Series 65: Unit 2 Quiz 2
An investor purchases a Treasury note and the confirmation shows a price of $102.25. Rounded to the nearest cent, the investor's cost, excluding commissions, is A. $1,020.25. B. $1,027.81. C. $102.25. D. $1,022.50.
$1,027.81 Treasury notes are quoted in 32nds, where each 32nd equals $0.3125. The 102 in the quote equals $1,020 and the 25/32 is an additional $7.81, bringing the total to $1,027.81.
The DERP Corporation has an outstanding convertible bond issue that is convertible into eight shares of stock. If the current market price of the bond is 80, the parity price of the stock is A. $125 per share. B. $100 per share. C. $80 per share. D. $64 per share.
$100 per share Parity means equal. With a conversion ratio of eight shares per bond, the investor can convert the bond into eight shares. If the bond is currently selling for $800, then, to be of equal value (parity), the eight shares must be selling at $100 each.
The minimum face amount of a negotiable CD is A. $100,000. B. $25,000. C. $10,000. D. $50,000.
$100,000 Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are usually traded in blocks of $1 million or more.
One of the more popular money market instruments is the negotiable CD. To be considered a negotiable CD, a CD must have a face value of at least A. $1 million. B. $500,000. C. $25,000. D. $100,000.
$100k Negotiable CDs, sometimes referred to as jumbo CDs, have a minimum denomination of $100,000. They are unsecured, interest-bearing obligations of banks.
If GHI currently has earnings of $3.00 and pays an annual dividend of $1.75 and GHI's market price is $35, the current yield is A. 5.00%. B. 3.00%. C. 1.75% D. 8.60%.
5% The current yield is calculated by dividing the annual dividend by the current market value ($1.75 ÷ $35.00 = 5%).
The current yield on a bond with a coupon rate of 5.5% selling at 110 is A. 5.5%. B. 6.0%. C. 2.0%. D. 5.0%.
5% The current yield of any security, equity, or debt is always the income return (dividend or interest) divided by the current market price. In this case, it is the annual interest of $55 ($1,000 × 5.5%) divided by $1,100, and that equals 5%.
An investor in the 25% federal income tax bracket is considering the purchase of some fixed-income instruments. Which of the following would provide the investor with the greatest after-tax return? A. 4.8% AAA rated insured municipal bond B. 7% Ba rated corporate bond C. 6% FDIC-insured CD D. 5% U.S. Treasury bond
7% Ba rated corporate bond The greatest after-tax return is provided by the instrument listed that, after subtracting 25% for income tax, leaves the investor with the greatest amount. Because the Treasury bond, the CD, and the corporate bond are all taxable at the same rate, the 7% bond must be the best deal. Even though the municipal bond is not taxed, its 4.8% net yield is far lower than the 5.25% ($70 − 25% tax) return on the corporate bond.
Richard purchased a 30-year bond for 103½ with a stated coupon rate of 8.5%. What is the approximate yield to maturity for this investment if Richard receives semiannual coupon payments and expects to hold the bond to maturity? A. 8.19% B. 8.50% C. 9.36% D. 8.68%
8.19%
A U.S. dollar-denominated bond that is sold outside the United States and the issuer's country but for which the principal and interest are stated and paid in U.S. dollars is best described as A. a Yankee bond. B. a Eurodollar bond. C. a Brady bond. D. a eurobond.
A Eurodollar bond This is the definition of a Eurodollar bond. Yes, it is also a eurobond, but because the question specifies U.S. dollars, the more accurate choice is Eurodollar bond. A Yankee bond is U.S. dollar-denominated but is issued in the United States; Eurodollar bonds are not. Brady bonds are issued only by foreign governments, usually—but not always—are U.S. dollar-denominated, and are available for purchase in the United States.
Which of the following statements represents an advantage of a municipal general obligation (GO) bond over a revenue bond? A. Only a facility's users pay for a GO bond. B. A GO bond is not charged against the municipality's borrowing limits. C. A GO bond generally involves less risk to the investor. D. A GO bond issuer is required to conduct a feasibility study.
A GO bond generally involves less risk to the investor
Which of the following best describes a Yankee bond? A. A U.S. dollar-denominated bond issued by a U.S. entity inside the United States B. A U.S. dollar-denominated bond issued by a U.S. entity outside the United States C. A U.S. dollar-denominated bond issued by a non-U.S. entity outside the United States D. A U.S. dollar-denominated bond issued by a non-U.S. entity inside the United States
A U.S. dollar-denominated bond issued by a non-U.S. entity inside the United States Yankee bonds are issued by non-U.S. entities in marketplaces inside the United States. The bonds are issued in U.S. dollars, meaning these foreign issuers will have currency risk if the dollar drops in value against their local currency.
