Unit 13 - Types and Characteristics of Fixed Income (Debt) Securities and Methods Used to Determine Their Value

BFJ Corp's 5% convertible bond is trading at 120. The bond is convertible at $50. An investor buying the bond now and immediately converting into common stock, would receive A) 20 shares B) 20 shares plus cash for fractional shares C) 24 shares D) 2.4 shares

A) 20 shares

A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of A) 5.56% B) 7.80% C) 5.00% D) 7.40%

A) 5.56% Current yield is determined by dividing the annual interest payment by the current market price of the bond ($50 ÷ $900 = 5.56%). Years to maturity is not a factor in calculating current yield.

Adam has a portfolio of bonds worth approximately $125,000. He is concerned that interest rates will increase in the near term. Which of the following would be the least desirable strategy for Adam? A) Sell bonds with a short duration and buy those with a longer duration B) Sell long-term bonds and buy short-term bonds C) Sell Treasury bonds and buy Treasury bills D) Sell bonds with lower coupons and buy those with higher coupons

A) Sell bonds with a short duration and buy those with a longer duration

If a bond has a long duration, it will A) be more sensitive to small changes in interest rates than a bond with a shorter duration B) be relatively unaffected by small changes in interest rates C) be less sensitive to small changes in interest rates than a bond with a shorter duration D) continue paying interest into perpetuity

A) be more sensitive to small changes in interest rates than a bond with a shorter duration

With respect to safety of principal, of the following investments, the least risky is A) corporate AA debentures B) common stock C) exchange-listed warrants D) equity options

A) corporate AA debentures The least risky investment listed is the corporate debenture because, as a debt instrument, it has priority over the others.

A $1,000 bond with a nominal yield of 8% will pay how much interest each year? A) $800.00 B) $80.00 C) $160.00 D) $40.00

B) $80.00

The current yield on a bond with a coupon rate of 5.5% selling at 110 is A) 2% B) 5% C) 5.5% D) 6%

B) 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 x 5.5%) divided by $1,100 and that equals 5%.

A bond fund owns $100 million each of a number of different corporate bonds. The duration of those individual bonds is 3, 4, 5, 6, 8, and 10 years. From this information, you would estimate the average duration of the bond fund to be A) 5.5 years B) 6 years C) 4 years D) 8 years

B) 6 years

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) Future value of $1,150 B) Interest payments of $40 C) 60 payment periods D) Present value of $1,100

B) 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.

Which of the following bonds would be the least price sensitive to changes in market interest rates? A) 6% AA bond due in 18 years with a YTM of 6.8% B) 4.5% Treasury bond due in 20 years with a YTM of 4.1% C) Zero due in one year with a YTM of 6% D) 10% BB bond due in 21 years with a YTM of 8.7%

C) Zero due in one year with a YTM of 6%

In order to perform a discounted cash flow estimation of the value of a bond, it would be necessary to know all of the following EXCEPT A) the discount rate B) the future cash flow C) the parity price of the bond D) the number of interest payments

C) the parity price of the bond In its simplest iteration, discounted cash flow is nothing more than taking all the money you are scheduled to receive over a given future period and adjusting that for the time value of money (the discount rate). Parity price is only relevant to convertible bonds.

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 is most likely TRUE with reference to the current market price of this bond? A) Cannot be determined from the information given B) Premium C) Par value D) Discount

D) Discount

The price of which of the following will fluctuate most with fluctuating interest rates? A) Money market instruments B) Common stock C) Short-term bonds D) Long-term bonds

D) Long-term bonds

What happens to outstanding fixed-income securities when interest rates decline? A) No change B) Coupon rates increase C) Yields increase D) Prices increase

D) Prices increase

An investor is considering a 10-year stripped U.S. Treasury and a 10-year U.S. Treasury note, both with a yield to maturity of 4.8%. Compared to the note, the strip has A) more reinvestment risk and less interest rate risk. B) more liquidity risk and less interest rate risk. C) less reinvestment risk and more interest rate risk. D) more interest rate risk and less liquidity risk.

C) less reinvestment risk and more interest rate risk. The strip is a zero-coupon security so it has no cash flows to reinvest and therefore no reinvestment risk. However, it has more interest rate risk (longer duration) than the Treasury note. Remember, the duration of a zero-coupon bond is its maturity date while any debt security paying periodic interest (Treasury notes pay semiannually) will always have a duration shorter than its length to maturity.

An investor purchases a Treasury note and the confirmation shows a price of $102.21. Rounded to the nearest cent, the investor's cost, excluding commissions, is A) $102.21. B) $1,022.10. C) $1,022.21. D) $1,026.56.

D) $1,026.56. Treasury notes are quoted in 32nds where each 32nd equals $.3125. The 102 in the quote equals $1,020 and the 21/32 is an additional $6.56 bringing the total to $1,026.56.

All of the following factors have an inverse relationship to a bond's duration except A) coupon rate. B) current yield. C) yield to maturity. D) time to maturity.

D) time to maturity. The relationship between the time to maturity (length) and duration is a linear one. That is, the longer the time until the bond matures, the higher (longer) the duration - it is a direct relationship. Yields, on the other hand, have an inverse relationship with duration. That is, the higher the yield, the lower (shorter) the duration. An example would be comparing a bond with an 8% coupon rate to one with a 6% coupon rate. All other things beging equal, the bond with the 8% coupon rate will have a shorter duration than the one with a 6% coupon; the relationship is inverse rather than linear.

Which of the following is NOT a valuation method for a fixed-income security? A) Discounted cash flow B) Price-to-earnings ratio C) Dividend discount model D) Conversion parity

B) Price-to-earnings ratio The P/E ratio is only used with common stock.

What happens to bond durations when coupon rates increase and maturities increase? As coupon rates increase, duration: As maturities increase, duration: A.) Increases Decreases B.) Increases Increases C.) decreases decreases D.) decreases increases

D.) decreases increases As coupon rates increase, the duration on the bond will decrease because investors are receiving more cash flow sooner. As maturity increases, duration will increase because the payments are spread out over a longer time.

One would look at the average maturities when doing a cash flow analysis for A) revenue bonds B) mortgage-backed pass-through securities C) Brady bonds D) subordinated debentures

B) mortgage-backed pass-through securities Mortgage-backed pass-through securities pass through interest and principal payments to their investors. The rate at which the cash flows are generated depends, among other things, on the rate at which the mortgages mature.