent in those bonds.

Which of the following statements are TRUE regarding corporate zero coupon bonds? I The rate of return for zero coupon bonds is subject to reinvestment risk II The rate of return for zero coupon bonds is not subject to reinvestment risk III The interest income from such obligations is taxable annually IV The interest income from such obligations is not taxable until maturity A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Zero coupon bonds do not offer a current return; instead, the holder earns the discount on the bond over its life. This "earning" of the discount is taxed annually as interest income to the bondholder even though no physical payment is made. With bonds that make interest payments, the holder is subject to "reinvestment risk" on the interest payments. Rates may fall, causing the bondholder to reinvest the interest payments at lower rates. This risk is not present in zero coupon bonds since no interest payments are made.

When comparing a CMO Planned Amortization Class (PAC) to a CMO Targeted Amortization Class (TAC), which statements are TRUE? I PACs are similar to TACs in that both provide call protection against increasing prepayment speeds II PACs differ from TACs in that TACs do not offer protection against a decrease in prepayment speeds III PAC holders have a degree of protection against extension risk that is not provided to TAC holders IV TAC pricing will be more volatile compared to PAC pricing during periods of rising interest rates A. I only B. II and III only C. I, II, III D. I, II, III, IV

The best answer is D. 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.

All of the following statements are true about CMOs EXCEPT: A. CMO issues have a serial structure B. CMO issues are rated AAA C. CMO issues are more accessible to individual investors than regular pass-through certificates D. CMO issues have the same market risk as regular pass-through certificates

The best answer is D. 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. The remaining statements are all true - 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.

All of the following statements describe Freddie Mac EXCEPT: A. Freddie Mac buys conventional mortgages from financial institutions B. Freddie Mac is an issuer of mortgage backed pass-through certificates C. Freddie Mac is a corporation that is publicly traded D. Freddie Mac debt issues are directly guaranteed by the U.S. Government

The best answer is D. Freddie Mac - Federal Home Loan Mortgage Corporation - buys conventional mortgages from financial institutions and packages them into pass through certificates. Freddie Mac pass through certificates are not guaranteed by the U.S. Government (unlike GNMA pass through certificates). This agency has been partially sold off to the public as a corporation that was listed on the NYSE. Freddie is now bankrupt due to excessive purchases of bad "sub prime" mortgages and has been placed in government conservatorship. Its shares have been delisted from the NYSE and now trade OTC in the Pink OTC Markets.

Which of the following statements are TRUE about Treasury Receipts? I The investor "locks in" a rate of return that is free from reinvestment risk if the Receipt is held to maturity II The underlying bonds are held by a trustee for the beneficial owners III The interest income on the Receipts is subject to Federal income tax annually IV The Receipts are issued by broker-dealers, who maintain a secondary market in these securities A. III and IV only B. I, II, III C. I, II, IV D. I, II, III, IV

The best answer is D. Treasury Receipts represent an undivided interest in a portfolio of U.S. Government securities held by a trustee. The portfolio is assembled by a broker-dealer, who sells "receipts" representing ownership of the interest. Each receipt is, essentially, a zero-coupon obligation, that is purchased at a discount, and which is redeemable at par at a pre-set date. Thus, there is no reinvestment risk, since semi-annual interest payments are not received. The implicit rate of return is locked-in when the security is purchased, and the customer will earn that rate of return if the security is held to maturity. The annual accretion amount is taxable, since the underlying securities are U.S. Governments. At maturity, the receipt will have an adjusted cost basis of par, and will be redeemed at par, for no capital gain or loss.

When does an investor receive payment of interest and principal on a Capital Appreciation Bond (CAB)? A. Both interest and principal payments are made semi-annually B. Interest is paid semi-annually and principal is paid at maturity C. Principal is paid semi-annually and interest is paid at maturity D. Both interest and principal are paid at maturity

The best answer is D. A Capital Appreciation Bond (CAB) is a municipal zero coupon bond with a "legal" twist to it. A conventional zero coupon G.O. bond is counted against an issuer's debt limit at par value because the discount is treated as "principal." If a new issue discount bond is legally crafted as a CAB, then the principal counted against the issuer's debt limit is the discounted principal amount and the discount earned is considered to be interest income. The bond is purchased at the discounted price and then par is returned at maturity, with the 2 components of that par payment being the return of the discounted purchase price (the "principal" amount) and the accreted interest income.

