Debt Quiz #1
What is quoted in terms of yield and trades at a discount? A. T-Bill B. T-Note C. T-Bond D. Corporate Bond
A. T-Bill Treasury Bills are short-term original issue discount obligations of the U.S. Government. They are quoted in a discount yield basis, aka a basis quote. Treasury Notes and Treasury Bonds are issued at par and are quoted as a percentage of par in movements of 32nds. Corporate bonds are issued at par and are quoted as a percentage of par in 1/8ths.
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. $6,900
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.
Moody's ratings measure: A. default risk of debt issues B. default risk of equity issues C. market risk of debt issues D. yields of debt issues
A. default risk of debt issues Moody's measures default risk of debt issues. Moody's only rates bonds, not equity securities.
A municipality is at its debt limit and wishes to sell additional bonds. Voter approval is required for the municipality to sell: A. general obligation bonds B. revenue bonds C. industrial revenue bonds D. water and sewer bonds
A. general obligation bonds Voter approval is needed for a municipality to sell general obligation bonds (non-self supporting debt) in an amount that exceeds the municipality's constitutional limit. Revenue bonds and industrial revenue bonds are not subject to debt limits because they are self-supporting and pay their own way from collected revenues. They are not paid from tax collections. Water and sewer bonds are a type of revenue bond.
All of the following statements are true regarding Treasury STRIPS EXCEPT: A. interest earned is subject to reinvestment risk B. interest income is accreted and taxed annually C. the bonds are issued at a discount D. the bonds are zero coupon obligations
A. interest earned is subject to reinvestment risk Treasury STRIPS are bonds "stripped" of coupons, meaning all that is left is the principal repayment portion of the bond. This security is a zero coupon obligation which is an original issue discount. The accretion of the discount over the bond's life represents the interest earned. Even though no payments of interest are made annually, the discount must be accreted annually and is taxable as interest income earned. This investment is not subject to reinvestment risk since no interest payments are made. The rate of return on this bond is "locked in" at purchase. Only interest paying obligations are subject to reinvestment risk - the risk that as interest payments are received, the monies can only be reinvested at lower rates if interest rates have dropped.
All of the following statements are true regarding repurchase agreements EXCEPT: A. investors in repurchase agreements have no interest rate risk B. investors in repurchase agreements have no price risk C. repurchase agreements are used by the Federal Reserve to influence money supple levels D. repurchase agreements typically mature in 1 to 90 days
A. investors in repurchase agreements have no interest rate risk Repurchase agreements are used by the Federal Reserve to inject funds into the money supply. The agreement stipulates that the Fed buys government securities from the dealer, with an agreement to sell back those securities at a pre-agreed price (hence there is no price risk) at a pre-set future date. The dealer gets a temporary infusion of cash, which the dealer can use to buy other securities or (if the dealer is a bank) which may be loaned to someone else. Most repos are "overnight," though durations can extend for longer periods. Repos expose the dealer to interest rate risk because, even though the agreement stipulates that the securities will be repurchased at a pre-agreed price; if interest rates rise substantially, the actual value of those repurchased securities can fall dramatically. When the dealer attempts to resell the securities, it can incur a substantial loss.
When comparing convertible to non-convertible corporate bonds, convertible bonds have: A. lower yields and price appreciation potential based on the market price of the common stock B. lower yields and no price appreciation potential based on the market price of the common stock C. higher yields and price appreciation potential based on the market price of the common stock D. higher yields and no price appreciation potential based upon the market price of the common stock
A. lower yields and price appreciation potential based on the market price of the common stock Convertible bonds are issued at lower interest rates than non-convertible issues, which bondholders accept in return for price appreciation potential based upon the market value of the common stock (since the bond is convertible into a fixed number of shares of common).
