SIE/7 Chapter 2: Debt (Bonds Basics)

In 2023, a customer buys 1 GM 10%, $1,000 par debenture, M '38, at 115. The interest payment dates are Jan 1st and Jul 1st. The yield to maturity on the bond is: A 6.96% B 8.00% C 8.37% D 10.23%

C Annual Interest- Capital Loss/ (Bond Price+Redemption Value)/2 100-10/ 1075= 8.37%

A customer who has taken his portfolio and invested it only in money market instruments is most likely concerned with: A purchasing power risk B credit risk C political risk D business risk

The best answer is A. If there a high level of inflation (purchasing power risk), then interest rates start to rise. This causes bond prices to fall. It also causes stock prices to fall, because companies have to pay higher interest rates on bonds that they issue, depressing profits, and companies have a hard time raising prices as fast as their input costs rise, also depressing profits. Because interest rates rise when there is substantial inflation, money market rates go up as well. However, these securities do not lose value because their maturity is short, and when they mature, the proceeds are reinvested in other money market instruments offering high yields. These are one of the best investments during inflationary times.

A 12%, $1,000 par corporate bond is trading at $1,100. What is the current yield? A 10.9% B 12.0% C 12.6% D 13.3%

The best answer is A. Since the bond is trading at a premium, its current yield must be lower than its coupon. The formula to find the current yield is: Annual Interest/ Market Price= Current Yield $120/ $1,100 = 10.9%

If a bond is purchased at a discount, which of the following statements are TRUE? I Yield to call is higher than the yield to maturity II Yield to call is lower than the yield to maturity III Yield to maturity is higher than the current yield IV Yield to maturity is lower than the current yield A I and III B I and IV C II and III D II and IV

The best answer is A. When a bond is purchased at a discount and called prior to its redemption date, the yield to call received will be higher than if the bond is held to maturity since the discount will be earned faster. Yield to maturity will always be higher than current yield for a discount bond because YTM includes the earning of the discount as part of the overall return received from the bond; while current yield ignores this component (it is simply Annual Income / Current Market Price).

Exchange rate risk exists when making an investment in a: A foreign security when the U.S. dollar strengthens B foreign security when the U.S. dollar weakens C U.S. security when the U.S. dollar strengthens D U.S. security when the U.S. dollar weakens

The best answer is A. When an investment is made outside the U.S. that is denominated in a foreign currency, the investor assumes exchange rate risk. This is the risk that the foreign currency weakens against the U.S. dollar (which is the same as the U.S. dollar strengthening). For example, assume that an investment is made in $100,000 of bonds denominated in Japanese Yen when the Yen is trading at 100 to the U.S. dollar. Thus, $100,000 x 100 Yen per U.S. dollar = 1,000,000 Yen being spent. Also assume that each bond costs 10,000 Yen, so 100 bonds are purchased at $100 each. Now assume that the bonds do not move in price, but the Yen weakens to 200 Yen to the U.S. dollar (each U.S. dollar now "buys" 200 Yen instead of 100 Yen). This means that 100 bonds are still priced at 10,000 Yen each in Japan. However, because each U.S. dollar is worth 200 Yen, the bonds are now worth 10,000 Yen / 200 Yen per U.S. dollar = $50 each. Thus, the bonds are now worth 1/2 of what was paid for them, solely due to the movement in currency exchange rates.

A bond issue where every bond has the same issue date, interest rate, and maturity is a: A term bond offering B series bond offering . C serial bond offering D combined serial and term bond offering

The best answer is A. A term bond issue is one where every bond has the same issue date, interest rate and maturity. Corporate issues and U.S. Government bond issues are typically term bonds.

A bond is rated AAA by Standard and Poor's. This bond is: A Highest Quality Investment Grade B High Quality Investment Grade C Low Quality Investment Grade D Highest Level Speculative Grade

The best answer is A. An AAA rating is the highest quality investment grade.

If interest rates are rising, which statement about discount and premium bonds is TRUE? A Discount bonds will depreciate faster than premium bonds B Premium bonds will depreciate faster than discount bonds C Both bonds will depreciate equally D The rate of depreciation depends on the credit rating of the issuer

The best answer is A. As a general rule, the longer the maturity on a debt issue, the greater the issue's price volatility in response to interest rate movements. Another general rule is that the lower the price of the issue (which would result from having a lower coupon), the greater the issue's price volatility in response to interest rate movements. As interest rates rise, bonds that are selling at a discount will fall proportionately more than bonds trading at an equivalent premium. This is true since the change in price as a percentage of the bond's cost is greater for a discount bond than for a premium bond.

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

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

All of the following affect the marketability of corporate bonds EXCEPT: A Bond denominations B Block size C Maturity D Bond rating

The best answer is A. For corporate bonds, the most marketable blocks are 5 bonds up to 100 bonds. Under 5 is an odd lot; over 100 is a large block which is more difficult to trade. The shorter the maturity, the more marketable the bond. The higher the rating, the more marketable the bond. The bond denominations have no effect on marketability.