A bond, preferred stock, or debenture exchangeable at the option of the holder (for common stock of the issuing corporation) is A. a synthetic security. B. a convertible security. C. a collateral-backed equity security. D. a nondilutive stock.
A convertible security A bond, preferred stock, or debenture exchangeable at the option of the holder for common stock of the issuing corporation is a convertible security.
An unsecured long-term debt security issued by a corporation is known as A. a mortgage bond. B. an equipment trust certificate. C. a debenture. D. a collateral trust bond.
A debenture A debenture is a long-term debt security issued by a corporation with no specific asset pledged as security for the loan.
In general, from the choices given, the type of security offering the greatest degree of safety to an investor is A. a debenture. B. preferred stock. C. a mortgage bond. D. common stock.
A mortgage bond Debt securities, because they are an obligation of the issuer, are generally considered safer than equity securities. Secured debt is safer than unsecured debt. The only one of these debt obligations with pledged assets as security for the loan is the mortgage bond. Debentures are unsecured corporate debt obligations.
One of the likely consequences of a rating downgrade on a bond is A. the current yield will be reduced. B. the call feature will be employed. C. a reduction in the market price of the bond. D. an increase to the coupon by the issuer.
A reduction in the market price of the bond If the rating agencies downgrade the quality of a bond, potential investors will look to compensate for the increased risk by demanding a greater yield on the issuer's bonds. This will inevitably result in a lower bond price. A change in rating is unlikely to lead to a call. In fact, with the reduction in the market price, the bond may be selling below par, giving the issuer the opportunity to retire the debt at a discount. Bonds are fixed-income securities because the coupon rate is fixed when the bond is issued and does not change.
Which of the following are not considered money market instruments? 1. American depositary receipts 2. Commercial paper 3. Corporate bonds 4. Jumbo (negotiable) certificates of deposit
American depositary receipts and corporate bonds A money market instrument is a high-quality, short-term debt security with maturity of one year or less. American depositary receipts (ADRs) are equity, and corporate bonds are long-term debt instruments.
Which of the following is true of Ginnie Maes but not of other agency mortgage-backed securities? A. Collateralized by mortgages B. Backed by the full faith and credit of the U.S. government C. Yield more than T-bonds D. Are pass-through securities
Back by the full faith and credit of the U.S. government
In the event of a company's insolvency, which of the following has first claim on assets? A. Bondholders B. Preferred stockholders C. Common stockholders D. Members of the board of directors
Bondholders
Which two of the following investments would offer your clients the best chance of minimizing inflation risk? 1. Common stock 2. Callable preferred stock 3. Money market mutual funds 4. TIPS
Common stock and TIPS Historically, common stock has been the best hedge against inflation. TIPS (Treasury Inflation-Protected Securities) are government-guaranteed debt issues that automatically adjust the principal based upon the inflation rate.
Corporate long-term debt securities that are issued on the general credit of the issuer and are not otherwise secured are called A. prior lien bonds. B. general obligation bonds. C. preferred stock. D. debentures.
Debentures Debentures are corporate long-term debt securities issued on the general credit of the corporation and are not backed by any specific assets. The term prior lien means there is a secured claim against a specific asset. Preferred stock is not a debt security, and general obligation bonds are municipal, not corporate, securities.
A corporation is likely to call eligible debt when interest rates are A. rising. B. declining. C. volatile. D. stable.
Declining
An investor is considering the purchase of $100,000 maturity value of zero-coupon AAA rated corporate bonds scheduled to mature in 20 years. Which of these are among the risks that this investor will be assuming? 1. Default risk 2. Interest rate risk 3. Prepayment risk 4. Reinvestment risk
Default and interest rate risk
All of the following debt instruments pay interest semiannually except A. Ginnie Mae pass-through certificates. B. municipal general obligation bonds. C. municipal revenue bonds. D. industrial development bonds.
Ginnie Mae pass-through certificates Ginnie Maes pay interest monthly, not semiannually.
When discussing convertible debt securities, it would be incorrect to state that A. holders may share in the growth of the common stock. B. holders have a fixed interest rate. C. the issuer pays a lower interest rate. D. holders receive a higher interest rate.
Holders receive a higher interest rate Because of the possibility of participating in the growth of the common stock through an increase in the market price of the common, the convertible can be issued with a lower interest rate.