A customer wishes to maximize liquidity and minimize interest rate risk. The best recommendation is (are): A. short term maturities B. long term maturities C. callable bonds D. non callable bonds
A. short term maturities Short term bonds do not fluctuate much in value as interest rates move since they will be redeemed shortly at par. (The longer the maturity, the greater the price movement in response to market interest rate changes). Short term maturities are also the most liquid
Which statement is TRUE regarding the trading of government and agency bonds? A. the trading is very active, with narrow spreads B. trading is confined to the primary dealers C. all government and agency securities are quoted in 32nds D. the market is regulartd by the Securities and Exchange Commission
A. the trading is very active, with narrow spreads The government obligation trading market is the deepest and most active market in the world. Trading is performed by both the primary and secondary dealers, and by the Federal Reserve trading desk. While long term government and agency securities are quoted in 32nds, T-Bills are quoted on a discount yield basis. The market is not regulated by the SEC because these are exempt securities under the Securities Acts. However, the Federal Reserve regulates and audits the commercial banks that are its members, and the primary government dealers are mainly the large commercial banks.
A corporation has issued 10% convertible debentures, convertible into 40 shares of common stock. The current market price of the common stock is $25.25. If the bonds are trading at parity, they are priced at: A. 100 B. 101 C. 106 D. 107
B. 101 The bonds are convertible into 40 shares of stock. The current market value of the stock is $25.25, so the parity price of the bonds is 40 x $25.25 = $1,010 = 101
Which of the following would be a quote for a U.S. Government bond with a dollar price of $1,012.50? A. 101.25 B. 101-8 C. 101 1/4 D. 101 4/16
B. 101-8 U.S. Government bonds are quoted on a percentage of par basis in 32nds. 101-8 = 101 8/32nds = 101.25% of $1,000 par = $1,012.50 per bond. Choice C 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. Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.
A customer bought a $1,000 par convertible subordinated debenture at par, convertible into common at $31.25 per share. If the bond's market price increases by 20%, the conversion ratio will be: A. 31.25:1 B. 32.00:1 C. 37.50:1 D. 38.40:1
B. 32.00:1 The conversion price (and hence the conversion ratio) is fixed when the convertible security is issued and does not change. In this case, the bond is issued with a conversion price of $31.25, based upon converting each bond at par. $1,000 par / $31.25 conversion price = 32:1 conversion ratio. Thus, for every bond that is converted, the holder receives 32 shares.
All of the following statements are true regarding equipment trust certificates ("ETCs") EXCEPT: A. Equipment trust certificates are secured by specified corporate assets B. ETCs are considered poor credit risks C. Equipment trust certificates are commonly issued by transportation companies D. Equipment trust certificates are issued in serial maturities
B. ETCs are considered poor credit risks ETCs are issued by transportation companies (railroads, airlines, truckers, etc.). The collateral for the certificates is specified "rolling stock" of the issuer. For example, United Airlines might finance the purchase of a new 787 jetliner by selling an ETC issue. That jetliner is the collateral for the certificates. The serial number of that jetliner will be printed on the ETCs to show that it is pledged as collateral to the certificate holders. ETCs are issued in serial maturities, so that a portion of the debt is repaid each year. This is the typical structure for ETC issues, since the plane is a depreciating asset. Thus, as the plane depreciates each year, part of the issue is being retired. Therefore, the outstanding debt never exceeds the collateral value. Default on ETCs has been rare. Even if there is a default, certificate holders have collateral (in this case, the plane), that they may sell to obtain the funds to repay the outstanding debt balance.
When comparing the debt issues of Ginnie Mae to Fannie Mae, which statement is TRUE? A. Both Ginnie Mae and Fannie Mae issues are backed by the implied guarantee of the U.S. Government B. Ginnie Mae issues are backed by the full faith and credit of the U.S. Government and typically trade at lower yields than Fannie Mae issues C. Fannie Mae issues are directly backed by the full faith and credit of the U.S. Government and typically trade at lower yields than Ginnie Mae issues D. Both Fannie Mae and Ginnie Mae are directly backed by the full faith and credit of the U.S. Government
B. Ginnie Mae issues are backed by the full faith and credit of the U.S. Government and typically trade at lower yields than Fannie Mae issues Ginnie Maes (Government National Mortgage Association issues) are directly backed by the faith and credit of the U.S. Government, since Uncle Sam owns the agency. Fannie Maes (Federal National Mortgage Association issues) are implicitly (indirectly) backed by the Federal Government. Based on their direct U.S. Government guarantee, Ginnie Mae issues typically trade at slightly lower yields when compared to Fannie Mae issues.