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.

CMO investors are subject to all of the following risks EXCEPT: A. Interest rate risk B. Prepayment risk C. Extended maturity risk D. Default risk

The best answer is D. CMO investors have almost no default risk, since the underlying mortgages are usually implicitly backed by the U.S. Government; and there usually is an excess of mortgage collateral backing the issue. The purchaser of a CMO tranch is subject to interest rate risk - if interest rates go higher, then the value of the tranch will decline. CMO tranch holders are subject to prepayment risk - the risk that the expected life of the tranch becomes much shorter due to a decline in interest rates causing homeowners to refinance and prepay their existing mortgages earlier than expected. Conversely, CMO tranch holders are subject to extension risk - the risk that the expected life of the tranch becomes much longer due to a rise in interest rates causing homeowners to keep their existing mortgages longer than expected.

Commercial paper can be issued for all of the following maturities EXCEPT: A. 14 days B. 30 days C. 90 days D. 360 days

The best answer is D. Commercial paper is issued by corporations with a duration of anywhere from over 1 to 270 days. The most common is 30 day commercial paper. No maturities longer than 270 days are issued, because then the issue would have to be registered with the SEC and sold with a prospectus. If the issue is 270 days or less, it is exempt from SEC registration and prospectus requirements.

All of the following statements are true regarding municipal bonds that have been called EXCEPT: A. interest ceases to accrue on the bonds B. the call price sets a ceiling on the market price of the bonds C. the holder may redeem the bonds at anytime D. the bonds will continue to trade "and interest"

The best answer is D. If a bond issue is called, interest ceases to accrue as of the date specified in the call. Thus, the bond will now trade "flat" - that is, without accrued interest. The call price will set a ceiling on the market price of the bond. Meaning, the market price of the bond will never go above the call price; if it did and the bonds were called, investors would suffer a loss. The bond can be tendered anytime thereafter, at which point the bondholder will be paid par value plus any specified call premium. The call price would not set the floor on the market price of the bonds as the market could go below the call price (which could occur if market interest rates started to rise).

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.

In a period of rising interest rates, a bond dealer would engage in which of the following activities? I Lower prices in interdealer quote publications such as Bloomberg for municipal bonds II Place "request for bids" in services such as Bloomberg on depreciated positions where the dealer has no current interest III Bid for bonds to cover previously established short positions IV Buy put options on debt instruments to hedge existing long positions A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. In a period of rising interest rates, bond prices will be falling. Therefore, a dealer would lower his quoted prices in Bloomberg. If the dealer has depreciated 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 take gains due to falling prices. To hedge existing long positions against falling prices, the dealer would buy put options. If prices fall, the dealer can "put" the bond at the contract price. Put options are used to hedge existing long positions from falling prices.

Which of the following municipal bonds would MOST likely be refunded by the issuer? A. 5% G.O., M '36, callable in 2016 at par B. 6% G.O., M '36, callable in 2016 at 102 C. 7% G.O., M '36, callable in 2016 at 102 D. 8% G.O., M '36, callable in 2016 at par

The best answer is D. In a refunding, an issuer refinances an outstanding debt by issuing new bonds. The proceeds of the new issue are used to retire the old debt; or are placed in escrow to "pre-refund" an older issue that cannot be immediately repaid. This is either done to reduce interest cost or to remove an onerous restrictive covenant. The bonds most likely to be refunded are those with the highest interest rates (to be replaced by lower interest rate bonds) and low call premiums (so it will not be too expensive to the issuer to call in the debt for refunding).

A customer buys 10 Allied Corporation 8% debentures, M '35, at 90 on Wednesday, April 19th in a regular way trade. The interest payment dates are Mar 1st and Sept 1st. How many days of accrued interest must be paid from buyer to seller on settlement? A. 50 B. 51 C. 52 D. 53

The best answer is D. Interest accrues on a 30 day month / 360 day year for corporate bonds, with interest accruing up to, but not including settlement. The bonds were purchased on Wednesday, April 19th. Settlement takes place 3 business days after purchase on Monday, April 24th, thus interest accrues through the 23rd of April. Since the last interest payment was made on March 1st, 30 days are due for March; and 23 are due for April; for a total of 53 days of accrued interest due.

