Progress Exam 3A & 3B
An indenture of a bond has a closed-end provision. This means that: Additional borrowing is prohibited if the bonds will have the same level of claim against assets Additional borrowing is permitted if the bonds will have the same level of claim against assets The bonds must be called before maturity A sinking fund must be established
A A closed-end provision in a bond indenture means that additional borrowing against a particular source of revenue is prohibited. An open-end provision means additional borrowing against a revenue source is permitted.
A corporate bond that has no specific collateral backing it and is guaranteed by the full faith and credit of the issuing corporation is called a(n): Debenture Guaranteed bond Income bond Equipment trust certificate
A A corporate bond that has no specific collateral backing it and is guaranteed by the full faith and credit of the issuing corporation is called a debenture. Most corporate debt issued falls into this category.
A holder of XYZ Corporation's convertible debentures is a(n): Creditor of XYZ Corporation Common stockholder of XYZ Corporation Preferred stockholder of XYZ Corporation Equity owner of XYZ Corporation
A A holder of the convertible debentures (unsecured bonds) is a creditor of XYZ Corporation. The holder of the bonds would become a common stockholder if he decided to convert the bonds into common stock.
Which of the following statements best defines the term duration? It is a measure of a fixed-income security's relative interest-rate risk It is a measure of a fixed income portfolio's average yield It is the period before a fixed-income security will be called It is the measure of volatility that compares an equity security to the S&P 500 Index
A Duration measures price sensitivity for fixed-income securities given changes in interest rates. For example, a bond with a 7-year duration would experience a 7 percent change in price for every one percent change in market interest rates.
Which of the following statements BEST describes exchange-traded notes (ETNs)? ETNs are debt instruments linked to the performance of a commodity, currency, or index ETNs are equity securities that pay a large dividend ETNs are mutual funds that invest in debt instruments ETNs are equity securities that represent ownership of a securities exchange
A Exchange-traded notes (ETNs) are a type of unsecured debt security. This type of debt security differs from other types of fixed-income securities since ETN returns are linked to the performance of a commodity, currency, or index minus applicable fees. Similar to ETFs, ETNs are traded on an exchange, such as the NYSE, and may be purchased on margin or sold short. Investors may also choose to hold the debt security until maturity.
American Utility Company of Ohio is offering $750,000,000 worth of 8% bonds at a price of 99.25% of par value. An investor buying the bonds will receive yearly interest of: $80.00 per $1,000 face amount $99.25 per $1,000 face amount $750.00 per $1,000 face amount $1,000.00 per $1,000 face amount
A The bonds have a coupon rate of 8%. The bonds pay 8% of their par value of $1,000 each year or $80 (8% of $1,000 = $80) in interest payments.
A corporation has issued a bond with a 5% coupon that is convertible into common stock at $40. The stock is selling at $43.50 and the bond is selling at 109. The number of shares that will be received on conversion is: 25 23 22 20
A The conversion price is $40. To find the conversion ratio (the number of shares of common stock received if the bond is converted), divide the par value of the bond ($1,000) by the conversion price ($40). This is equal to 25 ($1,000 divided by $40 equals 25). For every bond that is converted, the investor will receive 25 shares of common stock. The current price of the stock and bond are not relevant when calculating the conversion ratio.
When a bond is selling at a premium: The market price is greater than the par value The current yield is higher than the nominal yield It is a better quality bond than one selling at a discount The yield to maturity is greater than the current yield
A The only true statement is that the market price is greater than the par value. When a bond is selling at a premium, the current yield is lower than the coupon rate. Bonds that are selling at a premium are not necessarily of better quality than bonds selling at a discount.
A quote of 5.90 - 5.75 is a quote for which of the following securities? Treasury bills Treasury notes Treasury bonds A mortgage-backed security
A Treasury bills are quoted on a discount yield basis while the other choices are quoted at a price. Since yield is inversely related (moves opposite) to price, the higher yield (5.90) represents the lower price and is the bid. The lower yield (5.75) represents the higher price and is the ask (offer). The other securities are all quoted as a percentage of par in 32nds.
