MISSED DEBT QUIZ

Which of the following money market instruments is eligible for Fed trading? A. A 10-year T-Note which matures within a year B. Negotiable CD C. Commercial Paper D. Banker's Acceptances

A. A 10-year T-Note which matures within a year The eligible securities are U.S. Government debt, Government Agency debt, and prime Banker's Acceptances. These are the securities that the Fed trades with the primary U.S. Government dealers (the major commercial banks and brokerage firms) to control credit availability in the economy. Thus, only the Treasury Note due to mature in 1 year is eligible for Fed trading. For the banker's acceptance listed to be eligible, it must be a "prime" BA (meaning one issued by a commercial bank that is a primary U.S. Government dealer).

Which Treasury security is NOT sold on a regular auction schedule? A. CMBs B. Treasury Bills C. STRIPS D. TIPS

A. CMBs CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.

Which of the following are investment grade bonds? I A-rated II BBB-rated III BB-rated IV CCC-rated A. I and II only B. II and III only C. III and IV only D. I, II, III, IV

A. I and II only The lowest investment grade is BBB. Any securities below this rating (BB or lower) are considered to be speculative - and are commonly known as "junk" issues.

Which of the following can initiate repurchase agreements with government and agency securities as collateral? I Federal Home Loan Banks II Commercial banks III Federal Reserve Banks IV Government securities dealers A. II, III, IV B. I, II, III C. I, III, IV D. I, II, III, IV

A. II, III, IV Government securities dealers, Commercial banks, and the Federal Reserve through its open market trading desk, all initiate repurchase agreements. Federal Home Loan Banks sell bonds to obtain funding. With the funds, it buys mortgages from Savings and Loans, making a secondary mortgage market and injecting fresh funds into the S&L's.

Bonds quoted on a percentage of par basis are generally: A. term bonds B. series bonds C. serial bonds D. short term maturities

A. Term bonds Bonds quoted on a percentage of par basis are term bonds. Municipal bonds quoted in basis points (yield quotes) are serial bonds.

A government securities dealer quotes a 3 month Treasury Bill at 6.00 Bid - 5.90 Ask. A customer who wishes to buy 1 Treasury Bill will pay: A. a dollar price quoted to a 5.90 basis B. a dollar price quoted to a 6.00 basis C. $5,900 D. $6,000

A. a dollar price quoted to a 5.90 basis Treasury Bills are quoted on a yield basis. From the basis quote, the dollar price is computed. A customer who wishes to buy will pay the "Ask" of 5.90. This means that the dollar price will be computed by deducting a discount of 5.90 percent from the par value of $100. This is the discount earned over the life of the instrument.

Promises made by corporate issuers to bondholders, as well as any restrictions placed on the issuer are found in the: A. indenture B. legal opinion C. prospectus D. underwriting agreement

A. indenture The trust indenture of a bond spells out all of the protective and restrictive covenants made to the bondholders. The trustee ensures that the corporation adheres to the covenants.

The manager of a pension plan would most likely invest in which of the following debt issues? I Corporate Bonds II Municipal Bonds III Government Bonds A. I only B. I and III only C. II and III only D. I, II, III

B. I and III only Pension plans are "tax qualified" retirement plans. Earnings on securities held are tax deferred; so there is no benefit to investing in municipals, which have lower interest rates because their interest income is exempt from Federal income tax. Investments would be made in corporate and government bonds, both of which have higher interest rates because their interest income is taxable by the Federal government.

The principal advantage of purchasing a variable rate municipal note is: A. The interest rate can be expected to remain fairly stable B. The market value can be expected to remain fairly stable C. The marketability risk can be expected to be lower D. The credit risk can be expected to be lower

B. The market value can be expected to remain fairly stable With a fixed rate note, as interest rates rise or fall, the note's value must decrease or increase proportionately, so that the note gives a yield that approximates the current level of interest rates. Variable rate notes periodically adjust the rate of interest paid to holders, usually based upon an index of government securities. The interest rate on the notes will fluctuate up or down, depending upon market interest rates. Thus, the note always gives a yield that approximates current interest rate levels so the market price of these securities will remain fairly constant. These notes avoid "interest rate risk," also known as market risk, since a rise in interest rates will not devalue these securities. However, they still may have marketability risk (the risk that the securities cannot be easily sold); and can have credit risk.