A customer holds a very large, diversified portfolio of high grade municipal bonds with varying maturities. This customer has minimized all of the following risks EXCEPT: A. default risk B. interest rate risk C. marketability risk D. legislative risk

The best answer is D. Legislative risk for holders of municipal issues is the risk that the Federal Government will tax the interest income on the bonds. This risk cannot be diversified away. Default risk is minimized with a diversified portfolio; interest rate risk is minimized by mixing maturities. Marketability risk is also reduced by diversification, since it is unlikely that all the issues in the portfolio would become unmarketable at one time.

Level debt service is best described as: A. debt service increases as the years progress B. debt service decreases as the years progress C. principal repayments decrease as the years progress D. principal repayments increase as the years progress

The best answer is D. Level debt service means that the issuer pays the same amount each year, with the funds being used to pay both interest and a portion of principal on the issue. The balance of the level payment is used to pay off bonds for that year. Thus, each year, the principal repayment amount increases; and the interest amount decreases. The total of the two remains the same. This is essentially the same idea as a mortgage amortization schedule.

Municipal secondary market joint accounts are formed to: I bid on new issues of bonds announced in the Daily Bond Buyer II acquire a large block of bonds offered in Bloomberg III buy new issues being sold by municipal issuers IV buy blocks of bonds being offered by participants in the trading market A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Municipal secondary market joint accounts are formed to acquire, and then resell, large blocks of bonds in the secondary (trading) market. Dealer offerings of municipal bonds in the secondary market are found in Bloomberg. These accounts do not operate in the primary market (new issues from issuers). The municipal primary market publication is the Bond Buyer.

Which bond will exhibit the greatest price volatility? A. 2% coupon bond with a 2 year maturity B. 0% coupon bond with a 1 year maturity C. 6% coupon bond with a 10 year maturity D. 0% coupon bond with a 9 year maturity

The best answer is D. The longer the expiration, the more volatile a bond's price movements, which narrows the Choices to either C or D. The lower the coupon, the more volatile the bond's price movements, with the lowest coupon being "0." A 9-year zero coupon bond will actually be more volatile in price movements than a slightly longer maturity bond (10 years) with a fairly high coupon (6% in this case). The higher coupon means that more of the bond's value is represented by the interest stream than comes in early and this stabilizes the bond's price as market interest rates move.

A municipal bond dealer quotes 10 year 3 1/2% Revenue bonds at 97 1/4 - 98. The dealer's spread per $1,000 is: I $ .75 II $7.50 III 7.5 basis points IV 75 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 .75 points, which is .75% of $1,000 par, which equals $7.50. $7.50 is the same as 75 basis points, since each basis point equals $.10.

Pitter Patter Water Authority "Flow of Funds" Statement 20XX Water Charges: $6,000,000 Interest on Reserve Funds: $2,000,000 Gross revenues: $8,000,000 Operation and Maint: $4,000,000 Net Revenues: $4,000,000 Debt Service: $2,000,000 Addition to Reserves: $2,000,000 If the bonds were issued under a gross lien revenue pledge, how much in funds were available to pay the bondholders for this year? A. $2,000,000 B. $4,000,000 C. $6,000,000 D. $8,000,000

The best answer is D. Under a gross revenue pledge, all revenues from all sources (including investment income) are pledged to pay the bondholders prior to the payment of operation and maintenance. This water authority collected $8,000,000 in gross revenues - which would be the amount available to pay the bondholders under a gross revenue pledge.

Market uncertainty regarding future interest rate levels would indicate that the yield curve should be: A. ascending B. descending C. inverted D. flat

The best answer is D. Under the "market expectations" theory of yield curves, when investors expect interest rates to rise in the future, the yield curve will have an upward slope. Conversely, when investors expect interest rates to fall in the future, the yield curve will have a downward slope. If investors are uncertain as to the future direction of market interest rates, then the yield curve will be flat.