An indenture for a corporate bond would NOT include: Early redemption features A list of all bonds previously issued by the corporation A description of any pledged collateral The interest payment dates
B A bond indenture would not contain a list of all bonds issued by the corporation. The other items are found in the indenture.
An investor purchased T-bonds that mature January 1, 2020. He purchased the T-bonds on Friday, February 20, for regular-way settlement. How many days of accrued interest did the investor owe? 51 53 54 55
B Accrued interest is calculated from the last interest payment date up to, but not including, the settlement date. The last interest payment was made January 1. (Since maturity is January 1, 2020, interest payments are every January 1 and July 1.) The settlement date is Monday, February 23. (A transaction for government securities settles on the next business day.) Government securities accrue interest on actual days elapsed. The investor, therefore, owes 31 days for January and 22 days for February (not including settlement date), for a total of 53 days.
When comparing long-term bonds to short-term bonds, all of the following statements about long-term bonds are TRUE, EXCEPT: They usually have higher yields than short-term bonds They usually provide greater liquidity than short-term bonds They usually are more often callable than short-term bonds Their market prices are more sensitive to interest-rate changes than short-term bonds
B All of the statements about long-term bonds compared to short-term bonds are true except that they usually provide greater liquidity than short-term bonds.
From first to last, list the order of priority of payment if a corporation declared bankruptcy. Common stockholders Preferred shareholders Convertible bondholders Unpaid workers IV, II, III, I IV, III, II, I II, III, I, IV III, II, IV, I
B If a corporation goes bankrupt, salaries and wages are paid to unpaid workers first. The assets are then distributed to debenture holders (who are unsecured bondholders but still creditors such as the convertible bondholders), and common stockholders (who are equity owners, not creditors). Preferred stockholders (who are also equity owners) are paid prior to common stockholders.
An investor buys $10,000 par value of 4% Treasury bonds due July 1, 2040. For tax purposes, the interest earned on these bonds is: Subject to federal income tax Exempt from federal income tax Subject to state income tax Exempt from state income tax I and III I and IV II and III II and IV
B Interest on U.S. government bonds is subject to federal income tax but exempt from state income tax. This is just the opposite of the tax treatment on municipal (state) bonds where the interest is exempt from federal tax, but may be subject to state tax.
Which of the following statements is NOT a feature of GNMA pass-through certificates? They are backed by the U.S. government Interest is subject to federal tax but is exempt from state tax Interest and principal payments are made on a monthly basis Pools consist of fixed-rate residential mortgages
B The Government National Mortgage Association (Ginnie Mae) is an agency of the United States government. It guarantees a pool of mortgages purchased by investors through Ginnie Mae pass-through certificates. These instruments pay interest and principal monthly at a stated rate on the remaining principal. The repayment of principal and interest is guaranteed by the United States government. Ginnie Mae pass-through certificates are purchased in $25,000 minimums. Interest received from Ginnie Mae pass-through certificates is subject to federal, state, and local taxes.
The Trust Indenture Act of 1939 establishes: A legal relationship between a municipal issuer and a trustee for the benefit of bondholders A legal relationship between a corporate issuer and a trustee for the benefit of bondholders The requirements for call provisions in nonexempt issues Prospectus requirements
B The Trust Indenture Act relates to the issuance of corporate debt instruments. It requires that a trustee be appointed to act in the bondholders' interest.
Three-month and six-month Treasury bills are auctioned by the Federal Reserve Board: Daily Weekly Monthly Annually
B Three-month and six-month Treasury bills are sold at public auctions each Monday.