A municipal dealer buys a $1,000 par 30 year, 12% bond on a 12% basis. The dealer reoffers the bond, marking it up by 40 basis points. The yield at which the dealer is reoffering the bond is: A. 8% B. 16% C. 11.60% D. 12.40%

C. 11.60% If the municipal dealer buys a 12% coupon bond quoted on a 12% basis, the bond is being purchased at par. To make money, the dealer must sell (reoffer) the bond at a premium to par. To reoffer the bond at a premium, the yield must be lowered, in this case by .40% = 40 basis points). If the 12% bond is reoffered on an 11.60 basis the approximate price for the bond is found by dividing the coupon by the basis. Coupon /Basis = 12/11.60 = 1.03448% of $1,000 par = $1,034.48 (Note that this approximation only works for long term bonds quoted on a yield basis.)

All of the following securities are quoted on a yield basis EXCEPT: A. Commercial Paper B. Treasury Bills C. American Depositary Receipts D. Banker's Acceptances

C. American Depositary Receipts Money market instruments are original issue discount obligations quoted on a yield basis that are priced at a discount to par (with the exception of negotiable certificate of deposit that are priced at par plus accrued interest). The discount from par is the interest earned. American Depositary Receipts are not a money market instrument. They are essentially shares of a foreign company, traded domestically similar to equity securities. They are dollar price quoted in 1/8ths.

Which of the following projects would be financed by a revenue bond issue? I The construction of a new subway line II The construction of a new junior high school III The construction of a new hydroelectric generating plant IV The construction of a new sewage treatment plant A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

C. I,III, IV Public schools do not produce revenue and thus are not funded by revenue bond issues. Rather, school bond issues are general obligations of the issuer. A subway line, hydroelectric plant, and sewage treatment plant all charge for their use and can be financed with revenue bonds.

A municipal variable rate demand note: I is considered to be a short term issue II is considered to be a long term issue III gives the issuer the right to call the bond from the holder on pre-set dates IV gives the holder the right to put the bond to the issuer on pre-set dates A. I and III B. I and IV C. II and III D. II and IV

C. II and III A municipal variable rate demand note is a long-term municipal security because it has no stated maturity, but it is issued at short-term (lower) interest rates, because the holder has the right to "put" the bond to the issuer at par at each interest payment date. The interest rate is reset, usually weekly at the interest payment date, to an indexed rate for the next week. Thus, the interest rate will vary. With any variable rate note, the interest rate varies as market rates move; therefore the market price remains at, or very close to, par. Thus, these instruments have almost no market risk.

A corporation has issued $20,000,000 of 7%, 15 year, $1,000 par, convertible debentures, convertible at a ratio of 40:1. The bond is currently trading at 105, while the company's common stock is at $26.25. Which statements are TRUE? I An arbitrage opportunity exists between the convertible bond and the common stock II An arbitrage opportunity does not exist between the convertible bond and the common stock III The common stock is trading at the parity price IV The common stock is not trading at the parity price A. I and III B. I and IV C. II and III D. II and IV

C. II and III Since the common stock is trading at $26.25 per share and the parity price is $26.25 per share (market price of bond / conversion ratio = $1,050 / 40 = $26.25), the stock is trading at parity to the bond. When the common stock and the convertible are trading at parity, no arbitrage opportunity exists.

A prime bankers acceptance is one which is: A. rated P-1 by Moody's B. quoted at the current prime rate C. eligible for trading by the Federal Open Market trading desk D. traded only between primary U.S. Government dealers

C. eligible for trading by the Federal Open Market trading desk A prime banker's acceptance is one which is of sufficient quality to be eligible for trading by the Federal Reserve trading desk in New York.

Commercial paper with a maturity of 270 days or less: I must be registered under the Securities Act of 1933 II does not have to be registered under the Securities Act of 1933 III is a non-exempt security IV is an exempt security A. I and III B. I and IV C. II and III D. II and IV

D. II and IV Commercial paper is an exempt security under the Securities Act of 1933. It does not have to be registered and sold with a prospectus if its maturity is 270 days or less. This makes it much less expensive for an issuer to market the securities, since the regulatory burden is much lower.