Which of the ratings agencies listed below would most likely rate a municipal revenue anticipation note for credit risk? A Moody's B Morningstar C Fitch's D Best's

The best answer is A. Moody's and Standard and Poor's are, by far, the largest of the ratings firms. Both rate municipal revenue bonds. Standard and Poor's rates issues if the issuer pays; Moody's rates issues whether the issuer pays or not - their stance is that they are Moody's Investors Services, and their ratings are a service to the investor (though paid for by the issuer). Fitch's is a much smaller ratings agency and concerns itself mainly with rating corporate issues. Morningstar rates mutual funds, not municipal bonds. Best's rates insurance companies, not securities.

1 basis point equals: A .01% B .1% C 1% D 10%

The best answer is A. One basis point equals .01% movement in interest rates.

Regarding bonds with put options, which of the following statements are TRUE? I Exercise of the put is at the option of the bondholder II Exercise of the put is at the option of the issuer III Yields on bonds with put options are lower than similar bonds without this feature IV Yields on bonds with put options are higher than similar bonds without this feature A I and III B I and IV C II and III D II and IV

The best answer is A. Put options are exercisable at the option of the bondholder (not the issuer). Because the put option removes some of the market risk from the bond, this feature is valued by bondholders, who will accept lower yields on bonds having this option.

The current yield of a bond will: I increase as bond prices fall II decrease as bond prices rise III remain unchanged as bond prices fall IV remain unchanged as bond prices rise A I and II B III and IV C I and IV D II and III

The best answer is A. The current yield is the stated rate of interest as a percentage of the bond's market value. As bond prices fall, the current yield increases; as bond prices rise the current yield decreases.

The nominal yield on a bond is: A. stated interest rate / bond par value B. stated interest rate / bond market value C. market interest rate / bond par value D. market interest rate / bond market value

The best answer is A. The nominal yield is the stated rate of interest on the bond, based on par value.

Yield curve analysis is useful for an investor in debt securities for all of the following reasons EXCEPT: A the yield curve is used to compare the marketability risk of one issue to that of another B investors can compare rates of return relative to changing maturities C the yield of a specific security can be compared to the market expectation for similar securities D the curve shows market expectations for interest rates

The best answer is A. The yield curve is not used to compare the marketability risk of different issuers. This is the risk that the security will be difficult to sell. The yield curve shows market expectations for interest rates - depending on the shape of the curve. An ascending curve indicates that interest rates are likely to rise in the future; a descending curve indicates that interest rates are likely to fall in the future. Because the yield curve shows all the market interest rates for all maturities, investors can compare rates against differing maturities. The yield curve is an average for securities of a given risk class. An investor can compare the yield on a specific security to the curve for the risk class to evaluate the attractiveness of that investment. If there is a great demand for a specific maturity, the price will be pushed up and the yield lowered. One can pick this out in a yield curve since the curve would drop for that specific maturity.

Under the "market expectations" theory of yield curves, when investors expect interest rates to rise in the future, the yield curve should be: A ascending B descending C inverted D flat

The best answer is A. Under the "market expectations" theory of yield curves, when investors expect interest rates to rise in the future, the yield curve will have an upward slope. Conversely, when investors expect interest rates to fall in the future, the yield curve will have a downward slope. If investors are uncertain as to the future direction of market interest rates, then the yield curve will be flat.

When it is expected that a recession will occur, which statement is TRUE? A The yield spread between corporate and government bonds will widen B The yield spread between corporate and government bonds will narrow C The yield spread between corporate and government bonds will not be affected D An arbitrage opportunity will exist between corporate and government bonds

The best answer is A. When a recession is expected, investors sell corporate bonds (increasing their yields) and buy government bonds (decreasing their yields). Thus, the spread between corporate and government bond yields will widen.

For bonds trading at a discount, rank the yield measures from lowest to highest? A Nominal; Current; Yield to Maturity; Yield to Call B Yield to Call; Yield to Maturity; Current; Nominal C Yield to Maturity; Nominal; Yield to Call; Current D Current; Nominal; Yield to Call; Yield to Maturity

The best answer is A. When bonds are trading at a discount, the stated (nominal) yield will be lowest. The current yield will be higher, since it is based on the discounted market price - not par value. The yield to maturity will be the next highest, since it includes the portion of the discount earned annually as part of the annual return in addition to the interest received. Finally, yield to call will be highest, since the discount would be earned over a shorter period of time, increasing the annual yield on the security.

For bonds trading at a discount, rank the yield measures from lowest to highest? I Nominal II Current III Basis IV Yield to Call Basis A I, II, III, IV B IV, III, II, I C II, I, III, IV D I, III, II, IV

The best answer is A. When bonds are trading at a discount, the stated (nominal) yield will be lowest. The current yield will be higher, since it is based on the discounted market price - not par value. The yield to maturity will be the next highest, since it includes the portion of the discount earned annually as part of the annual return in addition to the interest received. Finally, yield to call will be highest, since the discount would be earned over a shorter period of time, increasing the annual yield on the security.

In 2023, a customer buys 5 GM 10% debentures, M '33, at 85. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2028 at 103. The nominal yield on the bonds is: A 10.00% B 10.81% C 11.76% D 12.43%

The best answer is A. The nominal yield is the stated rate of interest on the bond, based on par value.