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 issues would be overlapping debts? I School district bond issue where the school district is coterminous with the town that 100% uses that school district II School district bond issue where the school district encompasses three neighboring townships III Water revenue bond issue where the water district is coterminous with the town that 100% uses that water system IV Water revenue bond issue where the water district encompasses three neighboring townships A. I and II only B. III and IV only C. I and III only D. II and IV only

The best answer is A. An overlapping debt is a GENERAL obligation of a municipal issuer that is the responsibility of other municipal units. An example would be a school district bond issue covering a number of townships - the property tax collections of all 3 towns would be used to service the school district debt. A school district that only covers one township ("coterminous" means sharing the same geographic boundaries) overlaps that one township and the property tax collections within that township pay for that school district debt. Revenue bonds are never overlapping debts - rather they are self-supporting debts that pay their own way through collected usage fees.

If interest rates are rising, which statement about discount and premium bonds is TRUE? A. Discount bonds will depreciate faster than premium bonds B. Premium bonds will depreciate faster than discount bonds C. Both bonds will depreciate equally D. The rate of depreciation depends on the credit rating of the issuer

The best answer is A. As a general rule, the longer the maturity on a debt issue, the greater the issue's price volatility in response to interest rate movements. Another general rule is that the lower the price of the issue (which would result from having a lower coupon), the greater the issue's price volatility in response to interest rate movements. As interest rates rise, bonds that are selling at a discount will fall proportionately more than bonds trading at an equivalent premium. This is true since the change in price as a percentage of the bond's cost is greater for a discount bond than for a premium bond.

The "Effective" Federal Funds Rate is composed of rates offered by: I selected commercial banks across the United States II selected thrift institutions across the United States III the designated primary U.S. Government securities dealers A. I only B. III only C. I and II only D. I, II, III

The best answer is A. Federal Funds are overnight loans of reserves from commercial bank to commercial bank. The "effective" rate is an average rate for selected banks across the United States. Thrifts cannot loan Federal Funds, nor can all primary dealers, since many of these firms are broker-dealers, not commercial banks.

Which of the following statements are TRUE regarding municipal bonds that have been called? I Interest ceases to accrue on the bonds II Interest continues to accrue on the bonds III The holder may redeem the bonds at anytime IV The holder may only redeem the bonds on a regular semi-annual interest payment date A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. If a bond issue is called, interest ceases to accrue as of the date specified in the call, and the bond can be tendered anytime thereafter, at which point the bondholder will be paid par value plus any specified call premium.

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 marketability of the advance refunded bonds will increase II The issuer redeems an old bond issue by advancing funds from the U.S. Government for this purpose III The funds to pay debt service requirements are deposited to an escrow account and used to buy U.S. Government securities IV The funds to pay debt service requirements are deposited to an escrow account and used to buy Municipal securities 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 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. Municipal securities are not used for escrow in a prerefunding because they earn a lower rate of interest (since they are Federally tax-free) than Governments.

Industrial development bonds are issued by municipalities to build facilities that are leased to: A. corporations B. government agencies C. municipalities D. sovereign governments

The best answer is A. Industrial development bonds are issued by municipalities to build facilities that are leased to corporations. These are a type of revenue bond where the lease payments made by the corporate lessee are the source of funds to pay debt service on the issue.

Municipal brokers' brokers would deal with all of the following EXCEPT: A. Individuals B. Municipal bond dealers C. Bank dealers D. Institutions

The best answer is A. Municipal brokers' brokers handle large block trades of municipal securities for institutions such as banks. These middlemen perform the trades without disclosing the identity of the bank - which helps the bank acquire or dispose of large blocks without alerting the market as to its activities. Municipal brokers' brokers do not handle trades for individual customers - they perform wholesale trades for large institutions and bond dealers.

Which ratio test is used to analyze a revenue bond? A. Debt service coverage ratio B. Collection ratio C. Debt per capita D. Debt to assessed valuation

The best answer is A. The debt service coverage ratio applies to revenue bonds. This ratio gives us the pledged revenues of the municipality and divides this by the debt service requirement. 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. The other ratios are used to analyze G.O. issues.