Yields on 3 month Treasury bills have declined to 1.84% from 2.21% at the prior week's Treasury auction. This indicates that: A. Treasury Bill prices are falling B. Market interest rates are falling C. Demand for Treasury Bills is weakening D. The Federal Reserve may have to loosen credit
B. Market interest rates are falling If Treasury bill yields are dropping at auction, then interest rates are falling and debt prices must be rising
Eurodollar deposits are: A. U.S. currency held in banks in the US B. US currency held in banks in foreign countries; mainly Europe C. foreign currency held in banks in the US D. foreign currency held in banks in foreign countries, mainly in Europe
B. US currency held in banks in foreign countries; mainly Europe Eurodollar deposits are U.S. currency held in banks in foreign countries, mainly in Europe. The Eurodollar market is centered in London - and the interest rate paid on these deposits is "LIBOR" = London Interbank Offered Rate.
In a period of steep increases in interest rates, which issuer is most likely to be negatively affected? A. Trucking Company B. Utility Company C. Mining Company D. Technology Company
B. Utility Company Utilities are capital intensive - building electric generating plants is expensive! To obtain long term funds, utilities can issue either stock or bonds. Because their revenue stream is stable, utilities can issue large amounts of bonds at favorable interest rates without negatively affecting their credit rating. The vast majority of utility financing is done via the issuance of mortgage bonds. It is typical for a utility to have 90% of its capitalization come from the sale of bonds with only 10% from equity. It contrast, mature manufacturing companies can rarely have more than 30% of their capital base coming from the issuance of debt without negatively affecting their credit rating. If interest rates rise steeply, as its bonds mature, the utility must replace them with new bonds at steeply higher interest rates. This increases its interest cost (which is one of its largest expenses), so earnings will deteriorate, and the price of the stock will fall in the market. Because the other industries listed cannot issue such a large amount of bonds, the negative impact of higher current market rates is not as great.
The effective Fed Funds Rate is the: A. rate charged by the largest members of the Federal Reserve System B. average rate of member banks throughout the US C. highest rate charged by member banks, calculated on Wednesdays D. lowest rate charged by member bank, calculated on Wednesdays
B. average rate of member banks throughout the US The effective Federal Funds Rate is the average daily rate charged by member banks for overnight loans of reserves
When interest rates rise, which statement is TRUE? A. shorter maturity bond prices are affected more than longer maturity bond prices B. longer maturity bond prices are affected more than shorter maturity bond prices C. T-Bill prices are affected more than T-Bond prices D. Maturity does not materially affect the level of interest rate risk
B. longer maturity bond prices are affected more than shorter maturity bond prices The longer the maturity, the more volatile the price movements of the bond as interest rates move (rise or fall). Since T-Bonds have a longer maturity than T-Bills, T-Bond prices are affected more than T-Bill prices
Municipal variable rate demand notes have a: A: minimum value which will never go below par and are subject to market risk B. minimum value which will never go below par and are not subject to market risk C. maximum value which will never go above par and are subject to market risk D. maximum value which will never go above par and are not subject to market risk
B. minimum value which will never go below par and are not subject to market risk Municipal variable rate demand notes are issued by a municipality. The interest rate is reset to the market rate weekly; and at the reset date, the holder can "put" the bonds back to the issuer at par. Here, the minimum value of the bond is par - because of the put feature. Because the price of the bond cannot go below par, these bonds are not subject to market risk. However, if interest rates fall, the price can go above par (by a small amount) until the next reset date
Short sale transactions are typical for all of the following EXCEPT: A. treasury bonds B. municipal bonds C. common stock D. listed options
B. municipal bonds Municipal bonds are generally not sold short because the trading market in each maturity is very thin, making short covering difficult, if not impossible.