During a period when the yield curve is flat: A short term rates are more volatile than long term rates B long term rates are more volatile than short term rates C short term and long term rates are equally volatile D no relationship exists between short term and long term rate volatility

The best answer is A. Whether the yield curve is ascending (normal), flat or descending, the true statement always is that short term rates are more volatile than long term rates. Short term rates are susceptible to Federal Reserve influence, and move much faster than do long term rates. Long term rates respond more slowly; and reflect longer term expectations for inflation and economic growth, among other factors.

When short term interest rates are the same as long term interest rates, the yield curve is said to be: A flat B normal C inverted D bell shaped

The best answer is A. When short term rates are the same as long term rates, this is a flat yield curve. If the Federal Reserve tightens credit to a limited extent, the effect is felt mainly on short term rates, which can then rise to the same level as long term rates.

A municipal dealer quotes a 9 year, 6% term revenue bond at 109. The yield to maturity is: A 4.58% B 4.78% C 5.50% D 6.00%

The best answer is B.

Issuers are likely to call in their debt securities when: I new securities can be issued at lower current market interest rates II new securities can be issued at higher current market interest rates III during periods when there is a high level of inflation IV during periods when there is a low level of inflation A I and III B I and IV C II and III D II and IV

The best answer is B. Issuers are most likely to call in their securities when interest rates have bottomed. The issuer can issue new securities at lower current interest rates, and can use the proceeds to call the outstanding securities that are paying a higher rate of interest. Regarding periods of inflation, as the inflation rate increases, interest rates tend to rise, since an "inflation premium" is added to the real interest rate that is paid on fixed income securities. Since issuers will call their fixed income securities when interest rates have dropped, they will tend to call their issues during periods of low inflation.

Which of the following statements are TRUE regarding the effect of market interest rate movements on callable and puttable bond prices? I When interest rates fall, the call price tends to set a ceiling on the market price of the bond II When interest rates fall, the call price tends to set a floor on the market price of the bond III When interest rates rise, the put price tends to set a ceiling on the market price of the bond IV When interest rates rise, the put price tends to set a floor on the market price of the bond A I and III B I and IV C II and III D II and IV

The best answer is B. If interest rates drop, it is more likely that an issuer will call its bonds. As interest rates drop, bond prices in the market will rise. The price will not rise by as much for a callable issue as that for a non-callable issue. The reason: why would someone pay a premium for an issue that is likely to be called off the market? The price for a puttable bond sets a floor under the market price of the bond during periods of rising interest rates. The price will never drop much below par once the option is exercisable, because if it did, customers would buy as many of the bonds as possible and "put" them to the issuer at par for a capital gain.

Which bond will exhibit the greatest price volatility? A 10-year bond; 7% coupon; 8% yield; duration of 7.25 B 8-year bond; 0% coupon; 7% yield; duration of 8.00 C 4-year bond; 4% coupon; 3% yield; duration of 3.74 D 2-year bond; 2% coupon; 1% yield; duration of 1.97

The best answer is B. The longer the expiration, the more volatile a bond's price movements, which narrows the Choices to either A or B. The lower the coupon, the more volatile the bond's price movements, with the lowest coupon being "0." An 8-year zero coupon bond will actually be more volatile in price movements than a slightly longer maturity bond (10 years) with a fairly high coupon (7% in this case). The higher coupon means that more of the bond's value is represented by the interest stream than comes in early and this stabilizes the bond's price as market interest rates move. Duration is a concept that is tested as a "basic" idea on Series 7. It represents the amount of time that it will take for an investor to recoup his or her purchase price. The longer the duration, the longer it will take for an investor to get his or her money back and longer term bonds are more volatile. So the higher the duration number, the greater the bond volatility, and duration is often used as a measure of bond price volatility.

A municipal dealer quotes a 4 year, 4% term revenue bond at 98. The yield to maturity is: A 4.25% B 4.55% C 4.75% D 5.00%

The best answer is B. This bond has a coupon rate of 4% = 4% of $1,000 par = $40 of annual income. The bond is purchased at 98% of $1,000 par = $980; and will mature at $1,000 in 4 years, Thus, the $20 capital gain is earned over 4 years for an annual gain of $20 / 4 = $5 per year. The bond is purchased at $980 and matures at $1,000, for an average value of $980 + $1,000 / 2 = $990. the YTM is: 40+5/ 990= 4.55%

A wealthy customer has $2,000,000 to invest and wishes to create a bond portfolio that maximizes expected income, and is willing to assume a reasonable level of risk of default to achieve this objective. The registered representative recommends diversifying by investing $400,000 among 5 different corporate bond issues in different industries. Below are 4 possible portfolios for the customer: Expected Annual Rate of Return Default Risk Over 10 Years Portfolio A 10% 5% Portfolio B 11% 10% Portfolio C 12% 40% Portfolio D 14% 50% The best portfolio to meet the customer's investment objective and risk tolerance level is: A Portfolio A B Portfolio B C Portfolio C D Portfolio D

