UNIT 2 Checkpoint

A bond is convertible at $25. The market value of the stock is $30. What is the parity price of the bond?

. $1,200 If a bond is convertible at $25, each $1,000 bond will convert to 40 shares. Forty shares × $30 = $1,200 parity of the bond

A bond purchased at $900 with a 5% coupon and a 5-year maturity has a current yield of

. 5.6% Current yield is determined by dividing annual interest payment by the current market price of the bond ($50 / $900 = 5.6%). Years to maturity is not a factor in calculating current yield.

Which of the following debt securities does NOT have a fixed maturity date? A. Collateralized mortgage obligation B. General obligation bond C. Treasury STRIPS D. Subordinated debenture

. A. Collateralized mortgage obligations (CMOs) are mortgage-backed securities. Because mortgages are often paid off ahead of the scheduled maturity, the maturity date of a CMO is not certain.

CMOs are backed by A. mortgages B. real estate C. municipal taxes D. the full faith and credit of the U.S. government

. A. Collateralized mortgage obligations are collateralized by mortgages on real estate. They do not own the underlying real estate, so they are not considered to be backed by it.

If your customer wants to set aside $40,000 for when his child starts college, but does NOT want to endanger the principal, you should recommend A)municipal bonds for their tax benefits B)Treasury STRIPS C)corporate bonds with high rates of interest D)common stock

. B. Treasury Strips Treasury STRIPS are guaranteed by the U.S. government so there is no chance of default. They are zero-coupon bonds and offer no current income, which is appropriate for a client who wants 100% return paid at a future date for college expenses

Which of the following statements regarding convertible bonds is NOT true? A. Coupon rates are usually higher than nonconvertible bond rates of the same issuer. B. Convertible bondholders are creditors of the corporation. C. Coupon rates are usually lower than nonconvertible bond rates of the same issuer. D. If the underlying common stock declines to the point where there is no advantage to convert the bonds into common stock, the bonds will sell at a price based on their inherent value as bonds, regardless of the convertible feature.

. A. Coupon rates are not higher; they are lower because of the value of the conversion feature. The bondholders are creditors, and if the stock price falls, the conversion feature will not influence the bond's price.

A debt instrument, which may or may not be exchange traded, where the final payment at maturity is based on the return of a single stock, a basket of stocks, or an equity index is known as A. An Equity or Index-linked Note (ELN or ILN) B. CMO C. A Bond Fund D. Preferred Shares

. A. Equity-linked notes are debt instruments where the final payment at maturity is based on the return of a single stock, a basket of stocks, or an equity index. Some, but not all, are exchange traded and those that are can be referred to as exchange-traded notes (ETNs).

A customer wishes to buy a security providing periodic interest payments, safety of principal, and protection from purchasing power risk. The customer should purchase A. TIPS B. TIGRS C. CMOs D. STRIPS

. A. TIPS offer inflation protection and safety of principal because they are backed by the U.S. government.

Which of the following investments is most suitable for an investor seeking monthly income? A. GNMA B. Zero-Coupon Bond C. Mutual Fund Investing in small-cap issues D. Growth stock

. A. GNMA GNMA is the most suitable investment for an investor seeking monthly income. Zero-coupon bonds, growth stocks, and mutual funds which invest in small-cap issues offer higher long-term growth potential, but they are not designed to provide monthly income.

Which of the following statements regarding put and call features of bonds are TRUE? I.The put feature would likely be exercised if interest rates fall. II.The put feature would likely be exercised if interest rates rise. III.The issuer will likely call bonds if interest rates fall. IV.The issuer will likely call bonds if interest rates rise

. A. II and III A put feature on a bond benefits the bondholder. Once the bond becomes puttable, its holder has the right to put it back to the issuer at par. At this point, the bondholder is insulated from rate risk (the risk that rates will rise, putting downward pressure on bond prices). Once puttable, the bond will not trade below par. Issuers will likely call bonds if rates fall. The issuer can issue new bonds at a lower rate and use the proceeds to call in the original bond

All of the following are money market instruments EXCEPT A. Newly issued Treasury Notes B. Treasury Bills C. Commercial Paper D. Jumbo CDs