Which of the following is true of GNMA securities? 1. Interest is subject to federal income tax. 2. Interest is exempt from federal income tax. 3. They are backed by farm mortgages. 4. They are backed by residential mortgages.
Interest is subject to federal income tax and they are backed by residential mortgages Income received by investors in Government National Mortgage Association (GNMA) securities is subject to both state and federal income tax, and the asset backing them is residential mortgages.
Which of the following are characteristics of negotiable jumbo CDs? 1. Issued in amounts of $100,000 to $1 million or more 2. Typically pay interest on a monthly basis 3. Always mature in one to two years with a prepayment penalty for early withdrawal 4. Trade in the secondary market
Issued in amounts of $100k to $1 million or more and trade in the secondary market Negotiable jumbo CDs are issued for $100,000 to $1 million or more and trade in the secondary market. Most jumbo CDs are issued with maturities of one year or less. Being negotiable, there is no prepayment penalty. These CDs generally pay interest on a semiannual basis, not monthly.
Treasury bills are A. callable. B. issued in bearer form. C. issued in book-entry form. D. issued at par.
Issued in book-entry form All Treasury securities are issued in book-entry form. Treasury bills are always issued at a discount and are never callable.
Which of the following is unlikely to be issued at a discount? A. Commercial paper B. Treasury bill C. Jumbo CD D. Zero-coupon bond
Jumbo CD
The price of which of the following will fluctuate most with a change in interest rates? A. Common stock B. Short-term bonds C. Long-term bonds D. Money market instruments
Long-term bonds Long-term debt prices fluctuate more than short-term debt prices as interest rates rise and fall.
Ginnie Mae pass-throughs will pay back both principal and interest A. annually. B. monthly. C. semiannually. D. quarterly.
Monthly Ginnie Mae (GNMA) securities are called pass-through certificates because the monthly home mortgage payments, which consist of both principal and interest, pass through to the GNMA investor monthly.
Which of the following statements about municipal bonds is not true? A. Municipal bonds are bonds issued by governmental units at levels other than the federal. B. The interest on municipal bonds is usually not subject to federal income tax. C. Municipal bonds are generally considered riskier than corporate bonds. D. Municipal bonds generally carry lower coupon rates than corporate bonds of the same quality.
Municipal bonds are generally considered riskier than corporate bonds Municipal bonds are generally considered second only to Treasury instruments in relative safety.
When an investor owns a convertible security where, upon conversion, the account value would remain the same, it is considered that the convertible and the common are selling at A. parity. B. the nominal yield. C. the arbitrage level. D. equivalent value.
Parity Parity means equal. When one can convert the security and realize the same value, it is said that both are at parity.
A mortgage-backed security (MBS), such as a Ginnie Mae, makes a combination principal and interest payment to an investor. This payment will be A. partly taxed as ordinary income and partly a tax-free return of principal. B. taxed as a capital gain if underlying mortgage is prepaid. C. tax free. D. taxed as ordinary income.
Partly taxed as ordinary income and partly a tax-free return of principal
DERP Corporation's 5% convertible debentures maturing in 2030 are currently selling for 120. The conversion price is $40. One would expect the DERP common stock to be selling A. somewhat above $48 per share. B. somewhat below $48 per share. C. somewhat above $30 per share. D. somewhat below $30 per share.
Somewhat below $48 per share The first step here is to compute the parity price. A conversion price of $40 means the debenture is convertible into 25 shares of the common stock (par of $1,000 divided by $40 = 25 shares). With a current market price of $1,200, the parity price of the stock would be $48. Because convertible securities generally sell at a slight premium over their parity price, the stock should have a current market value a bit less than $48 per share.
Which of the following statements regarding a $1,000 corporate 8.50% bond offered at 110 is true? A. The bond's current yield is lower than its yield to maturity. B. The bond's current yield is calculated by dividing its annual interest by its current market price. C. To determine the bond's current yield, its stated rate must be compared against other fixed-rate investments in the client's portfolio. D. The bond is a discount bond.
The bond's current yield is calculated by dividing its annual interest by its current market price A bond's current yield is calculated by dividing its annual interest by its current (market) price. In this case, it would be $85 ÷ $1,100. The current yield will be higher than its yield to maturity, which takes into consideration the $100 difference between the purchase price and the par value (a loss of $100). The determination of a bond's yield is unrelated to other bonds. In addition, this bond is selling at a premium (more than $1,000), not at a discount (less than $1,000).
In order to compute yield to maturity, all of the following are necessary except A. the nominal yield. B. the maturity date. C. the call price. D. the current market price.