The best answer is B. This one is "interesting." The "default risk" represents the loss of return that is likely due to making higher risk investments. If Portfolio A has an expected annual rate of return of 10% over 10 years; but there is the probability that of the $2,000,000 invested, 5% of those bonds will default, so the net return will be 95% of 10% = 9.5%. If Portfolio B has an expected annual rate of return of 11% over 10 years; but there is the probability that of the $2,000,000 invested, 10% of those bonds will default, so the net return will be 90% of 11% = 9.9%. If Portfolio C has an expected annual rate of return of 12% over 10 years; but there is the probability that of the $2,000,000 invested, 40% of those bonds will default, so the net return will be 60% of 12% = 7.2%. If Portfolio D has an expected annual rate of return of 14% over 10 years; but there is the probability that of the $2,000,000 invested, 50% of those bonds will default, so the net return will be 50% of 14% = 7.0%.

Which of the following would be a quote for a U.S. Government bond? A 99.50 B 99-16 C 99 1/2 D 99 8/16

The best answer is B. U.S. Government bonds are quoted on a percentage of par basis in 32nds. 99-16 = 99 16/32nds = 99.50% of $1,000 par = $995.00 per bond. Choice C is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 99 1/2 = 99.50% of $1,000 par = $995.00 per bond. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.

Which of the following would be a quote for a U.S. Government bond? A 105.625 B 105-20 C 105 5/8 D 105 10/16

The best answer is B. U.S. Government bonds are quoted on a percentage of par basis in 32nds. 105-20 = 105 20/32nds = 105.625% of $1,000 par = $1,056.25 per bond. Choice C is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 105 5/8 = 105.625% of $1,000 par = $1,056.25 per bond. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.

A 7% corporate bond with 10 years left to maturity is currently trading at 108. The bond is callable in 3 years at 102. If a client buys the bond and then the issuer calls it in 3 years, the yield to call will be: A 3.98% B 4.76% C 4.81% D 6.86%

The best answer is B. YTC is Net Annual Return / Average Value. The annual income is 7% of $1,000 par = $70 per year. The bond can be purchased at 108, but it will be called in 3 years at 102, so there will be a 6 point ($60) loss over 3 years = 2 point loss ($20) per year. The Net Annual Return is: Annual Income ($70) - Annual Loss ($20) = $50 The Average Value is: $1,080 Purchase Price + $1,020 Redemption Price / 2 = $2,100 / 2 = $1,050 YTC is: $50 / $1,050 = 4.76%

An 8% corporate bond with 20 years left to maturity is currently trading at 120. The bond is callable in 4 years at 104. If a client buys the bond and then the issuer calls it in 4 years, the yield to call will be: A 2.98% B 3.57% C 3.63% D 6.66%

The best answer is B. YTC is Net Annual Return / Average Value. The annual income is 8% of $1,000 par = $80 per year. The bond can be purchased at 120, but it will be called in 4 years at 104, so there will be a 16 point ($160) loss over 4 years = 4 point loss ($40) per year. The Net Annual Return is: Annual Income ($80) - Annual Loss ($40) = $40 The Average Value is: $1,200 Purchase Price + $1,040 Redemption Price / 2 = $2,240 / 2 = $1,120 YTC is: $40 / $1,120 = 3.57%

Corporate bonds are quoted on what basis? A Yield to maturity B Dollar price C Discount yield D Nominal yield

The best answer is B. Corporate bonds are usually term bonds - all bonds of an issue having the same interest rate and maturity. Term bonds are quoted on a percentage of par basis in 1/8ths, which is the same as a "dollar" quote.

Two 20-year corporate bonds are issued at par, with stated interest rates of 10%. One issue is callable at par in 5 years, while the other is callable at par in 10 years. If interest rates drop by 200 basis points shortly after issuance, which statement is TRUE? A The bond callable in 5 years will appreciate more than the bond callable in 10 years B The bond callable in 10 years will appreciate more than the bond callable in 5 years C Both bonds will appreciate by equal amounts D The rate of appreciation depends on the credit rating of the bonds

The best answer is B. If a bond is callable at par in the near future, any price rise due to falling interest rates will be suppressed since the issuer is likely to call in the debt and refund at lower interest rates. Thus, the bond callable in 10 years will appreciate more than the bond callable in 5 years if interest rates fall.

Two 20-year corporate bonds are issued at par, with stated interest rates of 10%. One issue is puttable at par in 5 years, while the other is puttable at par in 10 years. If interest rates rise by 200 basis points shortly after issuance, which statement is TRUE? A The bond puttable in 5 years will depreciate more than the bond puttable in 10 years B The bond puttable in 10 years will depreciate more than the bond puttable in 5 years C Both bonds will depreciate by equal amounts D The rate of depreciation depends on the credit rating of the bonds

The best answer is B. If a bond is puttable at par in the near future, any price decline due to rising interest rates will be suppressed since the holder is able to put the bond back to the issuer sooner. Thus, the bond puttable in 10 years will depreciate more than the bond that is puttable in 5 years if interest rates rise.