Which TWO of the following statements are TRUE of U.S. Treasury bills? They do not have a stated rate of interest They mature in more than one year The interest received is taxed in the year they are sold They are issued at a discount I and III I and IV II and III II and IV
B Treasury bills do not have a stated rate of interest (a coupon rate). They are issued at a discount below their face value, and the difference received is considered interest, which is taxable in the year the securities mature (not in the year they are sold). They are sold in minimum amounts of $100 and currently are issued with maturities of 4, 13, 26, and 52 weeks.
Which of the following securities trade without accrued interest? Municipal bonds Treasury bills Debentures Convertible bonds
B Treasury bills do not trade with accrued interest. They are issued at a discount and mature at par.
Four municipal bonds have the same maturity date. Which of the following bonds will cost an investor the greatest dollar amount when purchased? A 4 3/4% coupon bond offered on a 5.10 basis A 5 1/4% coupon bond offered on a 5.00 basis A 5 3/4% coupon bond offered on a 6.00 basis A 6 1/4% coupon bond offered on a 6.50 basis
B When bonds are purchased at a discount (below the $1,000 par value) the yield to maturity (basis) will be greater than the coupon rate (nominal yield). This is the case in all of the choices listed except where the coupon rate of 5 1/4% is greater than the yield to maturity of 5%. This would mean that an investor purchased the bond at a premium (above the $1,000 par value) and paid the greatest dollar amount.
Which of the following would increase most in price if interest rates decline? Short-term bonds selling at a discount Long-term bonds selling at a discount Short-term bonds selling at a premium Long-term bonds selling at a premium
B When interest rates decline, bond prices rise. The longer maturities rise more in price than the shorter maturities due to market risk. Bonds selling at a discount rise more sharply in price than those selling at a premium. A bond with a high coupon would tend to trade at a premium and a bond with a low coupon would tend to trade at a discount. The bond with the high coupon will repay an investor sooner than a bond with a low coupon since the investor will be earning more money from the coupon on a bond selling at a premium. Therefore, bonds that have longer maturities and/or lower coupon rates will have a higher degree of interest rate risk. Due to this fact, if interest rates decline, the long-term bond selling at a discount will increase (in percentage terms) more than the long-term bond selling at a premium. Another way of looking at this is a $50 price change to a long-term bond selling at $900 is equal to a 5.55% change in price whereas a $50 price change in a long-term bond selling at $1,200 is equal to a 4.17% change in price.
A 5% $1,000 par value bond sells at $900 and matures in 10 years. What is the amount of each interest payment? $25 $45 $50 $90
Bonds pay interest every six months (semiannually). The dollar amount of interest payments is computed as a percentage of the par value. In this example, the coupon rate is 5%. The annual interest payment is $50 (5% of $1,000 par value). Each interest payment is one-half of that amount, or $25.00.
A municipality will refund a revenue bond issue for all of the following reasons, EXCEPT to: Reduce interest charges Issue new bonds at lower interest rates Reduce the market value of outstanding bonds that are not refunded Eliminate restrictions in the bond resolution
C A municipality will refund a revenue bond issue if interest rates declined to reduce interest charges, to issue new bonds at lower interest rates, and to eliminate restrictions in the bond resolution. The municipality would not refund an issue to reduce the market value of the outstanding bonds. The market value of the outstanding bonds is determined by supply and demand and by the general level of interest rates.
Which of the following statements BEST describes an indenture? It is a written agreement between the issuer of a bond and an underwriter It is a written agreement between the underwriter and investors when a new bond is issued It is a contract between the issuer of a bond and the trustee for the benefit of the holder of the bonds It is a contract between the issuer of stock and shareholders of a corporation
C An indenture is a written contract between the issuer of bonds and the trustee under which bonds and debentures are issued. Listed in the indenture are the maturity date, the coupon rate, other terms for the benefit of the bondholder, and obligations of an issuer of a bond.