The call price Computing the yield to maturity (YTM) does not require the call price or call date—that is necessary to compute the yield to call (YTC). We do need to know the current market price, the coupon (nominal yield), and the maturity date.
Which of the following statements is true if a corporate bond is callable? A. The issuing corporation has the option to redeem the bond before it matures. B. The owner of the bond may exchange it for shares of stock. C. The owner of the bond may demand that the issuing corporation redeem the bond before it matures. D. The issuing corporation may change the coupon rate at any time by giving the owner of the bond written notice.
The issuing corporation has the option to redeem the bond before it matures
If investors hold bonds until maturity, their realized rate of return, assuming all interim cash flows are reinvested at that same rate, would be equal to A. the yield to maturity. B. the price return. C. the income return. D. the coupon return.
The yield to maturity The yield to maturity is an investor's total return if they purchase the bond at any point and then hold it until maturity, assuming all interim cash flows are reinvested at that same YTM. This takes into consideration any capital gain or loss; therefore, the yield to maturity will fluctuate with the bond's price.
ABC Corporation's 5% mortgage bond is currently trading at a premium. The bond is callable at par in 10 years and matures in 15 years. When comparing the returns available to an investor, it would be accurate to state A. the yield to maturity is higher than the yield to call. B. the yield to maturity is higher than the current yield. C. the current yield is higher than the nominal yield. D. the yield to call is higher than the current yield.
The yield to maturity is higher than the yield to call Whenever a bond is selling at a premium, the return—in descending order—is nominal yield, current yield, YTM, and YTC. It is the reverse order when the bond is selling at a discount. When the bond is at par, all are the same (if the call is at par).
A corporation is capitalized with common stock, senior preferred stock, mortgage bonds, and subordinated debentures. Your client, who holds $10,000 of the debentures, is concerned about the future viability of the enterprise. You can inform the client that the debentures have a claim A. ahead of the common stock and the preferred stock but after the bonds. B. behind the bonds, the preferred stock, and the common stock. C. ahead of the common stock but after the preferred stock and the bonds. D. ahead of the common stock, the preferred stock, and the bonds.
Ahead of the common stock and the preferred stock but after the bonds
A bank is advertising a no-cost DDA. Your client asks you to describe what that is. You would respond that DDA stands for A. direct deposit account. B. deferred deposit account. C. digital deposit account. D. demand deposit account.
Demand deposit account
An individual purchases a $10,000 CD with a 5-year maturity from her local bank branch. In doing so, she is eliminating A. inflation risk. B. purchasing power risk. C. opportunity cost. D. interest rate risk.
Interest rate risk
The interest from which of the following bonds is exempt from federal income tax? 1. State of California bonds 2. City of Anchorage bonds 3. Treasury bonds 4. GNMA bonds
State of California bonds and City of Anchorage bonds Municipal bonds are exempt from federal income tax. Treasury bonds are exempt from state tax but not federal tax. GNMAs are subject to federal, state, and local income tax.
All of the following are true of negotiable, jumbo certificates of deposit except A. they usually have maturities of one year or less. B. they are secured obligations of the issuing bank. C. they are usually issued in denominations of $100,000 to $1 million or more. D. they are readily marketable.
They are secured obligations of the issuing bank
Your client with $100,000 to invest is looking for maximum current income. Which of the following would offer the highest current return? A. $200,000 of utility common stock paying a current dividend of 3.5% B. $100,000 of zero-coupon bonds with a yield to maturity of 6% C. $100,000 market value of corporate bonds selling at a premium and yielding 6% to maturity D. $100,000 AA rated corporate bonds trading at par with a 6% coupon rate
$100k market value of corporate bonds selling at a premium and yielding 6% to maturity When you read the full question, including the answer choices, you can immediately disregard two of the four options. With $100,000 to invest, the answer cannot be to purchase $200,000 of anything. Maximizing current income excludes zero-coupon bonds because there is no current income. Now, to the correct choice. Why does a bond sell at a premium over par? Although there are exceptions, primarily it is because the coupon rate on that bond is higher than the current market interest rate. Therefore, with a higher coupon rate, the current income on the same amount of principal invested ($100,000 in our question) will always be higher for a bond selling at a premium. That is the KISS (Keep It Simple Student) answer. For those who want to delve further, here we go. For example, if current market interest rates are 6% (likely the case here because the AA rated bonds with a 6% coupon are trading at par), then a bond with a 7% coupon will be selling at a premium. The current yield on $100,000 of the 6% bonds would be $6,000 per year. If a bond's yield to maturity is 6% and it is selling at a premium, it must be that the coupon is higher than 6%. For example (and we're doing the math that you won't have to do), $93,000 par (93 times $1,000) value of bonds with a 7% coupon, selling at $100,000 (a premium over the $93,000), and maturing in 10 years has a YTM of 6%. Investing $100,000 into these bonds will result in current income of $6,510 per year ($93,000 par times the 7% coupon).