An investor who expects interest rates to drop would NOT invest in: I non-callable debt issues II puttable debt issues III callable debt issues IV debt issues with adjustable interest rates A I and II only B III and IV only C I, II, III D I, III, IV

The best answer is B. If interest rates decline, it is likely that issuers will call in outstanding bonds and refund the issues at the lower current interest rates. An investor who expects interest rates to drop should avoid callable issues (choice III) or issues with adjustable interest rates (since each year as interest rates drop, the rate on the bond is dropped). Non callable bonds are fine, as are bonds with put options. The put option will only be used if interest rates rise, decreasing the value of the bond. Then, the bondholder would exercise the option and "put" the bonds to the issuer at par.

In 2023, a customer buys 5 GM 10% debentures, M '43. The interest payment dates are Feb 1st and Aug 1st. The current yield on the bonds is 11.76%. The bonds are callable as of 2033 at 103. The bond is trading: A at a premium B at a discount C at par D in the money

The best answer is B. If the bond's current yield (11.76%) is higher than the coupon yield (10%), the bond is trading at a discount. In order for the yield to rise above the stated fixed coupon rate, the price of the bond must drop in the market.

Which characteristics make a security least subject to liquidity risk? I Short term maturity II Long term maturity III Low credit rating IV High credit rating A I and III B I and IV C II and III D II and IV

The best answer is B. Liquidity risk is the risk that a security can only be sold by incurring large transaction costs. The easiest securities to sell (meaning the most readily marketable) are those with high credit ratings and short term maturities.

During a period when the yield curve has a normal ascending shape, which statement is TRUE? A Short term bond prices are more volatile than long term bond prices B Long term bond prices are more volatile than short term bond prices C Both short term and long term prices are equally volatile D No relationship exists between long term and short term bond price movements

The best answer is B. Long term bond prices are more volatile than short term bond prices as interest rates move. Thus, short term bond prices are more stable (move more slowly) as interest rates change compared to long maturities.

Political risk is generally associated with: A Corporate bond investments B International bond investments C Municipal bond investments D Treasury bond investments

The best answer is B. Political risk is the risk of investing internationally in countries that have weak political systems. Thus, the bondholder has very little in the way of legal protection. Political risk is an issue for consideration when making investments in 3rd World countries.

The bondholder of a municipal bond issue is the: A borrower of the bond proceeds B lender of the bond proceeds C guarantor of the payment of debt service on the bond issue D fiduciary acting for the benefit of the bondholders

The best answer is B. The "bondholder" of a bond issue is the party that is owed the debt service on the bonds. This is the "legal" name for the lender or creditor.

As interest rates rise, which of the following statements are TRUE? I Bonds trading at large discounts fall faster in price than bonds trading at small discounts. II Bonds trading at small discounts fall faster in price than bonds trading at large discounts. III Bonds trading at large premiums fall faster in price than bonds trading at small premiums. IV Bonds trading at small premiums fall faster in price than bonds trading at large premiums. A I and III B I and IV C II and III D II and IV

The best answer is B. The general rule is the lower the price of the bond, the faster that bond's price will move as market interest rates change. Deep discount bonds have a lower price than small discount bonds, hence their prices move faster. Small premium bonds have a lower price than large premium bonds, hence their prices move faster as well.

An investor buys a bond at a discount. Later in the year, the bond is trading at a premium. This is termed: A Amortization B Appreciation C Accretion D Accumulation

The best answer is B. When an asset increases in value, this is termed appreciation.

A customer has an objective of maximizing current income. Under which conditions would you recommend that the customer sell long term debt positions and buy short term obligations? A The yield curve is normal B The yield curve is inverted C The yield curve is hump shaped D The yield curve is ascending

The best answer is B. When the yield curve is "inverted," short term rates are higher than long term rates. To maximize income during this period, a customer would liquidate long term (lower rate) holdings and invest in short term (higher rate) holdings. During periods when the yield curve is ascending (a normal curve), long term rates are higher than short term rates. In this case, you would recommend long term securities for maximum income.

Which of the following Moody's MIG ratings is/are considered non-investment grade? I MIG 1 II MIG 2 III MIG 3 IV SG A I and II only B IV only C II, III, IV D I, II, III, IV

The best answer is B. Moody's rates municipal anticipation notes under the "MIG" (Moody's Investment Grade) ratings scale, with MIG 1, MIG 2, and MIG 3 being investment grades; and the non-investment grade being SG ("Speculative Grade").

The highest speculative grade rating is: A BBB B BB C B D CCC

The best answer is B. The highest speculative bond rating is BB or Ba. Any rating above that would be considered investment grade.