The nominal yield of a bond will: A. increase as bond prices fall B. remain unchanged as bond prices fluctuate C. increase as bond prices rise D decrease as bond prices rise
B. remain unchanged as bond prices fluctuate The nominal yield is the stated rate of interest as a percentage of par value. It does not change as bond prices move. However, the current yield and yield to maturity will be affected by changes in bond prices.
A certificate of deposit that changes the rate of interest based on the prevailing market interest rate is known as a: A. market rate CD B. step up/step down CD C. negotiable CD D. renewable CD
B. step up/step down CD Negotiable CDs that have interest rates that will vary with the market are called Step-Up/Step-Down CDs - since the interest rate steps up as market rates rise; and steps down as market interest rates drop
Which statement is TRUE regarding Treasury Inflation Protection securities in periods of deflation? A. the amount of each interest payment will stay the same and the principal amount received at maturity is unchanged at par B. the amount of each interest payment will decline and the principle amount received at maturity is unchanged at par C. The amount of each interest payment will stay the same and the principal amount received at maturity will decline D. The amount of each interest payment will decline and the principal amount received at maturity will decline.
B. the amount of each interest payment will decline and the principle amount received at maturity is unchanged at par Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. In periods of deflation, the principal amount is adjusted downwards. Even though the interest rate is fixed, the holder receives a lower interest payment, due to the decreased principal amount. In the situation where the principal amount has been adjusted below par due to deflation, when the bond matures, the holder receives par - not the decreased principal amount - a real benefit if an investor is concerned about deflation.
What will back a municipal revenue bond? A. any municipal revenue collected B. the specific revenue stipulated in the bond's Official Statement C. taxes collected by the state of issuance D. taxes collected by the issuing municipal entity
B. the specific revenue stipulated in the bond's Official Statement A revenue bond is backed by a "revenue pledge" - these are specific revenues from an enterprise activity (such as the revenue from operating an airport financed with an airport revenue bond issue). Other revenues (such as the revenue from a nearby toll bridge) would be used to pay for a revenue bond issue used to finance the building of that bridge - not of the airport, making Choice A incorrect. Tax collections by states and municipal entities are used to back General Obligation bonds, not revenue bonds.
A 5-year 3 1/2% Treasury Note is quoted at 101-4 - 101-8. The note pays interest on Jan 1st and Jul 1st. All of the following statements are true regarding this trade of T-Notes EXCEPT: A. interest accrues on an actual day month; actual day year basis B. the yield to maturity will be higher than the current yield C. the trade will settle in Fed Funds D. the trade will settle next business day if performed "regular way"
B. the yield to maturity will be higher than the current yield Because these T-Notes are trading at a premium, the yield to maturity will be lower than the current yield. The current yield does not factor in the loss of the premium over the life of the bond, whereas yield to maturity does. Government bond trades settle next business day; accrued interest is computed on an actual month/actual year basis; and trades settle through the Federal Reserve system in "Fed Funds."
The amount by which the purchase price of a municipal bond exceeds the par value of the bond is termed the: A. spread B. discount C. premium D. takedown
C. premium
A convertible bond is convertible into common stock at a 32:1 ratio. The common stock is currently trading at $30. The bond is currently trading at $980. What is the conversion price? A. $30.00 B. $30.63 C. $31.25 D. $32.67
C. $31.25 The conversion price is found by taking $1,000 par and dividing this by the conversion ratio. $1,000 / 32 = $31.25 conversion price.
Which statements are TRUE regarding the effect of interest rate movements on bond price volatility? A. Bonds with the lowest price volatility will be ones with the lowest coupon rates B. Bonds with the lowest price volatility will be zero coupon issues C. Bonds with the lowest price volatility will be ones with the highest coupon rates D. Bonds with the highest price volatility will be ones with the highest coupon rates
C. Bonds with the lowest price volatility will be ones with the highest coupon rates 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. (Zero coupon bonds are extremely volatile in pricing as interest rates fluctuate) Thus, to minimize price volatility due to interest rate movements ("interest rate risk"), high coupon bonds are more appropriate than low coupon bonds.