An outstanding municipal bond would most likely be called when interest rates: Rise above the bond's nominal yield Rise above the bond's yield to maturity Fall below the bond's nominal yield Fall below the bond's yield to maturity
C Bonds may contain a provision that allows the issuer, at its option, to redeem the bonds before they mature. Call provisions usually benefit the issuer, which has the option of calling in the bonds when interest rates decline. The issuer may then refinance the debt at a lower rate of interest. For instance, if an issuer's outstanding bond is paying a coupon rate (nominal yield) of 9% at a time when similar bonds are paying only 5%, the issuer can reduce its interest costs by calling in the 9% bonds and issuing new ones at 5%. As interest rates decline, a bond's yield to maturity or yield to call would also decline.
Which of the following statements is NOT TRUE regarding commercial paper? It is issued by a corporation for cash flow purposes It is usually not backed by any of the corporation's specific assets It is considered an exempt security if it matures in more than 270 days It may be sold to the public by a broker-dealer or the issuer
C Commercial paper is unsecured corporate debt with a maximum maturity of 270 days. Commercial paper is usually marketed through certain dealers but some corporations market their paper directly. Some issues are interest bearing (have a stated interest rate) but most are discount instruments. Corporations issue commercial paper to satisfy a short-term need for cash.
Which of the following statements is TRUE concerning bonds issued by FNMA (Fannie Mae)? They have yields that are lower than comparable Treasury securities They are a direct obligation of the U.S. government The value of these securities is highly dependent on current interest rates They are generally not considered suitable for investors seeking income
C Government-Sponsored Enterprise (GSE) bonds, such as those issued by FNMA (Fannie Mae) or FHLMC (Freddie Mac) are not direct obligations of the U.S. government. They are able to borrow funds from the government, which makes their yield slightly higher than Treasury securities with the same maturities. As with most fixed-income securities, their value is highly dependent on current interest rates, and they are suitable for investors seeking income.
Private label CMOs are more likely than government-sponsored CMOs to be subject to which of the following risks? Extension Prepayment Credit Interest-rate
C Private label CMOs include mortgages that are issued by banks and are subject to the creditworthiness of the issuer. By contrast, government-sponsored CMOs are supported by the government agency that backs them.
A bond is selling at a premium. This indicates that: The yield to maturity is greater than the nominal yield The market price is less than the par value Interest rates have decreased since the bond was issued The nominal yield is less than the current yield
C The amount that the market price exceeds the par value is known as a premium. One reason for selling at a premium is a decrease in interest rates after the bonds were issued. When looking at the yields for premium bonds, the nominal yield is the highest, followed by the current yield, with the yield to maturity being the lowest yield of the three.
The real interest rate is best defined as the: Interest earned by an investor after taxes Interest earned that is less than the rate of inflation Interest earned that exceeds the inflation rate Amount that LIBOR exceeds the fed funds rate
C The real interest rate received by an investor is the amount of interest received minus the inflation rate. If an investor is receiving a 10% interest rate when inflation is at 6%, the real interest rate received is 4% (10% - 6%).
XYZ Corporation has $40 million of convertible bonds outstanding. Each bond is convertible into 20 shares of common stock. The conversion price is: $20 $25 $50 $100
C To find the conversion price, divide the $1,000 par value by the 20-share conversion ratio. This equals a conversion price of $50 ($1,000 par value divided by the 20-to-1 conversion ratio equals $50). The amount of bonds outstanding is not relevant in calculating the conversion price.
XYZ convertible debentures are convertible into 20 shares of XYZ Corporation common stock. If the bonds were selling in the market at $960, what would the common stock need to be selling for to be on parity? $19.20 $20 $48 $50
C To find the stock's parity price, divide the current market price of the bond ($960) by the conversion rate (ratio) which is given as 20 shares. This equals $48.
