Unit 3

An investor owns a bond with a 3.5% nominal yield making semiannual interest payments. On each interest payable date, the investor can expect to receive how much? A) $17.50 B) $35.00 C) $175.00 D) $350.00

A) $17.50 A bond with a nominal yield of 3.5% pays $35 in interest annually (3.5% × $1,000 par value). Given the bond makes semiannual interest payments, each of those payments would be in the amount of $17.50.

A bond with a 3% stated yield and a $1,000 par value would pay how much in annual interest? A) $30 B) Not determinable C) $300 D) $3

A) $30 The amount of interest payable annually as the stated, nominal, or coupon yield is calculated as follows: rate 3% × par value ($1,000) = $30.

An investor purchases a bond at $900 with a 5% coupon and a 5-year maturity. The bond has a current yield of A) 5.6%. B) 4.5%. C) 7.8%. D) 7.4%.

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

Regarding different types of debt security maturities available to issuers, which of the following is accurate? A) A balloon maturity uses elements of both serial and term maturities. B) No maturity types incorporate the elements of any other. C) A term maturity uses elements of both serial and balloon maturities. D) A serial maturity uses elements of both term and balloon maturities.

A) A balloon maturity uses elements of both serial and term maturities. An issuer can schedule its bond's maturity using elements of both serial and term maturities. This is known as a balloon maturity. The issuer repays part of the bond's principal before the final maturity date, as with a serial maturity, but pays off the major portion of the bond at maturity.

Which of the following is considered an investment-grade debt rating? A) Baa B) Ba C) BB D) B+

A) Baa Baa is the same as BBB. At this level and above, a debt is considered investment grade. S&P uses "+" and "-" to indicate subgrades, but we do not expect that to be a tested point by itself. However, a "B" rating is not investment grade, regardless of the subgrade.

Each of the following makes regular interest payments except A) Treasury STRIPS. B) Treasury notes. C) Treasury bonds. D) corporate bonds.

A) Treasury STRIPS. Treasury STRIPS have the coupons removed and therefore do not make regular interest payments. Each of the remaining answer choices pays interest on a semiannual basis.

Which of the following is a debt instrument that pays no periodic interest? A) Treasury STRIPs B) Corporate bonds C) Treasury bonds D) Treasury notes

A) Treasury STRIPs STRIPS are Treasury bonds with the coupons removed. With no coupons, STRIPS do not make regular interest payments. Instead, they are sold at a deep discount and mature at par value.

When selling a bond, the issuer is taking A) a borrower's position. B) a creditors position. C) an equity position. D) a loaners position.

A) a borrower's position. Issuers of bonds are borrowing money from the purchaser of the bond.

To the benefit of the issuer, a callable bond is likely to be called when interest rates A) fall. B) remain stable for long periods of time. C) are volatile moving both up and down over short periods of time. D) rise.

A) fall. Bonds with call features are most likely to be called by an issuer when interest rates fall. For example, if an issuer has an outstanding bond paying 6% and interest rates have fallen to 4%, why pay out 6% when prevailing market rates are only 4%? Better to call in the 6% bond and reissue a new bond at the current rate of 4%. In this way, call features benefit the issuer.

A basis point is valued at A) 1% of market value. B) 1/100th of 1%. C) 1% of face value or $10. D) 1/1000th of 1%.

B) 1/100th of 1%. A basis point is a measurement of yield equal to 1/100 of 1%. A full percentage point is made up of 100 basis points (bps). A point is a measurement of the change in a bond's price which equals 1% of face value or $10 per bond.

Your customer is a resident of the state of New York. Which of the following debt issues would generate interest that would be taxable to your customer at the state level but not taxable at the federal level? A) 20-year Treasury bond B) Bridgeport, Connecticut, general obligation bond C) New York City Transportation Authority revenue bond D) Connecticut Steel, Inc., debenture

B) Bridgeport, Connecticut, general obligation bond A municipal bond's interest is received tax free at the federal level but is only tax free at the state level to residents of the state from which the bond was issued. Treasury issues are taxable at the federal level but not the state level. A corporation's interest payment is taxed at all levels.

Which of the following regarding capital and money markets is true? A) Money markets provide long-term financing. B) Capital markets provide intermediate to long-term financing. C) Money markets provide intermediate to long-term financing. D) Capital markets provide short-term financing.