All of the following are true statements about discount bonds EXCEPT: A bonds trading at a discount can indicate that the issuer's rating has deteriorated B bonds trading at a discount are more likely to be called than bonds trading at a premium C discount bonds will appreciate more rapidly as interest rates fall than will similar premium bonds D a bond trading at a discount can indicate that interest rates have risen

The best answer is B. If a bond issued at par is trading at a discount, it indicates that either market interest rates have risen; or that the issuer's rating has deteriorated. As interest rates fall, discount bonds will appreciate at a faster rate than will premium bonds. The change in value of the bond's price is a result of an increased "present value" of the remaining interest payments to be received. This increase in the "value" of the remaining interest payments is a larger percentage of a discount bond's price than of a premium bond's price. Thus, as interest rates drop, discount bond prices rise faster than premium bond prices. Similarly, as interest rates rise, discount bond prices fall faster than premium bond prices. If the bond is trading at a discount and is then called, then the issuer will have to pay par for the bonds. Why not, instead of paying par, purchase the bonds at the current market price? It would be better to pay the discount than the full market value. Furthermore, a bond trading at a discount indicates that market interest rates have risen - why would an issuer call in such an issue, when it has a bargain interest rate? The only bonds that are likely to be called are those trading at premiums - meaning that market interest rates have fallen. The issuer can call in the premium bonds at a price close to par, and refund at lower current market interest rates.

A municipal dealer quotes a 7 year, 5% term revenue bond at 94. The yield to maturity is: A 4.78% B 5.00% C 6.04% D 6.78%

The best answer is C.

Which of the following would be a quote for a railroad bond? A 101.25 B 101-8 C 101 1/4 D 101 4/16

The best answer is C. A railroad bond is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 101 1/4 = 101.25% of $1,000 par = $1,012.50 per bond. Choice B is a U.S. Government bond quote in 32nds. 101-8 = 101 8/32nds = 101.25% of $1,000 par = $1,012.50 per bond. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.

Which of the following would be a quote for an airline bond? A 105.625 B 105-20 C 105 5/8 D 105 10/16

The best answer is C. An airline bond is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 105 5/8 = 105.625% of $1,000 par = $1,056.25 per bond. Choice B is a U.S. Government bond quote in 32nds. 105-20 = 105 20/32nds = 105.625% of $1,000 par = $1,056.25 per bond. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.

Which statements are TRUE? I Most of the value of a bond is established by the present value of the first payment II Most of the value of a bond is established by the present value of the last payment III The longer the maturity of a bond, the greater the bond's price volatility IV The shorter the maturity of a bond, the greater the bond's price volatility A I and III B I and IV C II and III D II and IV

The best answer is C. The actual dollar price of a bond is computed by taking the yearly income stream and principal repayment at maturity and discounting it back to today's "present value" based on the current market interest rate. Most of the value of the bond comes not from the yearly interest payments, but rather from the final payment when the principal ($1,000 par) is being returned. From a present value standpoint, if a bond has a long maturity, the present value of the final principal payment is greatly affected by interest rate movements, since many years of compounding are applied to get the present value of the last $1,000 payment. On the other hand, if the bond has a short maturity, the present value of the final $1,000 principal payment is not affected much at all by market interest rate movements, because the basic truth is that the bond will be redeemed shortly at par, so the value of the payment cannot vary much from par.

How are Treasury Notes quoted? A Coupon B Yield to Maturity C Whole and Fractional D Decimal

The best answer is C. Treasury Notes and Bonds are quoted as a percentage of par value, with each "whole" point movement representing 1% of $1,000 par or $10. The minimum price increment is 1/32nd of 1%, so it is a fraction of par. Thus, Treasury Notes and Bonds are quoted in whole and fractional points. For example, a Treasury Note quoted at 100-8 is priced at 100 and 8/32nds % of $1,000 par = 100.25% = $1,002.50.

A 65-year old customer wishes to invest part of his retirement funds with the dual objectives of enhanced income and safety of principal. The customer notices that "C" rated corporate bonds yield significantly more than equivalent maturity Treasury issues and asks you, the registered representative, whether these would be an appropriate investment. The best response is to tell the customer that this is a: A good idea since corporate bonds are extremely safe investments since they are guaranteed by the issuing corporation B good idea because the yield spread between corporates and Treasuries guarantees a superior return C bad idea because "C" rated corporate bonds have a much higher risk of default than Treasury issues D bad idea because "C" rated corporate bonds are not permitted investment vehicles for retirement fund proceeds

The best answer is C. "C" rated bonds are true "junk" with a high risk of default. This is a totally inappropriate investment for a retiree who needs income.

Which bond does NOT have interest rate risk? A Zero Coupon Bond B Long Term Bond C Variable Rate Bond D High Coupon Bond

The best answer is C. A variable rate bond has an interest rate that resets periodically to the market rate of interest (weekly, monthly, quarterly, semi-annually). Because the interest rate moves to the current market rate, the price stays right around par. Any variable rate security has no interest rate (market) risk. A high coupon bond has lower market risk than a low coupon bond, but the risk still exists for this bond. Finally, long maturity bonds are more susceptible to market risk than short maturity bonds.

A customer has purchased three different bonds, each yielding 9%, with 5 year, 10 year, and 15 year maturities. If prevailing interest rates drop by 20 basis points, which will show the greatest percentage price change? A 5 year maturity B 10 year maturity C 15 year maturity D The bonds will all move by the same percentage

The best answer is C. As interest rates move, long term maturities will change in price at a faster rate than will short term obligations. This is due to the fact that the "compounding effect" is more acute as maturities lengthen. As interest rates move up, long term maturities fall faster in price than do short term maturities.