Which of the following securities will provide an investor with protection against purchasing-power risk? Treasury bills Treasury notes TIPS STRIPS
C Treasury Inflation-Protected Securities (TIPS) are U.S. government securities that are inflation-adjusted based on the Consumer Price Index (CPI). With TIPS, the rate of interest is fixed. However, the principal amount on which that interest is paid will vary based on the CPI. They are usually purchased as protection against inflationary or purchasing power risk. The other choices are U.S. government securities that pay an investor either a fixed rate or a fixed amount.
A U.S. government bond is selling in the market at 95.28. The dollar value of this bond is: $950.87 $952.80 $958.75 $9528.00
C U.S. government notes and bonds (Treasury securities) are quoted in 32nds. 95.28 is equivalent to 95 28/32nds (28/32 = .875). This is equivalent to 95.875 percent of the par value of $1,000, which equals $958.75.
If interest rates increase, which of the following securities has the most price change? A Treasury note trading at a discount A Treasury note trading at a premium A Treasury bond trading at a discount A Treasury bond trading at a premium
C When interest rates increase, outstanding bond prices will decline in value. The prices of longer-term maturities will fall more than the shorter-term maturities. Treasury bonds have maturities of up to 30 years, whereas Treasury notes have maturities of up to 10 years. The prices of bonds selling at a discount will fall more sharply than those selling at a premium.
A type of security that is issued by foreign governments and corporations, trades in U.S. markets, and is denominated in U.S. dollars is called a: Global mutual fund Eurodollar bond Yankee bond Repurchase agreement
C Yankee bonds are issued by foreign corporations and governments, are dollar-denominated securities, and trade in U.S. markets. Yankee bonds are normally issued by foreign entities when conditions in the U.S. are better than in the foreign country. Eurodollar bonds are issued by U.S. companies and sold to investors overseas and pay their interest in Eurodollars (dollars on deposit in banks outside the U.S.). Since Eurodollar bonds are not initially offered to investors in the U.S., they are exempt from SEC registration.
A bond secured by other bonds and securities is referred to as a: Collateralized mortgage obligation Guaranteed bond Mortgage bond Collateral trust bond
D A bond issued by a corporation that is secured by other bonds and securities is called a collateral trust bond. A CMO is backed by mortgages that were purchased from banks and other lenders who originated loans to homeowners.
A client is seeking a safe investment that pays interest on a monthly basis. Which of the following securities would be an appropriate recommendation? STRIPS Preferred stock Treasury notes GNMA modified pass-through certificates
D Interest (and principal) payments on GNMA pass-through certificates are made monthly. Treasury notes and bonds pay interest semiannually. Preferred stock dividends are paid to shareholders only when declared by the corporation's board of directors. STRIPS are a zero-coupon Treasury security (non-interest-bearing).
Which of the following statements describes the greatest risk associated with mortgage-backed securities? Borrowers might default on their mortgage payments The market for mortgage-backed securities is illiquid The market price of the bonds might fall due to a rating downgrade Falling interest rates might accelerate early repayment of principal
D Mortgage-backed securities are subject to prepayment risk. The early return of principal would then need to be reinvested when rates are low. Many mortgages that underlie mortgage-backed securities are backed by government guarantees or private mortgage insurance, which insulates many holders from defaults on the underlying mortgages.
Which of the following securities is NOT guaranteed by the U.S. government? Treasury notes Treasury bills Government National Mortgage Association (Ginnie Mae) certificates Federal National Mortgage Association (Fannie Mae) bonds
D Of the choices given, the only obligations that are not guaranteed by the U.S. government are FNMA (Fannie Mae) bonds. FNMA was created as a government-chartered private corporation. It borrows funds and uses the proceeds to purchase conventional residential mortgages. Although FNMA can borrow funds from the U.S. government, the securities it issues are not directly backed by the U.S. government.