The ratio of net direct debt plus overlapping debt to assessed valuation is used for all of the following EXCEPT to: A. evaluate the issuer's ability to collect taxes owed B. evaluate the issuer's overall ability to service its debt burden C. analyze general obligation bonds D. evaluate the issuer's creditworthiness

The best answer is A. The ratio of net direct debt plus overlapping debt to assessed valuation is used to evaluate general obligation bonds (which are typically paid by ad valorem taxes collected based upon property assessments). The lower the ratio, the better the creditworthiness of the issuer and the better able the issuer is to handle servicing the debt. However, the ratio does not indicate how good a job the municipality does collecting the taxes due. This is measured by the collection ratio - the ratio of taxes collected to taxes assessed.

The ratio of net direct debt plus overlapping debt to assessed valuation is used to: I analyze general obligation bonds II analyze revenue bonds III determine the municipality's ability to generate sufficient taxes to pay for debt service requirements IV determine the municipality's ability to collect taxes assessed upon real properties in the political subdivision A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. The ratio of net direct plus overlapping debt to assessed valuation is used to evaluate general obligation bonds (which are paid by ad valorem taxes assessed upon the real properties in the town). The assessed valuation of each property determines the taxes to be paid. Revenue bonds are self-supporting, whereas G.O. bonds are non-self supporting. Therefore, this ratio only applies to G.O. bonds.

If interest rates are rising rapidly, which U.S. Government debt prices would be LEAST volatile? A. Treasury Bills B. Treasury Notes C. Treasury Bonds D. Treasury STRIPS

The best answer is A. The shorter the maturity, the lower the price volatility of a negotiable debt instrument. Of the choices listed, Treasury Bills have the shortest maturity. Treasury STRIPS are a zero-coupon T-Bond issue with a long maturity, and would be the most volatile of all the choices offered.

Which of the following statements are TRUE about Treasury Receipts? I The interest income on the Receipts is subject to Federal income tax each year II The interest income on the Receipts is exempt from Federal income tax III An investment in Treasury Receipts is free from reinvestment risk IV An investment in Treasury Receipts is subject to reinvestment risk A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Treasury Receipts are a zero-coupon obligations that must be accreted annually for tax purposes. The annual accretion amount is subject to Federal income tax each year, as the underlying securities are U.S. Governments. Each receipt is, essentially, a zero-coupon obligation, that is purchased at a discount, and which is redeemable at par at a pre-set date. Since semi-annual interest payments are not received, there is no reinvestment risk. The implicit rate of return is locked-in when the security is purchased.

Treasury bills: 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 bills are original issue discount obligations that mature at par, in minimum denominations of $100 each.

A municipality is at its debt limit and wishes to sell additional bonds. Voter approval is required for the municipality to sell: I General obligation bonds II Revenue bonds III Industrial revenue bonds A. I only B. I and II only C. II and III only D. I, II, III

The best answer is A. Voter approval is needed for a municipality to sell general obligation bonds (non-self supporting debt) in an amount that exceeds the municipality's constitutional limit. Revenue bonds and industrial revenue bonds are not subject to debt limits because they are self-supporting and pay their own way from collected revenues. They are not paid from tax collections.

When it is expected that a recession will occur, which statement is TRUE? A. The yield spread between corporate and government bonds will widen B. The yield spread between corporate and government bonds will narrow C. The yield spread between corporate and government bonds will not be affected D. An arbitrage opportunity will exist between corporate and government bonds

The best answer is A. When a recession is expected, investors sell corporate bonds (increasing their yields) and buy government bonds (decreasing their yields). Thus, the spread between corporate and government bond yields will widen.

When the yield curve is inverted: I short term rates are higher than long term rates II long term rates are higher than short term rates III to maximize income, one should invest in short term maturities IV to maximize income, one should invest in long term maturities A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. When the yield curve is inverted, short term rates are higher than long term rates. To maximize income, one should invest in short term securities.