. A. Newly issued Treasury notes Money market securities have a maximum maturity of 1 year. Treasury notes are issued with maturities of 2 to 10 years. Treasury bills are money market instruments with maturities of 6 months or less. Jumbo CDs are issued by banks and have maturities of 1 year or less. Commercial paper (issued by corporations) is unsecured short-term debt with maturities of 270 days or less

You observe that a yield curve that was previously flat is moving toward having short- term interest rates lower than long-term interest rates. This new yield curve is considered to be A. Normal B. Adverse C. Breaking Out D. Inverted

. A. Normal When short-term interest rates are lower than long-term interest rates, the yield curve is considered to be normal

A convertible bond is purchased at its face value and convertible at $125. What is the conversion ratio? A. 2 B. 8 C. 12 D. 20

. B. $1,000 par ÷ $125 conversion price = 8 shares per bond.

The term tranche is associated with which of the following investments? A. FNMA B. CMO C. GNMA D. SLMA

. B. CMOs are a type of mortgage-backed security. A CMO issue is divided into several tranches, which set priorities for payments of principal and interest.

When selling a CMO to a customer, a registered representative must make which of the following disclosures? A. Repayment of principal is guaranteed by the federal government. B. The rate of return may vary owing to early repayment. C. The minimum investment is $15,000. D. A certificate is issued in the name of the beneficial owner.

. B. Prepayment risk is one of the important risks associated with CMOs and must be disclosed to prospective investors. All of the other statements are false.

A bond is convertible to common stock at $20 per share. If the market value of the bond falls to $800, what is the new parity price of the stock? A. $12 B. $16 C. $25 D. $40

. B. The calculations are: $1,000 ÷ $20 = 50 shares for one bond. $800 bond price ÷ 50 shares = $16 parity price.

In treasury auctions a bidding system known as a Dutch auction is used. With this auction process the winning bid is the I.lowest yield at which all of the securities can be sold II.highest yield at which all of the securities can be sold III.the price paid by bidders who bid at or below the winning yield bid IV.the price paid by bidders who bid at or above the winning yield bid

. B. I and III When a Dutch auction is used for treasury securities the winning bid is the lowest yield at which all of the securities can be sold. This is known as the "stop out price" and once established is the rate that all bidders who bid at or below that yield will pay

Which of the following bonds trade flat? A. GO bonds B. Income bonds C. Mortgage bonds D. Revenue bonds

. B. Income bonds Bonds that trade flat do not trade with accrued interest. These include income bonds (also known as adjustment bonds), zeroes, bonds in default, and bonds that settle on an interest payment date

All of the following statements regarding CMOs are true EXCEPT A)PACs provide protection against extension risk B)TACs provide protection against extension risk C)TACs provide protection against prepayment risk D)PACs provide protection against prepayment risk

. B. PACs provide protection against both prepayment and extension risk while TACs provide protection against prepayment risk only.

An investor who has purchased a CMO A)should expect a yield slightly lower than that of Treasury securities B)receives semiannual interest C)is subject to federal, state, and local taxation D)owns a security that is fully backed by the U.S. government

. C. Interest on CMOs is subject to federal, state, and local taxation. CMOs pay interest monthly and yield more than Treasury securities. They are issued by financial institutions, including banks and broker/dealers, and are not backed by the U.S. government

Which of the following callable debentures is least likely to be called? A)8% maturing in 2018, callable at 102 B)8% maturing in 2024, callable at 100 C)6% maturing in 2017, callable at 102 D)6% maturing in 2018, callable at 100

. C. The bond with the shortest maturity is the least likely to be called, because it will cost the issuer the least in net interest over the life of the bond. When determining which bonds to call, the comparison in order of priority is: (1) years to maturity, (2) coupon rate, (3) call premiums

An investor's portfolio includes 10 bonds and 200 shares of common stock. If both positions increase by one point, what is the appreciation?

. C. 300 The gain would be $100 for the bonds (one point for one bond is $10 × 10 bonds) and $200 for the common stock (one point is $1 × 200 shares). The total portfolio gain is $300.