Which of the following would NOT purchase STRIPS? A. Penion Fund B. IRAs C. Individual seeking current income D. Individual wishing to avoid reinvestment risk
C. Individual seeking current income Pension funds and retirement accounts are the large purchasers of STRIPS. These zero-coupon bonds are purchased at a deep discount and are held to maturity to fund future retirement liabilities. There is little credit risk, because the U.S. Treasury is a top credit. There is no current income because they don't pay until maturity. They have a huge amount of purchasing power risk as a long-term zero coupon obligation, but this is not an issue if they are held to maturity. Retirement plan managers like STRIPS because they don't have to worry about reinvestment risk - there are no semi-annual interest payments to reinvest! It is an investment that can be "tucked away" for 20 or 30 years, with no further work or worry on the part of the retirement fund manager.
A corporation has issued 8% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 7%. Which statement is TRUE about the outstanding 8% issue? A. the dollar price of the bond will be at a discount to par and the current yield will be higher than the nominal yield B. The dollar price of the bond will be at a discount to par and the current yield will be lower than the nominal yield C. The dollar price of the bond will be at a premium to par and the current yield will be lower than the nominal yield D. The dollar price of the bond will be at a premium to par and the current yield will be higher than the nominal yield
C. The dollar price of the bond will be at a premium to par and the current yield will be lower than the nominal yield The bond was issued with a coupon of 8%. Currently, yield for a similar issue is 7%. Therefore, interest rates have fallen subsequent to the issuance of the bond; or the credit quality of the bond has improved. When interest rates fall, yields on bonds already trading must also fall. What causes this is a rise in the dollar price of the issue - the bond now trades at a premium.
A corporate bond which obligates the issuer to pay interest ONLY if the company meets a specified earnings test is a(n): A. guaranteed bond B. subordinated bond C. income bond D. collateral trust certificate
C. income bond Income bonds (also known as adjustment bonds) obligate the issuer to pay interest only if the company meets a specified earnings test. If the earnings are not sufficient, no interest payment is legally required. All other bonds obligate the issuer to pay interest, regardless of events.
All of the following are likely to purchase dealer commercial paper EXCEPT: A. institutions B. trust companies C. individuals D. open-end investment companies
C. individuals Dealer commercial paper is sold for corporations by dealer firms such as Goldman Sachs. The minimum purchase amount is generally $100,000. This eliminates most individuals from the market. The dealer commercial paper market is primarily an institutional market, with purchasers including insurance companies, trust companies and money market mutual funds. As compared to "dealer" paper, many corporations sell their commercial paper directly to the investing public. "Direct" paper is sold directly to the investing public, usually via the web. It also sells in $100,000 and $500,000 minimum amounts, so the individual investor is pretty much cut out.
The term "Funded Debt" refers to: A. short term US government debt B. long term US government debt C. long term corporate debt D. short term corporate debt
C. long term corporate debt Funded debt is a somewhat archaic term that refers to corporate debt that is long term. This is considered to be part of a corporation's long term (permanent) funding.
Issuers of federal tax exempt commercial paper include: A. corporations B. federal government C. municipal governments D. ginnie-mae
C. municipal governments Only municipal issues are exempt from federal income tax on interest income. Corporate and U.S. Government debt interest income is subject to federal income tax.
A bond with a "C" rating is considered to be: A. lower medium grade B. lowest investment grade C. one having credit risk D. one having market risk
C. one having credit risk A bond rated "C" is considered to be speculative and would have substantial credit risk. The ratings agencies cannot rate bonds for market risk - only for credit risk. The lowest investment grade rating is BBB. BB, and B ratings are considered to be medium grade. CCC, CC, and C are all speculative, with a C rating being the most speculative.
