Series 7 - Chapter 5
A call premium is best described as the amount the: A. Investor pays above the par value B. Investor will receive if the bond is sold above the par value C. Issuer pays above 100 to retire bonds prior to maturity D. Bondholder receives at maturity
A bond issue's indenture will usually require that, if an issuer calls bonds (redeems prior to maturity), it must pay the bondholder a premium (above par value). For example, a bond that matures in 30 years is callable at 103.5 in 10 years. The issuer must pay a premium of $35 per bond (103.5% of $1,000 is $1,035) above par to retire the bonds prior to maturity.
A customer buys two bonds, both have a par value of $1,000, and she pays 103 5/8 for each bond. The bonds are callable at 105. If the customer's bonds are called, she will receive: A. $2,000 B. $2,100 C. $2,072.50 D. $1,050
If the bonds are called the investor will receive 105% of the par value for each bond. $1,000 x 105% = $1,050; however, this is multiplied by two bonds for a total of $2,100.
During an inflationary period when interest rates are rising, the market value of existing bonds would: A. Remain stable B. Increase C. Decrease D. Fluctuate
Interest rates and bond prices have an inverse (opposite) relationship. As interest rates rise, bond prices decrease. Therefore, in an inflationary period where interest rates are rising, the market value of existing bonds will decrease.
Which of the following is the lowest Moody's investment grade bond rating? A. BBB B. Baa C. Ba D. A
Moody's investment grade bond ratings, from highest to lowest, are Aaa, Aa, A, Baa. BBB is Standard & Poor's lowest investment grade rating. Use the following memory aide to distinguish Moody's ratings from S&P ratings. The name Moody's is a capital letter followed by small letters, just like their ratings (e.g, Baa). S&P consists of all capital letters, just like their ratings (e.g., BBB).
Which of the following Moody's ratings is the most speculative? A. Aa B. A C. Baa D. Ba
Of the choices given, Ba is the most speculative. The highest Moody's rating is Aaa.
The securities that are deposited in an escrow account for an advance refunding of a municipal bond are: A. Revenue bonds B. General obligation bonds C. Federal agency bonds D. Treasury bonds
Only Treasury obligations are acceptable securities as escrow when a municipal bond is being advance refunded.
Your firm has completed an underwriting of Zylo Plastics subordinated debentures. The bond indenture contains a five-year call protection provision. This covenant would be most valuable to bond purchasers if, during the five years following issuance: A. Interest rates decline B. Interest rates increase C. Interest rates remain stable D. The yield curve slopes downward
The call protection would be most valuable to a recent purchaser of the bond if interest rates are falling. If interest rates fall, bond prices rise. Corporations will call back bonds when interest rates decline and issue new bonds with lower rates of interest. Bonds are usually callable at a small premium above par value. If the bonds are not callable, the investor can realize the full benefit of an increase in the market price of the bonds.
Relative to a municipal bond purchased at a discount that is callable at par, place the following yields in the proper order from lowest to highest yield. I. Current yield II. Nominal yield III. Yield to maturity IV. Yield to call
A bond trading at a discount, which is callable at par, has a nominal yield that is less than its yield to maturity. Current yield falls between the nominal yield and yield to maturity, and the yield to call is greater than the yield to maturity. A bond trading at a premium has a nominal yield, which is higher than the yield to maturity, with the current yield in between the other two yields. The yield to call is lower than the yield to maturity for a bond selling at a premium, which is callable at par.
A 4.65% New York City GO bond matures in 20 years. The bond is callable in 8 years at 103. Which of the following statements is TRUE? A. The investor has 3 years of call protection B. The issuer must pay investors an 8-point call premium to exercise the call privilege on the bonds C. The investor will receive less for the bond if it is called versus holding the bond to maturity D. The issuer may exercise the call provision anytime after the 8th
The call premium of 3 points ($30 per bond) refers to the amount above par value which the issuer must pay the owner of the bond when the bond is called. Issuers usually call outstanding bonds when interest rates decline, and they are able to issue new bonds at lower rates of interest. The bond has 8 years of call protection. The issuer would need to make an outlay of cash to call back the bonds, but would save money because of the lower rate of interest the issuer would pay on the new bonds. A call provision is exercised by an issuer and not the bondholder.
The current yield on a municipal bond with a coupon rate of 4.50%, purchased at par and currently trading at $1,055, is:
The current yield is found by dividing the yearly interest payment of $45 by the market price of $1, 055. This equals 4.26%. The fact that the bond was purchased at par is not relevant.
