Unit 2 Practice Questions
The minimum face amount of a negotiable CD is
$100,000
A bond selling for $20 above par would be quoted
102.
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?
3.50% Treasury Inflation-Protected Securities (TIPS) adjust the principal value each six months to account for the inflation rate. Therefore, the real rate of return will always be the coupon.
Your client in the 28% federal income tax bracket currently owns some U.S. government bonds with a coupon yield of 6%. In order to receive the same income after taxes, she would need to buy municipal bonds with a coupon of
4.32%
A money market mutual fund would be least likely to invest in which of the following assets? A) Newly issued U.S. Treasury bills B) Newly issued U.S. Treasury notes C) Jumbo CDs D) Repurchase agreements
B) Newly issued U.S. Treasury notes typically invests in money market instruments—those with a maturity date not exceeding 397 days. Treasury notes are issued with maturity dates of 2-10 years.
Many fixed-income investors are looking to avoid loss of principal. Which of the following would likely have the lowest degree of exposure to credit risk? A) A-rated general obligation municipal bond B) Ba-rated corporate mortgage bond C) Aa-rated corporate debenture D) Baa-rated municipal revenue bond
C) Aa-rated corporate debenture
An investor is analyzing various risks related to corporate and government bonds. She is interested in finding a risk that is more specific to corporate bonds than to government bonds. Which of the following options correctly defines that risk?
Default risk
Which of the following would make a corporate bond more subject to liquidity risk? Short-term maturity Long-term maturity High credit rating Low credit rating
Long-term maturity Low credit rating
What rate of interest would a bank in England charge another British bank for a short-term loan?
SOFR
When investing in a foreign bond fund, a customer will profit if which of these occur? The U.S. dollar strengthens. The U.S. dollar weakens. Foreign currencies strengthen. Foreign currencies weaken.
The U.S. dollar weakens. Foreign currencies strengthen.
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? The dollar price per bond will be higher than par. The dollar price per bond will be lower than par. The current yield on the issue will be higher than the coupon. The current yield on the issue will be lower than the coupon.
The dollar price per bond will be lower than par. The current yield on the issue will be higher than the coupon.
Which of the following best describes a Yankee bond?
U.S. dollar-denominated bond issued by a non-U.S. entity inside the United States
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 Eurodollar bond.
DERP Corporation has issued 5% convertible debentures maturing in 2040. The conversion price is $40 and the common is currently trading at $48 per share. One would expect the DERP debentures to be selling somewhat
above $1,200.
An investor owns a debenture convertible into 20 shares of the issuer's common stock. After a 2-for-1 stock split, the terms of the debenture provide for conversion into 40 shares. This is because the debenture has
an antidilutive clauses that provide for an adjustment in the number of shares based on stock splits or stock dividends.
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
has declined.
A mortgage-backed security (MBS), such as a Ginnie Mae, makes a combination principal and interest payment to an investor. This payment will be
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
somewhat below $48 per share. 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.
In order to compute yield to maturity, all of the following are necessary except A) the maturity date. B) the current market price. C) the call price. D) the nominal yield.
the call price.
An investor buys 10M RAN 6.6s of 32 at 67. What is the total purchase price?
the investor bought $10,000 (10M) of the RAN Corporation bonds with a 6.6% coupon (interest rate stated on the face of the bond) that mature in 2032 (32). The price is 67, which represents 67% of $10,000, or $6,700.
One of the ways in which U.S. government agency issues differ from those offered directly by the U.S. Treasury is that agency issues
typically carry higher returns than Treasury issues because of the lack of direct government backing.
All of the following are true of government agency bonds except A) they trade openly. B) older ones have coupons attached, while new ones are book-entry. C) they are direct obligations of the U.S. government. D) they are considered relatively safe investments.
C) they are direct obligations of the U.S. government.
All of the following are true of negotiable, jumbo certificates of deposit except A) they are readily marketable. B) they usually have maturities of one year or less. C) they are secured obligations of the issuing bank. D) they are usually issued in denominations of $100,000 to $1 million or more.
C) they are secured obligations of the issuing bank.
A corporation has issued a 4% $60 par convertible stock with a conversion price of $20. With the preferred stock selling at $66 per share, an investor holding 100 shares of this stock will benefit by converting if the price of the common stock is
above $22.00 per share. 60/20 = 3 We divide the current price of the preferred ($66) by the three shares to arrive at the parity price of $22.
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 rising. B) interest rates are stable. C) interest rates are falling. D) the market price of the underlying common stock is increasing.
D) 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.
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 is selling at a discount. C) the bond will be called. D) the bond will go into default.
B) 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.
Regarding convertible debentures, one characteristic of which your clients should be aware of is that A) it is generally best to convert when the common stock is selling below its parity price. B) the conversion feature protects against an early call. C) they generally pay a higher interest rate than nonconvertible debentures. D) they trade in line with the issuer's common stock once the conversion price is reached.
D) they trade in line with the issuer's common stock once the conversion price is reached.
Your customer owns 1,000 shares of the XYZ $100 par 5½% callable convertible preferred stock convertible into four shares of XYZ common stock at $25. What should she be advised to do if the board of directors were to call all the preferred at 106 when the XYZ common stock is trading at $25.50?
Present the preferred stock for the call because the call price is $4 above the parity price. If the preferred stock is called, the client will receive $106 per share or $106,000. Tendering the preferred stock will provide the highest value. The value of converting the preferred stock into four shares of common is worth $102 (4 × $25.50 = $102), which is less than the call value of $106. On the 1,000 shares, this is a $4,000 difference. The dividends will cease on the call date if the preferred stock is held beyond the call date.