B) Capital markets provide intermediate to long-term financing. The capital market serves as a source of intermediate to long-term financing. The money market, on the other hand, provides short-term financing.

Which of the debt issued listed here would produce tax-free interest at all levels? A) 90-day T-bill B) General obligation bond issued by Puerto Rico C) Maryland Transportation District revenue bond D) General obligation bond issued by the County of San Francisco, California

B) General obligation bond issued by Puerto Rico Issues from a territory of the United States (like Puerto Rico) produce interest that is tax free at the federal, state, and local level. Municipal bond interest is tax free at the federal level and tax free at the state level if the bondholder is a resident of the same state as the issuer. Treasury issues are taxed at the federal level.

Which of the following statements regarding a bond issued with a 6% coupon and now trading in the secondary market is true? A) If the bond falls in price, the current yield will fall also. B) If interest rates rise, the coupon will remain at 6%. C) If interest rates fall, the bond's current yield will rise. D) If interest rates rise, the bond's price also rises in the secondary market.

B) If interest rates rise, the coupon will remain at 6%. Remember that interest rates and bond prices have an inverse relationship. If rates go up, the prices of bonds trading in the secondary market will fall. But regardless of where current interest rates move to (up or down), the bond's 6% coupon will remain the same. The bond will continue to pay annual interest that is computed as 6% of PAR value.

Which of the following is true for U.S. Treasury-issued securities? A) T-bills and T-bonds pay interest semiannually. B) T-bills are purchased at a discount, while T- bonds are purchased as a percentage of par. C) T-notes are purchased at a discount to par, while T-bonds are purchased as a percentage of par. D) T-notes and T-bills pay interest annually.

B) T-bills are purchased at a discount, while T- bonds are purchased as a percentage of par. T-bills are purchased at a discount, while T- bonds and T-note are purchased as a percentage of par. T-notes and T-bonds pay interest semiannually, but interest on T-bills is not paid until maturity (the difference between the discount paid and par value received).

Which of the following are securities representing other securities held on deposit with a trustee where the principal and interest payments have been separated? A) Treasury bills and notes B) Treasury receipts and STRIPS C) Treasury receipts, bills, and notes D) Treasury notes and bonds

B) Treasury receipts and STRIPS Treasury receipts or STRIPS can represent U.S. T-bonds and notes held on deposit at a bank where essentially the coupon interest payments have been separated from the principal. When the Treasury Department does this, the resulting new issues are known as Treasury STRIPS, and when broker-dealers do this, the resulting new issues are known as Treasury receipts.

When purchasing a bond, the investor is taking on A) an equity position. B) a creditor position. C) a debtor position. D) an obligation.

B) a creditor position. When an investor is purchasing a bond, he is lending money to the issuer and becomes a creditor of the issuer.

When interest rates in the open market move up or down, a bond's coupon rate will A) be adjusted to match the open-market rates. B) be unaffected by the open-market interest rates. C) move with the open-market interest rates. D) move inversely to the open-market interest rates.

B) be unaffected by the open-market interest rates. Though the price of a bond will react to market forces, such as supply and demand, and be interest-rate sensitive (inverse), the coupon is always the same: A fixed percentage of par value established by the issuer when the bond was first issued.

When interest rates in the open market move up or down, a bond's coupon rate will A) move with the open-market interest rates. B) be unaffected by the open-market interest rates. C) be adjusted to match the open-market rates. D) move inversely to the open-market interest rates.

B) be unaffected by the open-market interest rates. Though the price of a bond will react to market forces, such as supply and demand, and be interest-rate sensitive (inverse), the coupon is always the same: A fixed percentage of par value established by the issuer when the bond was first issued.

Negotiable jumbo CDs are characterized by all of the following except A) they are unsecured debt of the issuing bank. B) each issue generally matures in 5-10 years. C) they trade in the secondary market. D) they are issued in amounts of $100,000-$1 million.

B) each issue generally matures in 5-10 years. Negotiable jumbo CDs are issued in denominations of $100,000-$1 million and trade in the secondary market. Most jumbo CDs are issued with maturities of one year or less. These CDs are unsecured promissory notes backed only by the credit standing of the issuing institution.

A state government has outstanding debt that it issued to finance toll roads, sports facilities, and public housing projects. All of these issues are examples of A) municipal general obligation (GO) bonds. B) municipal revenue bonds. C) Treasury bonds. D) convertible bonds.

