Unit 4 Debt Securities Questions

Moody's Investment Grade (MIG) ratings are applied to A) municipal bonds. B) municipal notes. C) corporate bonds. D) money market instruments.

B) municipal notes. Moody's Investment Grade ratings are applied to municipal notes, which are short-term municipal debts such as bond anticipation notes (BANs).

It would be most unusual to see which of the following issued at a discount? A) Treasury bill B) Commercial paper C) Jumbo CD D) Banker's acceptance

C) Jumbo CD Jumbo (negotiable) CDs are one of the few money market instruments issued at face value. Unlike those issued at a discount, they are interest bearing.

When a corporation issues a debt security, the terms of the loan are expressed in a document known as the bond's deed of trust. The deed of trust is sometimes referred to as A) the loan agreement. B) the debenture. C) the indenture. D) the bond resolution.

C) the indenture. The indenture, sometimes also referred to as the deed of trust, states the issuer's obligation to pay back a specific amount of money on a specific date. A debenture is a debt security containing an indenture. Bond resolution is a term used for municipal bonds, not corporate debt.

In general, commercial paper, a popular money market instrument, has a maturity not exceeding A) 30 days. B) 90 days. C) 365 days. D) 270 days.

D) 270 days. Although there are rare cases where the maturity extends as long as 12 months (365 days), for exam purposes, think of CP with a maximum maturity of 270 days (9 months).

An investor is concerned about safety. When consulting the ratings, which of the following securities would appear to be least likely to default on its obligation to make timely payment of interest and principal? A) AA rated debenture B) AAA rated common stock C) BB rated sovereign debt D) A rated mortgage bond

A) AA rated debenture When it comes to reducing default risk, "the As have it." That is, the more As in the rating, the lower the default risk. True, the common stock is rated triple A, but stock has no obligation to pay interest and repay principal. Why isn't the mortgage bond a safer bet than the debenture? Aren't secured bonds the safest? These are good questions, but the rating services take that into consideration when giving a rating. In their eyes, the debenture, an unsecured debt, merits a double A rating while the mortgage bond, even with the pledged collateral, can only be awarded a single A rating. Sovereign debt, the debt of a country's government, is usually quite safe, but history has shown us that governments can, and do, default. The BB rating here indicates a certain question as to the safety.

If interest rates increase, the interest payable on outstanding corporate bonds will A) increase. B) decrease. C) change according to the inverse payout theory. D) remain unchanged.

D) remain unchanged. The interest payable is the nominal yield, which is stated on the face of the bond. It is the percentage of face value the bond will pay each year regardless of the prevailing interest rates in the market. It is the market price of bonds, not the interest payable, that responds inversely to changes in interest rates.

A corporate bond is quoted in the Wall Street Journal as follows: Bid: 100½ Asked: 100¾ Bid Chg.: -⅛ YTM: 5.75% From this information, you know the nominal yield is A) less than 5.75%. B) greater than 5.75%. C) 5.625%. D) 5.75%.

B) greater than 5.75%. The bid and asked prices show that the bond is being quoted at a premium (above par), with a yield to maturity of 5.75%. When bonds are trading at a premium, the nominal yield (coupon rate) is greater than the yield to maturity.

A bond with a 9% coupon, maturing in 18 years and 6 months, is selling at 120. The yield to maturity is closest to A) 11.66%. B) 7.50%. C) 9.00%. D) 7.05%.

D) 7.05%. Don't waste time trying to do the yield to maturity computation. This bond is selling at a premium (120% of par). Therefore, all of the computed returns must be lower than the 9% nominal (coupon) yield. Only two of them are. The 7.50% represents the current yield ($90 ÷ $1,200). We know from our charts that, just like a seesaw, the farther from the center you go, the bigger the move at the end. That means the nominal yield is the highest, followed by the current yield (CY), the yield to maturity (YTM), and finally the yield to call (YTC) as the lowest. Because only one choice is lower than the CY, you get the correct answer with minimal effort.

Which of the following is an example of sovereign debt? A) Sony Corporation debentures B) Royal Bank of Canada CDs C) Bank of England notes D) U.S. Treasury bonds

D) U.S. Treasury bonds Sovereign debt represents loans to governments. On the exam, it is likely that the examples will be foreign governments, not U.S. Treasury securities. The Royal Bank of Canada is a privately owned corporation and its debts are not those of the Canadian government. Bank of England notes are the paper currency issued (e.g., the ₤10 and ₤20 notes).

A bond is currently priced at 96. Which of the following yields would be the highest? A) Current yield B) Nominal yield C) Coupon yield D) Yield to maturity

D) Yield to maturity When a bond is selling at a discount (96 means 96% of par value, or $960), the investor's yield is greater than the stated coupon or nominal yield (those two terms are synonymous). Because the yield to maturity considers the $40 profit to be made when the bond matures, the YTM is higher than the current yield.

Which of the following is not considered a debt security? A) Prior lien preferred stock B) Debenture C) Promissory note D) Equipment trust certificate

A) Prior lien preferred stock Stock, whether preferred or common, represents equity (ownership) and is never considered a debt security. The most common example of a promissory note on the exam is commercial paper, a money market instrument. Debentures represent an unsecured debt of the issuer. Equipment trust certificates represent debt secured by specific equipment, typically rolling stock.

Which of the following would be considered an equity security? A) Equity-linked notes B) Negotiable CDs C) Exchange-traded notes D) Preemptive rights

D) Preemptive rights Rights (and warrants) are included in the term equity security. Confusingly, equity-linked notes are debt securities, even though the term equity is in the name. On this exam, notes always represent a form of debt security.