An individual owns an ARF corporation 8% convertible debenture. The debenture is convertible at 20 and is currently selling in the market at 97 1/2. If ARF common stock is trading in the market at 18, at what price should the debenture sell to be at a 10% premium to parity with the common? $900.00 $965.25 $975.50 $990.00
D Since the conversion price is $20 per share, the debenture can be converted into 50 shares ($1,000 par divided by $20 per share). If converted, the stock will have a total value of $900 (50 shares x $18 per share market price). To be at a 10% premium to parity, the debenture should be trading at $990 ($900 parity plus 10% of $900).
Which of the following formulas is used to calculate the current yield on a bond? Annual dividend/Investor's cost Semiannual interest/Current market value Semiannual interest/Investor's cost Annual interest/Current market value
D The current yield on a bond is determined by dividing the annual interest by the current market value. If an investor owns a bond, his current yield is the annual interest divided by the investor's cost.
Which of the following CMOs has the MOST prepayment risk? Sequential pay tranches Accrual or Z tranches Planned amortization class (PAC) tranches Support or companion tranches
D The planned amortization class (PAC) is a type of CMO that is designed for more risk-averse investors and provides a predetermined schedule of principal repayment, as long as mortgage prepayment speeds are within a certain range. This greater predictability of maturity is accomplished by establishing a sinking-fund type of schedule. The PAC tranche has top priority and receives principal payments up to a specified amount. Any excess principal goes to a companion or support tranche that has lower priority. Holders of the companion tranche are generally compensated for this risk with higher yields.
A tombstone ad states that Southern California Gas is issuing 8 3/4% first mortgage bonds at a price of 96.35% of their par value. The payment of interest and principal on the bond is secured by: The general credit of the state of California The mortgages on property owned by the state of California The state of California A lien on property owned by Southern California Gas
D The tombstone ad states the bonds are first mortgage bonds, which means they are secured by a lien on property owned by the Southern California Gas Company. The company is a publicly owned corporation. Therefore, the bonds are not secured by property owned by the state of California.
Which of the following Moody's rated bonds are considered speculative? Aaa Aa Baa Ba
D The top-4 Moody's ratings, Aaa, Aa, A, and Baa, are termed investment-grade (basically nonspeculative or high-grade). Ratings lower than Baa (such as Ba) are considered speculative or non-investment-grade. The investment-grade category in S&P ratings includes AAA, AA, A, and BBB.
A company has $50,000,000 par value convertible bonds outstanding. The coupon rate is 8%. The bonds are currently selling at 96. What is the current yield? 7.0% 7.5% 8.0% 8.3%
D To find the current yield of the bonds, divide the yearly interest paid on the bonds by the current market value of the bonds. The yearly interest is $80. The market value of a bond is $960. Therefore, the current yield equals 8.3% ($80 divided by $960 equals 8.3%). The fact that these are convertible bonds is not relevant.
Which TWO of the following securities may be included in the STRIPS program to create zero-coupon securities? Treasury bills Treasury notes TIPS Treasury bonds I and III I and IV II and III II and IV
D Treasury STRIPS are created when Treasury notes and Treasury bonds are separated (stripped) of their coupons. Treasury bills and Treasury Inflation-Protected Securities (TIPS) are not permitted to be stripped.
Treasury bills are issued to mature in all the following time frames, EXCEPT: One month Three months Six months Nine months
D Treasury bills mature in one month, three months, six months, or twelve months. They do not have nine-month maturities at issuance.
A customer purchased a government security, and later discovered that it was nonnegotiable. This security could have been: A Treasury bill Commercial paper A GNMA pass-through An EE savings bond
D U.S. savings bonds, which include EE, HH, and I bonds, are nonnegotiable. This means purchasers may not resell them to other investors in the secondary market. They can only be redeemed.
Which of the following Moody's ratings is the most speculative in the investment-grade category? Aa A Baa Ba
The top-4 ratings in both Moody's and S&P are investment grade. The top-4 ratings are: Moody's S&P Aaa AAA Aa AA A A Baa BBB If the question had asked for the most speculative, then Ba would be the answer.