A repurchase agreement is effected between two U.S. Government securities dealers. The interest charged under the agreement is the: A. coupon rate of the underlying US government securities, paid directly from the issuer to the securities' original buyer B. coupon rate of the underlying US government securities, paid directly from the issuer to the securities' original seller C. "repo" rate, paid by the buyer of the securities to the seller D. "repo" rate, paid by the seller of the securities to the buyer
D. "repo" rate, paid by the seller of the securities to the buyer In a repurchase agreement between 2 government dealers, a government securities dealer "sells" securities to another dealer, with an agreement to buy them back at a later date. The selling dealer obtains cash, and for this, agrees to pay interest to the buying dealer. The interest rate charged is known as the "repo" rate - the repurchase agreement interest rate. The rate fluctuates with, and parallels, the Federal Funds rate
To smooth out cash flow, a corporation will issue: A. TANs B. RANs C. BANs D. Commercial Paper
D. Commercial Paper Commercial paper is a short term unsecured IOU issued by corporations. TANs (Tax Anticipation Notes), RANs (Revenue Anticipation Notes) and TRANs (Tax and Revenue Anticipation Notes) are municipal short term notes.
All of the following debt securities may be issued by corporations EXCEPT: A. Equipment trust certificates B. Mortgage bonds C. Adjustment bonds D. Moral obligation bonds
D. Moral obligation bonds Corporations do not issue moral obligation bonds. Municipalities that are at their legal debt limits may issue such bonds, which morally obligate them to pay (but there is no legal obligation to pay). Corporations can issue equipment trust certificates backed by equipment owned by the company. Also, they can issue adjustment bonds, also known as income bonds, that obligate the issuer to pay only if there are sufficient earnings. Finally, corporations can issue mortgage bonds backed by real property.
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.
Which statement is TRUE when the Federal Reserve enters into a reverse repurchase agreement with a U.S. Government securities dealer? A. The Fed buys US government securities from the dealer and is loosening credit in the banking system B. The Fed buys U.S. Government securities from the dealer and is tightening credit in the banking system C. The Fed sells U.S. Government securities to the dealer and is loosening credit in the banking system D. The Fed sells U.S. Government securities to the dealer and is tightening credit in the banking system
D. The Fed sells U.S. Government securities to the dealer and is tightening credit in the banking system In a reverse repurchase agreement, the Fed sells government securities to a dealer (taking cash from the dealer) and will buy them back at a later date. This withdraws cash from the banking system, tightening credit.
The type of municipal bond issue that would be used to finance the construction of public schools would be a: A. revenue bond B. special tax bond C. moral obligation bond D. general obligation bond
D. general obligation bond 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. Special tax bonds pledge collected "special taxes," such as excise taxes, to pay for the financing of a project. For example, a road improvement district bond issue could be financed by a special gasoline tax. A moral obligation bond is only issued in times of municipal distress, when the municipality does not have enough taxing power or revenue generating ability to sell a normal bond issue. To bail out the local municipal issuer, the state can morally obligate itself to pay if the municipal issuer cannot
Municipal bonds would NOT be an appropriate investment for which of the following? A. individuals B. institutions C. bank holding companies D. individual retirement accounts
D. individual retirement accounts It makes no sense to place "federally tax exempt" municipal bonds into a "tax deferred vehicle" such as an IRA or Keogh account. Since the account is tax deferred, one would place securities earning the highest "before tax" return, such as corporates or governments into the account
Zero coupon bonds: A. do not pay interest B. pay interest semi-annually C. pay interest annually D. pay interest at maturity
D. pay interest at maturity Zero coupon bonds do not make semi-annual interest payments. The bonds are bought at a deep discount and mature at par. The difference is the interest earned, so all of the interest is paid at maturity.
Which risk is NOT associated with Long Term Negotiable Certificates of Deposit? A. market risk B. call risk C. reinvestment risk D. prepayment risk
D. prepayment risk Prepayment risk is the risk that, as interest rates fall, homeowners will pay off their mortgages earlier than anticipated and refinance at lower rates. This risk is applicable to mortgage-backed securities. It is not applicable to Long-term Certificates of Deposit. Long-term negotiable Certificates of Deposit (over 1 year maturity) are subject to market risk, as are any long-term fixed rate debt instruments. Market risk for fixed income securities is the risk that if market interest rates rise, securities prices, as a whole, will fall, dragging down both good and bad investments. Long-term CDs can be callable, so they are subject to call risk in a declining interest rate environment. Interest is paid semi-annually and, again in a declining interest rate environment, if these payments are reinvested in new CDs, the rate of return on reinvested monies will decline - thus Long Term CDs have reinvestment risk.