An investor buys 10M 6.6s of 10 at 67. The investor will receive annual interest of A. $1,000. B. $670. C. $660. D. $820.
$660 Interpret "10M" as "$10,000 worth of." The investor receives the nominal yield of the bonds, which is 6.6% of $10,000. The M is from the roman numeral for 1,000.
If a convertible bond is purchased at its $1,000 par value and is convertible at $83.33 per common share, what is the conversion ratio of common shares per bond? A. 12 shares for each bond B. 2 shares for each bond C. 1.2 shares for each bond D. 8 shares for each bond
12 share for each bond
During the past year, the market price of Kapco common stock has increased from $47 to $50 per share. Over that period, Kapco's earnings per share (EPS) have increased from $2.00 to $2.50 per share, and their dividend payout ratio has decreased from 50% to 40%. Based on this information, the current yield on Kapco common stock is A. 6.34%. B. 4.26%. C. 2.00%. D. 2.13%.
2% The current yield on a stock is computed by dividing the annual dividend rate by the current market price. With EPS of $2.50 and a 40% payout ratio, the annual dividend is $1.00. This dollar divided by the current market price of $50.00 results in a current return of 2%.
A client has TIPS with a coupon rate of 3.5%. The inflation rate has been 4% for the last year. What is the inflation-adjusted return? A. -0.50% B. 7.50% C. 3.50% D. 4.00%
3.5%
If GHI currently has earnings of $3.00 and pays an annual dividend of $1.75 and GHI's market price is $35, the current yield is A. 3.00%. B. 5.00%. C. 1.75% D. 8.60%.
5%
A company with 20 million shares outstanding paid $36 million in dividends. If the current market value of the company's shares is $36, the current yield is A. 5%. B. not determinable from the information given. C. 10%. D. 2%.
5% The current yield formula is annual dividends per share divided by current market price. The dividends per share are $36 million ÷ 20 million shares = $1.80 per share. Current yield is $1.80 ÷ $36.00 = 5%.
The term Eurodollars refers to A. obsolete currency that was formerly backed by the gold standard. B. American dollars held by banks in other countries, especially in Europe. C. European currency held in U.S. banks. D. a worldwide currency system that is expected to someday replace existing currency systems.
American dollars held by banks in other countries, especially in Europe American dollars held in international banks, especially—but not exclusively—in Europe, are known as Eurodollars.
When a U.S. resident investor purchases foreign bonds, A. depreciation of both the bonds and the foreign currency benefits the domestic investor. B. appreciation of both the bonds and the foreign currency benefits the domestic investor. C. appreciation of the bonds and depreciation of the foreign currency benefit the domestic investor. D. depreciation of the bonds and appreciation of the foreign currency benefit the domestic investor.
Appreciation of both the bonds and the foreign currency benefits the domestic investor
A company has two outstanding bond issues, both with a coupon rate of 10%. Bond A will mature in 3 years while Bond B will mature in 20 years. If interest rates were to decrease to 8%, which of the following statements is correct? A. Bond B will be selling at a greater premium than Bond A. B. The issuer will attempt to call in Bond A. C. Both bonds will be selling at a discount. D. Bond B will be selling at a greater discount than Bond A.
Bond B will be selling at a greater premium than Bond A When interest rates go down, bond prices will go up. As far as which bond will sell at the higher premium using the discounted cash flow method, it is clear that the bond with the longer duration will be worth more.
A bond offered at par has a coupon rate A. greater than its yield to maturity. B. equal to its current yield. C. less than its yield to maturity. D. less than its current yield.
Equal to its current yield When a bond is selling at par, its coupon or nominal rate, current yield, and yield to maturity are all the same.
Municipal bonds are often called tax-exempts. This refers to the exemption of their income from A. state income taxes. B. federal income taxes. C. state, federal, and inheritance taxes. D. federal estate taxes.
Federal income taxes Although municipal bonds are sometimes exempt from state income tax (if issued in the state of residence of the taxpayer), all references to tax exemption refer to their exemption from federal income taxes.