The City of Peoria, Illinois has outstanding $100,000,000 of 7% General Obligation bonds, M '35. The bonds are callable at 103, beginning 1/1/15. The bonds are currently trading at 104 1/2. The call premium on the bonds is: A. 1 1/2 points B. 3 points C. 4 1/2 points D. 5 1/2 points

The best answer is B. A bond "call premium" is simply the price above par at which the issuer has the right to call in the bonds from the bondholders. These bonds are callable at 103, hence the call premium is 3 points (above 100 par).

In 2016, a customer buys 1 GE 8%, $1,000 par debenture, M '31, at 85. 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. 9.73%

The best answer is D. The formula for yield to maturity for a discount bond is: $80 + ($150 discount / 15 years to maturity) ($850 + $1000) / 2 = $80 + $10 $925 = $90 $925 = 9.73% Note: When the bond trades at a discount, its yield to maturity is GREATER than its coupon.

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).

Which statement is TRUE regarding the tax treatment of the annual adjustment to the principal amount of a Treasury Inflation Protection Security? A. An annual upward adjustment due to inflation is taxable in that year; an annual downward adjustment due to deflation is not tax deductible in that year. B. An annual upward adjustment due to inflation is taxable in that year; an annual downward adjustment due to deflation is tax deductible in that year. C. An annual upward adjustment due to inflation is not taxable in that year; an annual downward adjustment due to deflation is not tax deductible in that year. D. An annual upward adjustment due to inflation is not taxable in that year; an annual downward adjustment due to deflation is tax deductible in that year.

The best answer is B. If the principal amount of a Treasury Inflation Protection Security is adjusted upwards due to inflation, the adjustment amount is taxable in that year as ordinary interest income. Conversely, if the principal amount of a Treasury Inflation Protection Security is adjusted downwards due to deflation, the adjustment is tax deductible in that year against ordinary interest income. (TIPS are usually purchased in tax qualified retirement plans that are tax-deferred. This avoids having to pay tax each year on the upwards principal adjustment.)

When comparing the effect of changing interest rates on prices of a CMO issues versus the prices of regular bond issues, which of the following statements are TRUE? I When interest rates rise, mortgage backed pass through certificates fall in price faster than regular bonds of the same maturity II When interest rates rise, mortgage backed pass through certificates fall in price slower than regular bonds of the same maturity III When interest rates fall, mortgage backed pass through certificates rise in price faster than regular bonds of the same maturity IV When interest rates fall, mortgage backed pass through certificates rise in price slower than regular bonds of the same maturity A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. 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 expected 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 expected 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 expected 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 expected 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.

The term "Funded Debt" applies to: I Commercial Paper II Corporate Bonds III Municipal Notes IV Treasury Bills A. I only B. II only C. I and II D. II, III, IV

The best answer is B. "Funded debt" is a term that applies to long term corporate obligations. This debt is "funded," indicating that the monies are long term and do not have to be repaid shortly. Short term debt is termed "unfunded" debt - these are not a long term funding. All of the other choices - commercial paper, municipal notes, and Treasury bills are short term obligations.

Which of the following municipal securities would be considered a "double barreled" issue? A. Revenue Bond backed by two sources of revenue B. Hospital Revenue Bond backed by Ad Valorem taxing power C. Moral Obligation Bond D. Bond Anticipation Note

The best answer is B. A "double barreled" bond is a revenue issue that is also backed by a municipal issuer's taxing power. A revenue bond backed by two sources of revenue is known as a parity bond since the bondholders have equal claim to both sources of revenue backing the bond issue.

A municipal note that is issued in anticipation of receiving future revenues is a: A. TAN B. RAN C. TRAN D. BAN

The best answer is B. A Revenue Anticipation Note (RAN) is issued by a municipality that wishes to borrow short-term against revenues that are expected to be received in the near future. An example would be the City of New York borrowing, via a RAN issue, against a mass transit subsidy payment from the Federal government to be received in the near future.