The proceeds of a "Build America Bond" may be used for all of the following EXCEPT: A. public buildings B. transportation infrastructure C. water and sewer projects D. prerefunding outstanding issues
D. prerefunding outstanding issues Build America Bonds (BABs) were issued by municipalities in 2009 and 2010. They are taxable municipal bonds that get a 35% Federal interest rate subsidy and the bond proceeds must be used for capital improvements (this is part of the economic stimulus program after the 2008-2009 "great recession"). These bonds were meant to create jobs and make to it easier for municipalities to access the debt market for needed capital projects. The proceeds of BABs cannot be used to prerefund existing issues (that does not create jobs).
The bond counsel will review all of the following sources to ascertain if a municipal issuer has the authority to sell bonds EXCEPT: A. state constitution and judicial opinions B. validity of the signatures of the issuer's representatives C. enabling legislation and local statutes D. securities exchange act of 1934
D. securities exchange act of 1934 The bond counsel will review several sources to ascertain if a municipal issuer has the authority to sell bonds. The state constitution which gives those powers; any enabling legislation which affects the issuance of new bonds; any court opinions that are relevant; and the counsel will ascertain that the issuer's representatives are authorized to sell the bonds. Municipal bonds are exempt securities and not subject to the Securities Act of 1933 or the Securities Exchange Act of 1934, with the exception of the anti-fraud provisions.
A municipal bond which funds an improvement that benefits only a small portion of the community is a: A. general obligation bond B. double barreled bond C. moral obligation bond D. special assessment bond
D. special assessment bond Special assessment bonds are used to fund an improvement which benefits only a small portion of the community. For example: new street lights are installed in a specific area where only that area is assessed higher taxes to pay for the improvement.
All of the following statements are correct regarding overnight repurchase agreements EXCEPT: A. the seller loses control of the underlying securities for the duration of the agreement B. the interest rate charged is most similar to the Federal Funds rate C. the investment as interest rate risk D. the investment as liquidity risk
D. the investment as liquidity risk Overnight repurchase agreements are typically effected between government securities dealers. A dealer who needs cash will "sell" some of its inventory overnight to another dealer, with an agreement to buy the position back the next day. The difference between the sale price and the repurchase price is the interest earned. There is virtually no liquidity risk, since the loan is of the shortest term and is secured by pledged government securities. The interest rate on such agreements generally parallels and is somewhat lower (since the loans are secured) than the Fed funds rate, since overnight loans using government securities are most similar to overnight loans of reserves (Fed Funds) from bank to bank. Since government securities are pledged as collateral, the dealer gives up custody of the securities overnight. Repos do have interest rate risk, relating to the underlying securities. If interest rates rise, the underlying securities can decline in value. Since the maturity of the underlying securities can be of any length, long maturity values may decline more than the accrued interest to be earned on the agreement. When the borrower of the funds buys back the securities the next day at the pre-agreed price, it buys back securities at more than they are worth!
A 30-year bond is issued with a 6% stated rate of interest, and is callable starting in 10 years at 102. It is now 11 years later and market interest rates for similar bonds are now at 9%. Which statement is TRUE? A. the coupon rate on the bond will be changed to 9% B. the bond is likely to be called by the issuer C. the credit rating of the bond is likely to be lowered D. the market price of the bond will fall substantially below par
D. the market price of the bond will fall substantially below par Because interest rates have risen by 50% (6% to 9%), the bond will now be selling at a substantial discount. The issuer would not call the bond, because it has a great deal. It is currently paying 6% interest, and if it wanted to sell new bonds, it would have to pay 9%. The coupon rate is fixed at issuance and does not change. Finally, the credit rating on the bond evaluates the issuer's ability to pay interest and principal - it has nothing to do with market interest rate movements.