Which of the following is NOT a risk to a U.S. resident owning a eurodollar bond? A. Inflation risk B. Interest Rate Risk C. Currency Risk D. Default Risk

. C. Currency Risk Eurodollar bonds are denominated in dollars; therefore, no currency risk exists for a U.S. resident

Which of the following statements regarding the federal funds rate is NOT true? A)It tends to lead the upward and downward moves of other interest rates. B)It tends to fluctuate more than long-term interest rates. C)It tends to fluctuate in response to the prime rate. D)It is the rate at which member banks of the Federal Reserve System lend money to each other.

. C. It tends to fluctuate in response to prime rate The federal funds rate is charged by banks with excess reserves on overnight loans made to meet reserve requirements. It is determined by supply and demand of federal funds between Federal Reserve member banks. It is considered the most volatile rate in the economy and generally fluctuates on a daily basis. The federal funds rate is set by the market, not the banks.

Prices quoted for immediate payment and delivery of currencies are known as A. Forward Prices B. Last Sales C. Spot Prices D. Future Prices

. C. Spot Prices Spot rates or prices are those quoted for immediate payment and delivery of foreign currencies. Settlement for actively traded currencies will take place in 1 business day and for less actively traded currencies in 2 business days

Under what economic circumstances do issuers call bonds?

. Calls occur when interest rates are declining.

Interest received from a CMO investment is taxable at which level(s)? I. Federal II. State III. Local

. D. Interest received from CMOs is fully taxable at federal, state, and local levels.

Moody's bond page lists the following bonds: GMAC ZR '19 54¼, Ogden 5s '22 26½. The annual interest on 50 Ogden bonds is A. $93 B. $500 C. $930 D. $2,500

. D. Ogden 5s means 5% bonds. Five percent of $1,000 par equals $50 interest per bond annually. For 50 bonds, the annual interest is $2,500.

A registered representative may compare the performance of a CMO investment to the performance of a security issued by which of the following agencies? A. GNMA B. FDIC C. SLMA D. None of the above

. D. The performance of CMOs may not be compared to any other investment vehicle.

A municipal bond has a coupon of 6.25% and at the present time, its yield to maturity is 6.75%. From this information, it can be determined that the municipal bond is trading A. Flat B. At a premium C. At par D. At a discount

. D. At a discount The YTM is greater than the nominal yield, or coupon yield. Therefore, the bond is trading at a discount.

A trust indenture spells out the covenants between A. trustee and underwriter B. issuer and underwriter C. issuer and bondholders D. issuer and a trustee for the benefit of a bondholder

. D. The trust indenture is a contract between the issuer and a trustee for the benefit of a bondholder. It spells out the covenants to be honored by the issuer and gives the trustee the power to monitor compliance with the covenants and the ability to take action on behalf of the bondholder(s) if a default of the covenants is found.

Of the following bonds, which has the greatest price volatility? A)Corporate bond fund B)Zero-coupon bond with 5 years to maturity C)AA corporate bond with 7 years to maturity D)Zero-coupon bond with 15 years to maturity

. D. Zero-coupon bond with 15 years to maturity The longer the duration of a bond, the greater the volatility will be of its market price when interest rates change. Because zero-coupon bonds do not make interest payments but are priced at a deep discount to par value, they are more volatile than coupon-bearing bonds

Accrued interest on a bond confirmation is I.added to the buyer's contract price II.added to the seller's contract price III.subtracted from the buyer's contract price IV.subtracted from the seller's contract price

. I and II The accrued interest calculation is made to determine the seller's share of the upcoming interest payment. It is added to the buyer's contract price (the buyer pays), and it is added to the seller's contract price (the seller receives).

How much is 80 basis points? I. $8 II. $80 III. .8% IV. 8%

. I and III We know that 100 basis points = $10 = 1% of a bond's face value.Therefore, 80 basis points = .8% and is worth $8.00 (80 × $.10).

The federal funds rate is which of the following? I.Computed daily II.Generally higher than the discount rate III.Set by the Federal Reserve IV.The rate charged in bank-to-bank lending

. I and IV The federal funds rate is computed daily, is lower than the discount rate, and is the rate charged in bank-to-bank lending. The only interest rate the Federal Reserve directly sets is the discount rate. It does not set the federal funds rate, although it heavily influences its level

When the U.S. dollar is devalued I.U.S. products become more competitive abroad II.U.S. products become less competitive abroad III.foreign products become more competitive in the U.S. IV.foreign products become less competitive in the U.S.