A convertible debenture is convertible into common at $40 per share. If the market price of the bond rises to a 5 point premium over par, which statements are TRUE? I The conversion ratio is 20:1 II The conversion ratio is 25:1 III The parity price of the stock is $40 IV The parity price of the stock is $42 A. I and III B. I and IV C. II and III D. II and IV

D. II and IV The conversion ratio is established when the bond is issued, and is par value divided by the conversion price. In this case, the conversion price is set at $40 per share, so the conversion ratio is $1,000 par / $40 conversion price = 25:1 (25 shares per bond). If the bond moves to a 5 point premium over par, its new price will be 105, or $1,050 per bond. For the common stock to be valued at parity to the bond, the price per share must be $1,050 / 25 shares per bond = $42 per share parity price.

Which of the following are TRUE statements regarding revenue bonds? I Yields for revenue bond issues are generally higher than yields for comparable G.O. issues II Revenue bonds are only suitable for investors willing to assume a high level of risk III The bonds may be double barreled with backing by ad valorem taxes IV Issuance of the bonds is dependent on earnings requirements A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

D. II,III,IV In order to issue revenue bonds, a feasibility study must be prepared and it must show adequate net revenues ("earnings") to service the debt before the bonds can be floated. A revenue bond can be double barreled to improve its safety by additionally backing the issue with the ad valorem taxing power of the issuer. Yields on revenue bonds are higher than that of comparable G.O. bonds because of generally higher risk. Revenue bonds are suitable for investors willing to take on low, medium or high risk. To evaluate credit risk on these issues, look at Moody's or Standard and Poor's ratings.

In a corporate liquidation, the priority of claim to corporate assets is: A. Unpaid wages and taxes, debenture holders, mortgage bond holders, preferred stockholders B. Unpaid wages and taxes, preferred stockholders, debenture holders, mortgage bondholders C. Mortgage bond holders, debenture holders, unpaid wages and taxes, preferred stockholders D. Mortgage bond holders, unpaid wages and taxes, debenture holders, preferred stockholders

D. Mortgage bond holders, unpaid wages and taxes, debenture holders, preferred stockholders The priority of claim to corporate assets in a liquidation is: Secured creditors, unpaid wages and taxes, trade creditors, unsecured bondholders, preferred stockholders, common stockholders.

Which of the following securities cannot be margined? A. Treasury bills B. Commercial paper C. Bankers' acceptances D. Structured products

D. Structured products Because money market instruments are "safe," they can be margined - meaning that the brokerage firm can lend money against these securities held as collateral for the loan. Government securities, agency securities, investment grade money market instruments, investment grade corporate bonds and listed stocks are the marginable securities. As a general rule, structured products cannot be margined because they are not readily transferable.

All of the following statements are true about the Federal National Mortgage Association Pass-Through Certificates EXCEPT: A. FNMA is a publicly traded company B. interest payments are subject to state and local tax C. certificates are issued in minimum units of $25,000 D. the credit rating is considered the highest of any agency security

D. the credit rating is considered the highest of any agency security FNMA is a publicly traded company. Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets. Unlike GNMA, whose securities are directly U.S. Government guaranteed; FNMA only carries an "implicit" U.S. Government backing, so its credit rating is lower than that of GNMA. Interest received by the holder of a mortgage backed pass through security is fully taxable by both federal, state, and local government. Certificates are issued in minimum $25,000 denominations. For most investors this is too much money to invest, so they buy shares of a mutual fund that invests in these instruments instead.

All of the following are true statements about Treasury STRIPS EXCEPT: A. the investor's interest rate is locked in at purchase, eliminating any reinvestment risk B. at maturity, there is no capital gain C. the income is accreted and taxed annually D. these are suitable investments for individuals seeking current income and a high level of safety

D. these are suitable investments for individuals seeking current income and a high level of safety Treasury STRIPS are government bonds that are "stripped" of coupons. They do not provide current income. The discount on the bonds must be accreted annually, with the annual accretion amount being taxable as interest income. As the bond is accreted, its cost basis is adjusted upwards so that at maturity, the bond has an adjusted cost basis of par. Therefore, no taxable capital gain is realized at maturity. This is a zero coupon obligation with a "locked in" rate of return over the life of the bond.