Which of the following is a direct obligation of the U.S. government? A. Ginnie Maes B. Fannie Maes C. Bank for cooperatives bonds D. Government bond mutual funds
Ginnie Maes Ginnie Maes are backed by the full faith and credit of the United States. Other agencies have a moral, but not direct, government backing. Government bond mutual funds are not backed by the U.S. government.
A customer bought a 10-year 6% AAA bond at par when it was issued. Two years later, if the CPI has increased from 2% to 4%, the price of the bond most likely A. has stayed at par. B. has increased. C. cannot be determined. D. has declined.
Has declined
A client of yours owns some convertible preferred stock. She notices an article in the business section of her local newspaper that reports the company is going to pay a 20% stock dividend on their common stock. How will this affect her? A. There will be no effect. B. If there is an antidilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend. C. She will also receive 20% more shares because preferred stock has a priority claim ahead of common. D. More than likely, the price of the preferred stock will rise.
If there is an antidilution clause, her conversion privilege will permit her to acquire 20% more shares than before the stock dividend Most convertible securities are sold with antidilutive clauses that provide for an adjustment in the number of shares based on stock splits or stock dividends.
A bond with a par value of $1,000 and a coupon rate of 5%, paid semiannually, is currently selling for $1,200. The bond matures in 10 years and is callable in six years at 103. In the computation of the bond's yield to call, which of the following would be a factor? A. Future value of $1,200 B. 20 payment periods C. Present value of $1,030 D. Interest payments of $25
Interest payments of $25 The YTC computation involves knowing the amount of interest payments to be received, the length of time to the call, the current price, and the call price. A bond with a 5% coupon will make $25 semiannual interest payments. With a six-year call, there are only 12 payment periods, not 20. The present value is $1,200 and the future value is $1,030, the reverse of the numbers indicated in the answer choices.
A bond with a par value of $1,000 and a coupon rate of 8% paid semiannually is currently selling for $1,150. The bond is callable in 10 years at $1,100. In the computation of the bond's yield to call, which of these would be a factor? A. Present value of $1,100 B. 60 payment periods C. Interest payments of $40 D. Future value of $1,150
Interest payments of $40 The YTC computation involves knowing the amount of interest payments to be received, the length of time to the call, the current price, and the call price. A bond with an 8% coupon will make $40 semiannual interest payments. With a 10-year call, there are only 20 payment periods, not 60. The present value is $1,150 and the future value is $1,100, the reverse of the numbers indicated in the answer choices.
Partners with the United States in the creation of Brady bonds were which of these? 1. International Monetary Fund (IMF) 2. Import/Export Bank 3. United Nations 4. World Bank
International Monetary Fund (IMF) and World Bank
What rate of interest would a bank in England charge another British bank for a short-term loan? A. Fed funds rate B. SOFR C. Prime rate D. Discount rate
SOFR
When current interest rates are at 6%, you would expect a bond with a nominal yield of 4% to be A. selling at a premium. B. selling at par. C. selling at a discount. D. in danger of default.
Selling at a discount With the market rate of return at 6%, a 4% bond just isn't as valuable, so the only way investors will be interested is if they can acquire it at a discount. That discount works out to be a figure that will result in a 6% return for the purchaser. Remember, as interest rates go up, bond prices go down, and vice versa.
Money market instruments are A. long-term debt. B. long-term equity. C. short-term debt. D. intermediate debt.
Short-term debt Money market instruments are high-quality debt securities with maturities that do not exceed one year.
Your client in the 25% federal income tax bracket lives in a state where his earnings place him in the 6% bracket for state income tax purposes. If he were to purchase a 4% bond issued by a political subdivision of another state, his total tax-equivalent yield would be A. slightly more than 5.33%. B. 4.00%. C. slightly less than 5.33%. D. approximately 12.90%.
Slightly less than 5.33%
Your client in the 25% federal income tax bracket lives in a state where his earnings place him in the 6% bracket for state income tax purposes. If he were to purchase a 4% bond issued by a political subdivision of another state, his total tax-equivalent yield would be A. approximately 12.90%. B. slightly more than 5.33%. C. 4.00%. D. slightly less than 5.33%.
Slightly less than 5.33% When an individual owns a municipal bond issued in a state other than his state of residence, although the interest is tax free on a federal basis, it is taxable (at least in all cases on the exam) in that state. Therefore, the tax-equivalent yield here is slightly lower than it would be if we only computed using the federal tax rate. Because that would be 4.0% divided by 0.75 (100% minus the 25% tax bracket) or 5.33%, paying the state income taxes would decrease the yield slightly.