In 2016, a customer buys 5 GE 10% debentures, M '26, at 85. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2021 at 103. The yield to maturity on the bonds is: A. 10.00% B. 10.81% C. 11.76% D. 12.43%

The best answer is D. The formula for yield to maturity for a discount bond is: $100 + ($150 discount / 10 years to maturity) ($850 + $1000) / 2 = $100 + $15 $925 = $115/$925 = 12.43%

Issuers are MOST likely to call their outstanding fixed income securities: I when stock prices have reached a peak II when stock prices have reached a trough III during periods of high levels of inflation IV during periods of high levels of deflation A. I or III B. I or IV C. II or III D. II or IV

The best answer is B. Issuers are most likely to call in their securities when interest rates have bottomed. The issuer can issue new securities at lower current interest rates, and can use the proceeds to call the outstanding securities that are paying a higher rate of interest. When stock prices have peaked, this usually indicates that interest rates have fallen, making stocks a relatively more attractive investment than fixed income securities that are paying lower rates of interest. During such periods, issuers will sell common stock at high market prices, and use the proceeds to retire outstanding debt with high interest rates. Regarding periods of inflation and deflation, as the inflation rate increases, interest rates tend to rise, since an "inflation premium" is added to the real interest rate that is paid on fixed income securities. Conversely, as deflation occurs, interest rates tend to fall as that "inflation premium" is eliminated from interest rate levels.

All of the following statements are true regarding mortgage bonds EXCEPT: A. Mortgage bonds are issued in term maturities B. Default of mortgage bonds is common during recessionary periods C. Mortgage bonds are commonly issued by utilities D. Mortgage bonds are secured by real property

The best answer is B. Mortgage bonds are term issues; all of the bonds are issued at the same date and mature on the same date. A serial structure is not required since real property is not a depreciating asset (as is the case with rolling stock pledged as collateral for equipment trust certificates). At maturity, it is common for mortgage bond issuers to sell a "refunding" bond issue. A new mortgage bond issue is floated, with the proceeds used to retire the maturing debt. In essence, the issuer is rolling over the debt. Mortgage bonds originated in the 1890s as a means of financing the growth of utility companies. As a means of lowering the interest cost to the issuer, bondholders were given a lien on all real property of the utility. In theory, if the issuer defaulted, the bondholders could sell that real property to repay the outstanding debt balance. Historically, mortgage bond defaults have been very low, because we need to keep our lights on!

Which of following statements best describe the activities of municipal broker's brokers? I They perform trades on an agency basis only II They perform trades on a principal basis only III They carry inventory positions IV They do not carry inventory positions A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Municipal broker's brokers perform specialized trades for institutions on an agency basis only - they do not carry inventory positions.

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 minimum value which will never go below par II have a maximum value which will never go above par III are subject to market risk IV are not subject to market risk 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. However, if interest rates fall, the price can go above par (by a small amount) until the next reset date.

When comparing CMO Companion Classes to Planned Amortization Classes, which statements are TRUE? I The PAC has a more certain maturity date II The Companion Class has a more certain maturity date III The PAC has a higher level of prepayment risk if interest rates fall IV The Companion Class has a higher level of prepayment risk if interest rates fall A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. 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.

The listing of current municipal bond offerings shows the following: Cook County School District Bond P/R @ 102 4.20 6/15/16 M'26 2.50 Which of the following statements are TRUE? I The bonds will be redeemed in 2016 II The bonds will be redeemed in 2026 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 2026. 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 6/15/16). 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%).

All of the following statements are true regarding repurchase or reverse repurchase agreements EXCEPT: A. under a reverse repurchase agreement, the dealer is buying securities from the Federal Reserve B. if a repurchase agreement extends for longer than overnight, the agreement is known as a "Due Bill" repurchase agreement C. repurchase agreements are used by dealers to reduce the carrying cost of Government securities held in their inventory D. repurchase agreements are initiated by the Federal Reserve to loosen the money supply

The best answer is B. 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. Under a "reverse repurchase agreement," the dealer is buying securities from the Federal Reserve, draining the dealer of cash. Choice B is 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 previous years, 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.

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.

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.