B) municipal revenue bonds. These are all examples of municipal revenue bonds, which are bonds issued to finance a project or facility with the bonds' debt service backed by the facility's revenue stream. The revenue might come from rents, tolls, or admission fees, among other sources.

The coupon on a bond can be described as its A) basis yield. B) nominal yield. C) yield to call. D) current yield.

B) nominal yield. The coupon on a bond is also known as the nominal or stated yield and indicates the annual interest paid. For example, a 4% bond pays $40 of interest per year (4% × $1,000 par value).

If the Midlands Pencil Corporation has issued several different debt securities, an investor would expect the lowest income stream from A) speculative bonds. B) secured debt. C) ordinary debentures. D) subordinated debentures.

B) secured debt. Secured debt is considered the safest type of corporate debt, but the investor accepts a lower rate of interest for that safety.

If a bond is trading at a premium, which of the following rates is correctly ranked from high to low? A) Yield to call, yield to maturity, current yield, nominal yield B) Nominal yield, yield to maturity, current yield, coupon rate C) Coupon rate, current yield, yield to maturity, yield to call D) Yield to call, current yield, nominal yield, coupon rate

C) Coupon rate, current yield, yield to maturity, yield to call The order from high to low is coupon rate, current yield, yield to maturity, yield to call.

For Treasury bills, which of the following are true? I. T-bills are issued at a discount to par. II. T-bills have maturities of 1-10 years III. Most T-bill issues are callable and convertible. IV. T-bills are a direct obligation of the U.S. government. A) II and IV B) I and III C) I and IV D) II and III

C) I and IV T-bills are issued at a discount to par, are six months or less to maturity, and are a direct obligation of the U.S. government. Callable and convertible features are those that should be associated with corporate issues not government issues.

Which of the following is not considered a money market instrument? A) Negotiable jumbo certificates of deposit (CDs) B) Banker's acceptances (BAs) C) Money market funds D) Commercial paper

C) Money market funds Money market instruments are short-term debt instruments. Money market funds are a type of mutual fund that holds money market instruments: they have the shares, but have no maturity date. Remember that in order to be considered a money market security, the debt instrument should have one year or less to maturity. BAs and commercial paper both have maximum maturities of 270 days; most negotiable jumbo CDs mature in one year or less.

A bond offered at par has a yield to maturity A) less than its current yield. B) less than its nominal yield. C) equal to its current yield. D) greater than its current yield.

C) equal to its current yield. When a bond is selling at par, its coupon (or nominal) rate, current yield, and yield to maturity are the same.

U.S. Treasury notes are U.S. government-issued A) short-term debt securities with maturities of 2-10 years. B) short-term debt securities with maturities of 2-12 months. C) intermediate-term debt securities with maturities of 2-10 years. D) long-term debt securities with maturities of 10-20 years.

C) intermediate-term debt securities with maturities of 2-10 years. Treasury notes (T-notes) are U.S. government-issued intermediate-term debt securities having maturities of 2-10 years.

The U.S. federal government is the nation's A) largest borrower and therefore considered least safe credit risk. B) smallest borrower and therefore considered best credit risk. C) largest borrower and considered the best credit risk. D) smallest borrower and considered least safe credit risk.

C) largest borrower and considered the best credit risk. The federal government is the nation's largest borrower, as well as the best credit risk. Securities issued by the U.S. government are backed by its full faith and credit. There is no stronger backing than that of the U.S. federal government.

Repurchase agreements and reverse repurchase agreements are A) equity instruments. B) long-term bonds. C) money market instruments. D) intermediate-term notes.

C) money market instruments. Repurchase (repo) agreements and reverse repurchase agreements are short-term debt securities and are, therefore, a type of money market instrument.

A bond certificate represents A) the lender's right to receive an ownership share in the entity it leant the funds to. B) the borrower's right to receive interest on the amount it received. C) the borrower's obligation to repay the amount it borrowed plus interest. D) the lender's obligation to repay the amount it borrowed plus interest.

C) the borrower's obligation to repay the amount it borrowed plus interest. When an investor lends money to an entity, the certificate evidencing the loan is known as a bond. This certificate represents the borrower's obligation to pay the investor back the amount it borrowed plus interest.

Which of the following is a reason an investor might choose to invest in a corporate bond? A) Bonds can grow faster than the rate of inflation. B) Corporate bond interest is tax-free. C) Bonds pay a higher dividend than stocks. D) A corporation is legally obligated to pay interest on its bonds.