Corporate bonds are usually: A serial bonds and are quoted on a percentage of par basis B serial bonds and are quoted on a yield basis C term bonds and are quoted on a percentage of par basis D term bonds and are quoted on a yield basis

The best answer is C. Corporate bonds are usually term bonds - all bonds of an issue having the same interest rate and maturity. Term bonds are quoted on a percentage of par basis in 1/8ths, which is the same as a "dollar" quote.

A percentage of par quote is also known as a: A firm quote B yield quote C dollar quote D basis quote

The best answer is C. Dollar Bonds - most corporate, government, and any municipal issues which are term bonds - are quoted on a percentage of par basis. Anytime a bond is quoted as a percentage of par, it is quoted on a dollar basis. In contrast, municipal serial issues are quoted on a yield basis.

A corporate bond was issued on Jan 1, 2010, that matures on Jan 1, 2030. The trust indenture allows the corporation to call the bond starting in 2020 at a price equaling 100 1/4 plus an additional 1/8 point premium for every 6 month period remaining until maturity. If the bond is called on Jan 1, 2025, the redemption price will be: A 102 1/4 B 102 C 101 1/2 D 100 1/2

The best answer is C. If the bond is called on Jan 1, 2025, it has 5 years left to maturity. This is the same as 10 - six month periods. For each six month period prior to maturity that the bond is called, 1/8 point is added to the call premium (total equals 1 1/4 points). Since the call price is 100 1/4 plus the additional premium of 1 1/4 points, the total call price is 101 1/2.

Which statements are TRUE regarding bonds? I Short term bonds fluctuate more in value than long term bonds due to interest rate movements II Long term bonds fluctuate more in value than short term bonds due to interest rate movements III Short term maturities are more liquid than long term maturities IV Long term maturities are more liquid than short term maturities A I and III B I and IV C II and III D II and IV

The best answer is C. Long term bonds fluctuate more in value than do short term bonds in response to market interest rate changes. Short term bonds do not fluctuate much in value as interest rates move since they will be redeemed shortly at par. There is more active trading of short term debt than long term debt, so short term debt is more liquid.

Which statements are TRUE? I Most of the value of a bond is established by the present value of the first payment II Most of the value of a bond is established by the present value of the last payment III The lower the coupon of a bond, the greater the bond's price volatility IV The higher the coupon of a bond, the greater the bond's price volatility A I and III B I and IV C II and III D II and IV

The best answer is C. The actual dollar price of a bond is computed by taking the yearly income stream and principal repayment at maturity and discounting it back to today's "present value" based on the current market interest rate. Most of the value of the bond comes not from the yearly interest payments, but rather from the final payment when the principal ($1,000 par) is being returned. If a bond has a low coupon, more the bond's value comes from the final principal payment (money received later) and less from the interest payment stream (money received sooner). If a bond has a high coupon, more of the bond's value comes from the interest payment stream (money received sooner) and less from the final principal payment (money received later). The present value of money received later will change more rapidly as market interest rates move as compared to the present value of money received sooner. Thus, low coupon issues will have more volatile price movements.

Which statements are TRUE regarding the effect of interest rate movements on bond price volatility? I Bonds with the lowest price volatility will be ones with the lowest coupon rates II Bonds with the lowest price volatility will be ones with the highest coupon rates III Bonds with the highest price volatility will be ones with the lowest coupon rates IV Bonds with the highest price volatility will be ones with the highest coupon rates A I and III B I and IV C II and III D II and IV

The best answer is C. The bond with the lowest price volatility will be the one with the highest coupon rate. Bonds with low coupon rates exhibit greater price volatility. Thus, to minimize price volatility due to interest rate movements ("interest rate risk"), high coupon bonds are more appropriate than low coupon bonds.

A customer has purchased a 20-year maturity corporate bond with a 5% coupon at par. The bond is callable in 10 years @ 103. The customer intends to hold the bond to maturity. If market interest rates rise to 7%, which statement is TRUE? A The bond is likely to be called in 10 years, and the customer's yield to call will be higher than the 5% coupon B The bond's yield to maturity will be 7% for this customer C The market value of the bond shown on the customer's account statement will be less than par D The customer will receive less than par at maturity

The best answer is C. This question is cute. We know that if market interest rates rise, bond prices will fall - the customer's bond will show at a depreciated value on his or her account statement. As long as this bond is held to maturity (it will not be called by the issuer if interest rates rise), this customer's yield to maturity will be the 5% coupon. The customer will not experience any loss of principal, unless the bond is sold prior to maturity.

A 30-year bond is issued in 2023 with the following Call Schedule: The bond is first callable on a redemption Date in 2043. This issue has how many years of "call protection"? A 10 B 15 C 20 D 25

The best answer is C. To make callable issues marketable to the public, investors are protected from calls for a stated period after the bonds' issuance. In this example, the bonds issued in 2023 are first callable in 2043 so the investor has 20 years of "call protection" with this issue.