. I and IV. When the U.S. dollar is devalued, U.S. products become more competitive abroad since the foreign currency is stronger. Of course, the exact opposite happens to foreign products in the United States as they become less competitive. In other words, since the American dollar is worth less, it takes more American dollars to purchase those foreign products.

You buy ten 8% T-notes at 101-16. What is the dollar amount of this purchase? A. $1,001.50 B. $1,011.60 C. $10,150.00 D. $10,812.00

. I, II and IV Government notes and bonds are quoted in 32nds. Therefore, a quote of 101-16 means 101¹⁶)₃₂. To find the price of one of the bonds, multiply the price by 10 points: 101.5 × 10 = $1,015; $1,015 × 10 bonds = $10,150.

ABC, Inc., has filed for bankruptcy. Interested parties will be paid off in which order? I. Holders of secured debt II. Holders of subordinated debentures III. General creditors IV. Preferred stockholders

. I, III, II, IV The order in a liquidation is as follows: IRS and other government agencies, secured debt holders, unsecured debt holders, general creditors (in most cases, unsecured debt holders are given a slight priority over all but the largest creditors), holders of subordinated debt, preferred stockholders, and common stockholders.

Which of the following statements regarding U.S. government agency obligations are TRUE? I. They are all direct obligations of the U.S. government. II. They generally have higher yields than yields of treasury securities. III. The FNMA is a publicly traded corporation. IV. Securities issued by GNMA trade on the NYSE floor.

. II and III U.S. government agency debt is an obligation of the issuing agency. This causes agency debt to trade at higher yields reflecting this greater risk. FNMA was created as a government agency but was spun off in 1968 and is now an NYSE listed corporation. GNMA pass-through certificates trade OTC.

Which of the following scenarios would be TRUE about a step-down CD? I.Initially purchased the CD at a lower rate II.Initially purchased the CD at a higher rate III.Later the interest rate adjusts to a lower rate than when it was purchased IV.Later the interest rate adjusts to a higher rate than when it was purchased

. II and III With a step-down CD the interest rate will pay a higher rate in the earlier months and adjust downward in later months to pay a lower rate than when it was initially purchased

When a customer purchases a new municipal bond, the accrued interest is calculated I.from the trade date II.from the dated date III.up to the interest payment date IV.up to, but not including, the settlement date

. II and IV Interest accrues from the bond's dated date up to, but not including the settlement date

Which of the following characteristics describe Treasury bills? I.Issued at face value II.Issued at a discount III.Pay semiannual interest IV.Pay all interest on maturity

. II and IV Treasury bills are issued at a discount and pay all interest at maturity

Which of the following statements regarding convertible and callable bonds are TRUE? I. If called, the owners have the option of retaining the bonds and will continue to receive interest. II. After the date it is called, interest will cease to be paid. III. Upon conversion, there will be dilution. IV. The coupon rate would be lower than the rate for a nonconvertible bond.

. II, III and IV When a bond is called and the owner does not redeem, the interest payments cease. Conversion causes dilution, and generally interest rates on convertible bonds are lower than straight debt issues.

Which of the following statements regarding T-bills are TRUE? I. T-bills trade at a discount to par. II. T-bills mature in less than 1 year. III. Most T-bill issues are callable. IV. T-bills are a direct obligation of the U.S. government.

. T-bills trade at a discount to par, mature in less than 1 year, and are a direct obligation of the U.S. government. T-bills are noncallable.

Which of the following would an issuer most likely call? A. High-interest bond, callable at a premium B. High-interest bond, callable at par C. Low-interest bond, callable at a premium D. Low-interest bond, callable at par

B. Issuers want to call bonds that are costly to them at as low a price as possible. A high-interest bond with no call premium is the best combination. The issuer would be least likely to call a low-interest bond with a high call premium.

Investors who purchase callable bonds face what types of investment risk?

Call risk is the risk that the bonds will be called and the investor will lose the stream of income from the bond. Remember that bonds do not pay interest after they have been called. The call feature also causes reinvestment risk. If interest rates are down when the call takes place, what likelihood does the investor have of investing the principal received at a comparable rate? Both call risk and reinvestment risk also apply to callable preferred stock.