Your client in the 25% federal income tax bracket lives in a state where his earnings place him in the 6% bracket for state income tax purposes. If he were to purchase a 4% bond issued by a political subdivision of his state, his total tax-equivalent yield would be A. approximately 12.90%. B. slightly less than 5.33%. C. slightly more than 5.33%. D. 4.00%.
Slightly more than 5.33% When an individual owns a municipal bond issued in his state of residence, not only is the interest tax free on a federal basis but (at least in all cases on the exam) also it is nontaxed in that state. Therefore, the tax-equivalent yield here is slightly higher than it would be if we only computed using the federal tax rate. Because that would be 4.0% divided by 0.75 (100% minus the 25% tax bracket) or 5.33%, saving on state income taxes would increase the yield slightly.
An investor interested in investing in sovereign debt would most likely purchase A. Sweden 2.5s of 2032. B. bonds backed by gold sovereigns. C. European Central Bank debt issues. D. bonds issued by the Bank of the United States.
Sweden 2.5s of 2032 Sovereign debt refers to bonds and other debt instruments issued by a specific country. The European Central Bank manages the currency of the 19 countries that have adopted the euro. There is no such thing as the Bank of the United States, and gold sovereigns are coins—they are not used to back debt.
Which of the following debt instruments does not make periodic interest payments? A. TIPS B. T-bonds C. T-notes D. T-bills
T-bills Treasury bills are always issued at a discount from their face value. At maturity, the investor receives the face value. The other choices pay interest semiannually. What makes TIPS different from the others is that the principal adjusts for inflation every six months. That means the fixed interest rate is paid on a varying principal.
A bond's yield to maturity is A. the annualized return of a bond if it is held to maturity. B. set at issuance and printed on the face of the bond. C. determined by dividing the coupon rate by the bond's current market price. D. the annualized return of a bond if it is held to call date.
The annualized return of a bond if it is held to maturity The yield to maturity is the annualized return of a bond if it is held to maturity. The computation reflects the internal rate of return and is frequently referred to as the market required rate of return for a debt security. The rate set at issuance and printed on the face of the bond is the nominal or coupon rate. Dividing the coupon rate by the current market price of the bond provides the current yield. The return of a bond if it is held to the call date is the YTC.
The yield to maturity is A. determined by dividing the coupon rate by the current market price of the bond. B. set at issuance and printed on the face of the bond. C. the annualized return of a bond if it is held to call date. D. the annualized return of a bond if it is held to maturity.
The annualized return of a bond if it is held to maturity The yield to maturity reflects the annualized return of a bond if it is held to its maturity. The computation reflects the internal rate of return and is frequently referred to as the market required rate of return for a debt security. The rate set at issuance and printed on the face of the bond is the nominal or coupon rate. Dividing the coupon rate by the current market price of the bond provides the current yield. The return of a bond if it is held to the call date is the yield to call.
A corporation issued a bond with a coupon of 6%, callable at 103. The bond matures in 2059. Current interest rates are 8%. It is most likely that A. the coupon will be increased. B. the bond will be called. C. the bond will go into default. D. the bond is selling at a discount.
The bond is selling at a discount There is excess information in this question (a favorite trick of the test authors). We don't need to know the call price or the maturity date. We have a 6% bond when current market interest rates are 8%. The inverse relationship between interest rates and bond prices teaches us that this bond is going to be selling at a discount. Bonds are called when interest rates go down, not when they rise. The coupon on a bond is fixed.
On the initial public offering, an investor buys a $10,000 Aa-rated, 20-year corporate bond with a 4% coupon rate. One year later, the prevailing market rate is 5% and the bond has had its rating increased to Aa1. Which of the following statements is most likely true with reference to the current market price of this bond? A. The bond would be selling at a discount. B. The bond would be selling at a premium. C. The yield to maturity of this bond is above 4%. D. The bond would be selling at par value.
The bond would be selling at a discount
Assume that a corporation issued a 5% Aaa/AAA rated debenture at par. Two years later, similarly rated debt issues are being offered in the primary market at 5.5%. Which of the following statements regarding the outstanding 5% debenture are true? 1. The current yield on the debenture will be higher than 5%. 2. The current yield on the debenture will be lower than 5%. 3. The dollar price per bond will be higher than par. 4. The dollar price per bond will be lower than par.
The current yield on the debenture will be higher than 5% and the dollar price per bond will be lower than par Because interest rates have risen after the issue of the 5% debenture, the bond's price will be discounted to result in a higher current yield (computed as annual income divided by current market price). Accordingly, the discounting of the issue will make the 5% debenture competitive with new issues offered with a 5.5% coupon.