D) A corporation is legally obligated to pay interest on its bonds. Corporate bonds are, depending on rating, generally reliable producers of income through interest payments. A failure to make timely interest payments puts the corporation into default and has legal consequences. Bonds do not pay dividends, nor do they grow in value with inflation. Corporate interest is fully taxable.

A company reorganizing with the intent to emerge from a bankruptcy is likely to issue which of the following type of bonds to accomplish that goal? A) Debentures B) Subordinated debt C) Mortgage bonds D) Adjustment bonds

D) Adjustment bonds Income bonds, also known as adjustment bonds, are used when a company is reorganizing. These bonds allow the issuer to only pay interest if the corporation has enough income to meet the interest payment obligations. This allows the corporation some flexibility while attempting to reorganize and emerge from bankruptcy.

Which of the following is the highest noninvestment grade debt rating? A) BBB B) C C) B D) Ba

D) Ba BB (Ba) is the highest noninvestment grade rating. B and C are lower ratings. BBB is an investment grade rating.

Which of the following corporate bonds is backed by the securities of other corporations or those of a subsidiary? A) Equipment trust certificate B) Debenture C) Mortgage bond D) Collateral trust bond

D) Collateral trust bond Collateral trust bonds are backed by a portfolio of other securities; mortgage bonds are backed by real estate. Equipment trust certificates are backed by equipment. Debentures are backed only by the company's promise to pay (good faith and credit).

Which of the debt issued listed here would produce tax-free interest at all levels? A) 90-day T-bill B) Maryland Transportation District revenue bond C) General obligation bond issued by the County of San Francisco, California D) General obligation bond issued by Puerto Rico

D) General obligation bond issued by Puerto Rico Issues from a territory of the United States (like Puerto Rico) produce interest that is tax free at the federal, state, and local level. Municipal bond interest is tax free at the federal level and tax free at the state level if the bondholder is a resident of the same state as the issuer. Treasury issues are taxed at the federal level.

Which of the following is an example of an unsecured debt security? I. Debenture II. Preferred stock III. Mortgage bond IV. Income bond A) I and II B) I and III C) II and IV D) I and IV

D) I and IV A debenture and income bonds are examples of unsecured debt instruments. Preferred stock is an equity security and a mortgage bond is secured (collateralized) by real estate.

Given bonds are interest-rate sensitive, which of the following statements regarding put and call features for bonds are true? The put feature would likely be exercised if interest rates fall. The put feature would likely be exercised if interest rates rise. The issuer will likely call bonds if interest rates fall. The issuer will likely call bonds if interest rates rise. A) I and II B) I and IV C) III and IV D) II and III

D) 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.

When interest rates in the marketplace move up, what happens to the coupon rate on existing bond? A) The movement depends on the duration of the bond. B) The coupon rate moves in the opposite direction. C) The coupon rate moves in the same direction. D) Nothing; it does not change.

D) Nothing; it does not change. The coupon rate (the fixed rate, the nominal rate, the stated rate) is fixed when the bond is issued and does not change.

All of the following are U.S. government agency debt securities except A) Farm Credit Administration securities. B) Government National Mortgage Association (GNMA) securities. C) Federal National Mortgage Association (FNMA) securities. D) STRIPS.

D) STRIPS. T-bills, notes, STRIPS, and bonds are issued directly by the U.S. Treasury and are not agency debt. However, agencies of the federal government also issue debt securities. GNMA, FNMA, FHLMC, and others such as the Farm Credit Administration are government agencies.

An investor who is seeking income might choose a corporate bond because A) bonds pay a higher dividend than stocks. B) corporate bond interest is tax free. C) bonds can grow faster than the rate of inflation. D) a corporate bond pays a steady income and are generally reliable.

D) a corporate bond pays a steady income and are generally reliable. Corporate bonds are, depending on rating, generally reliable producers of income through interest payments. Bonds do not pay dividends, nor do they grow in value with inflation. Corporate interest is fully taxable.

Bonds can be issued with additional features attached, making them more attractive to investors. All of the following can be considered such features except A) puttable. B) convertible. C) callable. D) maturity.

D) maturity. The features most commonly attached to a bond issue would be having the bond be callable, puttable ( a bond with a put feature), or convertible. Each of these features in its own way might make the issue more attractive to an investor. All bonds have a stated maturity, and as such, this would not be considered an additional feature.