Bonds Midterm from homework

When classified by type of issuer, asset-backed securities are part of the: a. Corporate sector b. Structured finance sector c. Government and government-related sector

b. structured finance sector

Relative to an otherwise similar option-free bond, a: putable bond will trade at a higher price. callable bond will trade at a higher price. convertible bond will trade at a lower price.

A is correct. A put feature is beneficial to the bondholders. Thus, the price of a putable bond will typically be higher than the price of an otherwise similar non-putable bond. B is incorrect because a call feature is beneficial to the issuer. Thus, the price of a callable bond will typically be lower, not higher, than the price of an otherwise similar non-callable bond. C is incorrect because a conversion feature is beneficial to the bondholders. Thus, the price of a convertible bond will typically be higher, not lower, than the price of an otherwise similar non-convertible bond.

The provision that provides bondholders the right to sell the bond back to the issuer at a predetermined price prior to the bond's maturity date is referred to as: a put provision. a make-whole call provision. an original issue discount provision.

A is correct. A put provision provides bondholders the right to sell the bond back to the issuer at a predetermined price prior to the bond's maturity date. B is incorrect because a make-whole call provision is a form of call provision; i.e., a provision that provides the issuer the right to redeem all or part of the bond before its maturity date. A make-whole call provision requires the issuer to make a lump sum payment to the bondholders based on the present value of the future coupon payments and principal repayments not paid because of the bond being redeemed early by the issuer. C is incorrect because an original issue discount provision is a tax provision relating to bonds issued at a discount to par value. The original issue discount tax provision typically requires the bondholders to include a prorated portion of the original issue discount (i.e., the difference between the par value and the original issue price) in their taxable income every tax year until the bond's maturity date.

A liquid secondary bond market allows an investor to sell a bond at: a. The desired price b. A price at least equal to the purchase price c. A price close to the bond's fair market value

c. A price close to the bond's fair market value

Which of the following provisions is a benefit to the issuer? Put provision Call provision Conversion provision

B is correct. A call provision (callable bond) gives the issuer the right to redeem all or part of the bond before the specified maturity date. If market interest rates decline or the issuer's credit quality improves, the issuer of a callable bond can redeem it and replace it by a cheaper bond. Thus, the call provision is beneficial to the issuer. A is incorrect because a put provision (putable bond) is beneficial to the bondholders. If interest rates rise, thus lowering the bond's price, the bondholders have the right to sell the bond back to the issuer at a predetermined price on specified dates. C is incorrect because a conversion provision (convertible bond) is beneficial to the bondholders. If the issuing company's share price increases, the bondholders have the right to exchange the bond for a specified number of common shares in the issuing company.

1. Sovereign bonds are best described as: a. Bonds issued by local governments b. Secured obligations of a national government c. Bonds backed by the taxing authority of a national government

c. Bonds backed by the taxing authority of a national government

If interest rates are expected to increase, the coupon payment structure most likely to benefit the issuer is a: step-up coupon. inflation-linked coupon. cap in a floating-rate note.

C is correct. A cap in a floating-rate note (capped FRN) prevents the coupon rate from increasing above a specified maximum rate. This feature benefits the issuer in a rising interest rate environment because it sets a limit to the interest rate paid on the debt. A is incorrect because a bond with a step-up coupon is one in which the coupon, which may be fixed or floating, increases by specified margins at specified dates. This feature benefits the bondholders, not the issuer, in a rising interest rate environment because it allows bondholders to receive a higher coupon in line with the higher market interest rates. B is incorrect because inflation-linked bonds have their coupon payments and/or principal repayment linked to an index of consumer prices. If interest rates increase as a result of inflation, this feature is a benefit for the bondholders, not the issuer.

A bond that is characterized by a fixed periodic payment schedule that reduces the bond's outstanding principal amount to zero by the maturity date is best described as a: bullet bond. plain vanilla bond. fully amortized bond.

C is correct. A fully amortized bond calls for equal cash payments by the bond's issuer prior to maturity. Each fixed payment includes both an interest payment component and a principal repayment component such that the bond's outstanding principal amount is reduced to zero by the maturity date. A and B are incorrect because a bullet bond or plain vanilla bond only make interest payments prior to maturity. The entire principal repayment occurs at maturity.

Investors who believe that interest rates will rise most likely prefer to invest in: inverse floaters. fixed-rate bonds. floating-rate notes.

C is correct. In contrast to fixed-rate bonds that decline in value in a rising interest rate environment, floating-rate notes (FRNs) are less affected when interest rates increase because their coupon rates vary with market interest rates and are reset at regular, short-term intervals. Consequently, FRNs are favored by investors who believe that interest rates will rise. A is incorrect because an inverse floater is a bond whose coupon rate has an inverse relationship to the reference rate, so when interest rates rise, the coupon rate on an inverse floater decreases. Thus, inverse floaters are favored by investors who believe that interest rates will decline, not rise. B is incorrect because fixed rate-bonds decline in value in a rising interest rate environment. Consequently, investors who expect interest rates to rise will likely avoid investing in fixed-rate bonds.

Agency bonds are issued by: a. Local government b. National governments c. Quasi-government entities

c. Quasi-government entities

A company has issued a floating-rate note with a coupon rate equal to the three-month Libor + 65 basis points. Interest payments are made quarterly on 31 March, 30 June, 30 September, and 31 December. On 31 March and 30 June, the three-month Libor is 1.55% and 1.35%, respectively. The coupon rate for the interest payment made on 30 June is: 2.00%. 2.10%. 2.20%.

C is correct. The coupon rate that applies to the interest payment due on 30 June is based on the three-month Libor rate prevailing on 31 March. Thus, the coupon rate is 1.55% + 0.65% = 2.20%.

The repo margin on a repurchase agreement is most likely to be lower when: a. The underlying collateral is in short supply b. The maturity of the repurchase agreement is long c. The credit risk associated with the underlying collateral is high

a. The underlying collateral is in short supply

An investment bank that underwrites a bond issue most likely: a. Buys and resells the newly issued bonds to investors or dealers b. Acts as a broker and receives a commission for selling the bonds to investors incurs less risk associated with selling the bonds than in a best effort offering

a. buys and resells the newly issued bonds to investors or dealers

A repurchase agreement is most comparable to a(n): a. Interbank deposit b. Collateralized loan c. Negotiable certificate of deposit

b. Collateralized loan

For the issuer, a sinking fund arrangement is most similar to a: a. Term maturity structure b. Serial maturity structure c. Bondholder put provision

b. Serial maturity structure

With respect to floating-rate bonds, a reference rate such as the London interbank offered rate (Libor) is most likely used to determine the bond's: a. Spread b. Coupon rate c. Frequency of coupon payment

b. coupon rate

The distinction between investment grade debt and non-investment grade debt is best described by differences in: a. Tax Status b. Credit Quality c. Maturity Dates

b. credit quality