Which of the following statements regarding corporate zero-coupon bonds is true? A. They are beneficial for investors in higher tax brackets. B. The discount is in lieu of periodic interest payments. C. They have lower price volatility than other bonds. D. Interest is paid semiannually.
The discount is in lieu of periodic interest payments The investor in a corporate zero-coupon bond receives the return in the form of growth of the principal amount over the bond's life. The bond is purchased at a deep discount and redeemed at par at maturity. That discount from par represents the interest that will be earned at maturity date. However, the discount is accreted annually and the investor pays taxes yearly on the imputed interest creating "phantom income." Zero-coupon bonds have greater, not lower, price volatility.
Currently, a company issues 5% Aaa/AAA debentures at par. Two years ago, the corporation issued 4% AAA rated debentures at par. Which of the following statements regarding the outstanding 4% issue are true? 1. The dollar price per bond will be higher than par. 2. The dollar price per bond will be lower than par. 3. The current yield on the issue will be higher than the coupon. 4. The current yield on the issue will be lower than the coupon.
The dollar price per bond will be lower than par and the current yield on the issue will be higher than the coupon
A new convertible debt security has a provision that it cannot be called for five years after the issue date. This call protection is most valuable to a recent purchaser of the security if A. interest rates are falling. B. interest rates are rising. C. interest rates are stable. D. the market price of the underlying common stock is increasing.
The market price of the underlying common stock is increasing Convertible debt securities are more sensitive to the price of the underlying common stock than they are to interest rates. Call protection would enable this investor to hold on to the debt security while the stock rises in value rather than having it called away. Although it is true that call protection protects against a potential call when interest rates decline, the protection against a call when the underlying stock is rising is considered to be more valuable.
A client is trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors are equal and your client is in a 28% marginal income tax bracket, which bond do you tell the client to purchase and why? A. The municipal bond because its equivalent taxable yield is 6.30% B. The corporate bond because the after-tax yield is 6.25% C. The municipal bond because its equivalent taxable yield is 6.60% D. The corporate bond because the after-tax yield is 4.50%
The municipal bond b/c its equivalent taxable yield is 6.6% If we compute the tax-equivalent yield of the muni, we see that it is 6.60%, which is a higher return than the 6.25% on the corporate bond. The formula to get this starts by taking the investor's tax bracket and subtracting it from 100%. 100% − 28% = 72%. We then divide the muni coupon of 4.75% by the 72%, and the result rounds off to 6.6%.
Which of the following regarding corporate debentures are true? 1. They are certificates of indebtedness. 2. They give the bondholder ownership in the corporation. 3. They are unsecured bonds issued to finance capital expenditures or to raise working capital. 4. They are the most senior security a corporation can issue.
They are certificates of indebtedness and they are unsecured bonds issued to finance capital expenditures or to raise working capital Debentures are debt securities that represent unsecured loans of the issuer. They are senior to common and preferred stock in claims against an issuer. They are issued to finance capital expenditures or raise working capital.
The most common collateral securing a Brady bond is A. the credit standing of the sovereign nation issuing the Brady bond. B. U.S. Treasury zero-coupon bonds with a maturity corresponding to the maturity of the individual Brady bond. C. an asset, or group of assets, pledged by the borrowing entity. D. the credit standing of the banking institution acquiring the Brady bond.
U.S. Treasury zero-coupon bonds w/ a maturity corresponding to the maturity of the individual Brady bond
Investors interested in acquiring convertible debentures as part of their investment portfolio would A. want the safety of a fixed-income investment along with potential capital appreciation. B. want the assurance of a guaranteed dividend on the underlying common stock. C. be interested in tax advantages available to convertible debt securities. D. seek to minimize changes in the bond price during periods of steady interest rates.
Want the safety of a fixed-income investment along w/ potential capital appreciation Investors who want the safety of a fixed-income investment with the potential for capital gains would be most interested in purchasing a convertible debenture. However, because convertible debentures can be exchanged for common stock, their market price tends to be more volatile during times of steady interest rates than other fixed-income securities.
Which of the following statements about zero-coupon bonds are true? 1. Zero-coupon bonds are sold at a deep discount from face value. 2. Zero-coupon bonds pay periodic interest payments. 3. The owner of a zero-coupon bond receives his return only at maturity.
Zero-coupon bonds are sold at a deep discount from face value and the owner of a zero-coupon bond receives his return only at maturity