Exchange rate risk is a factor to consider when investing in foreign debt issues and the: I U.S. dollar depreciates in value II U.S. dollar appreciates in value III foreign currency depreciates in value IV foreign currency appreciates in value A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. When an investment is made outside the U.S. that is denominated in a foreign currency, the investor assumes exchange rate risk. This is the risk that the foreign currency weakens against the U.S. dollar (which is the same as the U.S. dollar strengthening). For example, assume that an investment is made in $100,000 of bonds denominated in Japanese Yen when the Yen is trading at 100 to the U.S. dollar. Thus, $100,000 x 100 Yen per U.S. dollar = 1,000,000 Yen being spent. Also assume that each bond costs 10,000 Yen, so 100 bonds are purchased at $100 each. Now assume that the bonds do not move in price, but the Yen weakens to 200 Yen to the U.S. dollar (each U.S. dollar now "buys" 200 Yen instead of 100 Yen). This means that 100 bonds are still priced at 10,000 Yen each in Japan. However, because each U.S. dollar is worth 200 Yen, the bonds are now worth 10,000 Yen / 200 Yen per U.S. dollar = $50 each. Thus, the bonds are now worth 1/2 of what was paid for them, solely due to the movement in currency exchange rates.

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.

A guaranteed corporate bond is one which is: A. insured by a private agency such as FGIC B. guaranteed by the Federal Government C. guaranteed by another corporation D. funded through mandatory sinking fund payments

The best answer is C. A guaranteed corporate bond is one guaranteed by another corporation. For example, a corporation may want to issue bonds through a subsidiary. The subsidiary may have a lower credit rating than the parent company. The parent can guarantee the issue, which then takes on the parent's higher credit rating.

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" the bond issue under the terms specified in the bond contract. An issuer will take advantage of this covenant if interest rates have dropped and the issue is not currently callable. If the issue was callable, instead of advance 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).

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.

Trades of all of the following will settle in Fed Funds EXCEPT: A. Prime Banker's Acceptances B. Treasury Bills C. Treasury Bonds D. Prime Commercial Paper

The best answer is D. Securities that are eligible to be traded by the Federal Reserve are those backed by the guarantee of the U.S. Government as well as certain agency obligations, and Prime Banker's Acceptances. Trades in eligible securities settle through the Federal Reserve system, and therefore settle in "Fed Funds." Corporate securities such as commercial paper are not eligible for trading and settling through the Federal Reserve system; trades of these securities settle in "clearing house" funds.

Which of the following municipal bonds should be trading at the lowest dollar price? A. 4.80 coupon; 7.10 basis; M '20 B. 6.80 coupon; 8.30 basis; M '30 C. 7.20 coupon; 6.50 basis; M '35 D. 6.00 coupon; 8.60 basis; M '40

The best answer is D. The basic truths about bond price movements caused by changes in market interest rates are: 1. The longer the maturity, the greater the price will move for a given change in interest rates. 2. The deeper the discount on the bond (caused by the coupon being lower than the market rate of interest), the greater the price will move for a given change in interest rates. Choice D is both a very long maturity, and a relatively low coupon compared to current interest rates (the basis is the fairest representation of current market rates for that type of issue), so it would be trading at the deepest discount. While Choice A has an even lower coupon, its very short maturity would reduce the bond's potential price drop as market interest rates rise. This is true because the essential truth is that this short maturity bond must be worth par at redemption in just a few years, so its price cannot drop very much below this level.

All of the following would be found in a municipal bond resolution EXCEPT: A. the issuer's duties to the bondholders B. the nature of the obligation C. any restrictive covenants to which the issuer must adhere D. any costs to be paid by the issuer in connection with issuing the bonds

The best answer is D. The bond resolution (or bond contract) is the contract between the issuer and the bondholder. It spells out the nature of the obligation; the issuer's duties to the bondholders; and any restrictive covenants to which the issuer must adhere. Any costs that the issuer incurs to sell the bonds has no bearing on the bond contract, since the bondholder is not involved in these expenses - they are solely the responsibility of the issuer.

An investor in the 28% tax bracket buys a 6% municipal bond quoted on an 8.00 basis. To calculate the equivalent taxable yield: A. multiply 6% by 72% B. divide 6% by 72% C. multiply 8% by 72% D. divide 8% by 72%

The best answer is D. The formula for the equivalent taxable yield is: 8% (100% - 28%) = 8% /.72 = 11.11%