When the yield curve is inverted, which of the following statements are TRUE? I Short term rates are lower than long term rates II Short term rates are higher than long term rates III To maximize income, an investor should invest in short term maturities IV To maintain income, an investor should invest in long term maturities A I and III B I and IV C II and III D II and IV

The best answer is C. When the yield curve is "inverted," short term rates are higher than long term rates. To maximize income during this period, a customer would liquidate long term (lower rate) holdings and invest in short term (higher rate) holdings.

The lowest investment grade rating is: A B B BB C BBB D CCC

The best answer is C. The lowest investment grade rating is BBB. BB and B ratings are considered to be medium grade while CCC, CC, and C are all speculative with C rating being the most speculative.

When a bond increases in value due to market demand, this is termed: A amortization B accretion C appreciation D accumulation

The best answer is C. When an asset increases in value, this is termed appreciation.

Which of the following are required to calculate the yield to maturity of a bond? I Maturity Date II Coupon III Purchase Price IV Redemption Price (Par) A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is D. Annual Interest +/- Capital Gain or Loss/ (Bond Cost+Redemption Price)/2 The coupon rate x par value gives the annual interest. The annual capital gain or loss is the difference between the purchase price and the redemption price divided by the number of years to maturity. Therefore, all of the items listed are required to calculate the YTM of a bond.

In 2023, a customer buys 5 GM 10% debentures, M '33, at 85. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2028 at 103. The yield to maturity on the bonds is: A 10.00% B 10.81% C 11.76% D 12.43%

The best answer is D. The formula for yield to maturity for a discount bond is: Annual Interest+ Capital Gain/ (Price of Bond+ Redemption Price)/2 $100+($150 discount/ 10 year maturity)/ ($850+1000)/2 100+15/ 925= 12.43%

Purchasing power risk is the risk that: A the issuer will default B the security will be difficult to sell C the security will be called prior to maturity D inflation will reduce the value of future interest payments

The best answer is D. "Purchasing power" risk is the risk that inflation reduces the value of future interest payments and the principal repayment yet to be received in the future.

A call premium on a bond is the amount: I by which the bond's redemption price at maturity exceeds par II by which the bond's redemption price prior to maturity exceeds par III the bondholder will pay the issuer to call in bonds prior to maturity IV the issuer will pay the bondholder to call in bonds prior to maturity A I and III B I and IV C II and III D II and IV

The best answer is D. A call premium is the excess over par value that the issuer will pay the bondholder to call in the bonds prior to maturity.

An increasing market rate of interest would lead to: A higher bond prices and higher bond yields B higher bond prices and lower bond yields C lower bond prices and lower bond yields D lower bond prices and higher bond yields

The best answer is D. A rising market rate of interest means that interest rates are increasing. If interest rates rise, then bond prices will drop, and yields on those bonds will rise.

Which of the following investments has the lowest level of reinvestment risk? A Preferred Stock B Municipal Bond C Collateralized Mortgage Obligation D Treasury Bill

The best answer is D. Reinvestment risk is an issue for investments that make periodic payments held over long time horizons. If interest rates drop during the investment time horizon, the periodic payments received from these long-term securities must be reinvested at lower and lower current market rates, reducing the overall rate of return on the portfolio. Short-term investments have minimal reinvestment risk; and zero-coupon obligations have no reinvestment risk.

When a bond trades at a premium, which bond yield will be the lowest? A Nominal B Stated C Current D Basis

The best answer is D. When bonds are trading at a premium, the stated yield or nominal yield will be the highest, since it is the annual income divided by par value. Current yield is lower because it is annual income divided by the current market price (which is at a premium to par). Basis (or yield to maturity) is even lower because it not only considers that the current market price is at a premium to par; it also pro-rates the loss of the premium over the life of the bond, reducing the annual yield below the current yield.

Which of the following are TRUE statements about the trading of bonds and their prices? I Bonds trading at a premium are more likely to be called than bonds trading at a discount II A bond trading at a discount can indicate that the issuer's rating has deteriorated III Discount bonds will appreciate more rapidly as interest rates fall than will similar premium bonds IV A bond trading at a discount can indicate that interest rates have risen A I and II only B III and IV only C I, II, IV D I, II, III, IV

The best answer is D. All of the statements are true regarding bonds. If a bond issued at par is trading at a discount, it can indicate that the issuer's rating has deteriorated or that market interest rates have risen. As interest rates fall, discount bonds will appreciate at a faster rate than will premium bonds. The change in value of the bond's price is a result of an increased "present value" of the remaining interest payments to be received. This increase in the "value" of the remaining interest payments is a larger percentage of a discount bond's price than of a premium bond's price. Thus, as interest rates drop, discount bonds rise faster than premium bonds. Similarly, as interest rates rise, discount bond prices fall faster than premium bond prices. If the bond is trading at a discount and is then called, then the issuer will have to pay par for the bonds. Why not, instead of paying par, purchase the bonds at the current market price? It would be better to pay the discount than the full market value. Furthermore, a bond trading at a discount indicates that market interest rates have risen - why would an issuer call in such an issue, when it has a bargain interest rate? The only bonds that are likely to be called are those trading at premiums - meaning that market interest rates have fallen. The issuer can call in the premium bonds at a price close to par, and refund at lower current market interest rates.