Debt Securities (quiz)
Brady is a municipal finance professional for XYZ Municipal Broker-Dealer. He lives in Little Town, USA where his neighbor Drew is running for Mayor. Brady wants Drew to win and has contributed $150 to his election campaign. XYZ Broker-Dealer has been working with Little Town putting together a new issue of municipal bonds. Based on MSRB Rules what additional amount if any could Brady contribute to Drews campaign without exceeding the allowable contribution limit to ensure there is no impact for XYZs ability to continue the business relationship with Little town USA?
$100 Under MSRB Rules, contributions cannot exceed $250 per election if the individual can vote in the election. Brady has already contributed $150 therefore he would only be allowed to contribute another $100 to stay within the $250 limit. Do not confuse this MSRB Rule with the SEC pay to play rule limit of $350
Corporate bonds usually have a face value of
$1000 It also can be referred to as a Par value
Assume your customer has 300 shares of common stock with a current market value of 21.25 and 20 first mortgage bonds at par. Both increase 3/4 of a point. What is the increase in the value of his holdings?
$375 1 pt on a stock = $1 1pt on a bond = $10 3/4pt on a stock = .75 per share 3/4pt on a bond = 7.50 per bond .75x300 shares = $225 increase on stock 7.50x20 bonds = $150 increase on bonds $375 Overall increase in value
Mr, Jones purchased $10,000 par value of 8% bonds to yield 5%. On the normal interest payment date, he will receive:
$400 "Normal" interest payment is semi annual and based on the coupon rate not yield. Mr. Jones has purchased $10,000 worth of bonds, or (10) $1,000 bonds. So we can multiply the overall par value of the bonds by the coupon rate to find the annual interest, then divide by 2 to find the semi annual payment. $10,000 x .08 = $800 (annual interest) $800/2 = $400 (semi annual payment)
In what order are payments received in the event of corporate liquidation?
1- taxes 2- Senior Lien bond holders 3- Debenture holders 4- preferred stock holders
List the yields from lowest to highest, if a corporate bond is trading at a premium.
1. Basis 2. Current Yield 3. Normal Yield Because the price is high (the question states it is trading at a premium) the current yield and basis will be less than the normal yield. Remember basis always has the greatest reaction.
An investor located in the U.S. would be most concerned with exchange risk on which of the following securities?
15-year bonds offered by the federal government of Canada Exchange risk or foreign exchange risk is the risk that fluctuations in currency values will negatively impact an investment in a foreign security. For this reason the 15-year bonds offered by the federal government of Canada would be the security where the investor would have the most concern with exchange risk. This is due to the fact that the investor may find that changes in the currency values between the U.S. dollar and the Canadian dollar have caused a decrease in return once the interest from the Canadian bonds is converted back to the U.S. dollars.
ABC Corporation wants to issue @20,000,000 of debentures each of which would be convertible in 20 shares of common stock. How many common shares are issued if all the debentures are converted?
400,000 The question states that you get 20 shares of common stock per bond. The next step would be to figure out how many bonds are allowed in total: $20,000,000/$1,000 (par value)=20,000 bonds. For each bond you can receive 20 shares of stock and you have 20,000 bonds: 20x20,000=4000,000 common shares issued.
Corporate bonds issued in serial form typically have which two features?
A balloon maturity and different maturity dates Note that most serial bonds have a balloon payment after the staggered maturity dies
If a customer believes that interest rates will decline substantially, she should invest in
A long term Corporate Bond with a coupon rate of 10% at a 12% basis, non callable Bonds have an inverse reaction to interest rate movements, when interest rates go down the prices of outstanding bonds will rise. In addition, long term bonds react the greatest to interest rate changes compared with bonds with shorter maturities. The non callable feature is also appealing because it gives the investor some protection against her bonds being called by the issuer when interest rates fall.
Commercial paper issued by an industrial company may be rated by all of the following credit rating services EXCEPT
A.M. Best A.M. Best only rates insurance companies. The other companies rate various industries and all kinds of debt instruments
Zero coupon bonds would be most suitable for an investor seeking which one of the following?
Accumulation Capital Zero coupon bond interest is paid upon attrition, therefore an investor seeking accumulation of capital rather than semi-annual interest payments would buy these bonds.
If a corporation is in liquidation, the holder of a subordinated debenture would be paid at what time?
After bank loans and after general creditors A subordinated debenture is one that is paid after any senior lien debt. If a corporation was in liquidation, bank loans and general creditors including accounts payable would be paid before the holder of a subordinated debenture would receive any money.
Three AA corporate bonds having a 6% coupon rate are selling at par. Bond A has a one year maturity. Bond B has a 20 year maturity and Bond C has a 40 year maturity. If there is a rise in the general level of interest rates, which is most likely to occur?
All bonds will fall in price; the longer maturity will have a greater fall When interest rates change, prices of short term bonds react the quickest but long term bond prices react the GREATEST
Long term bonds differ from short term bonds in that long term bonds
Are more price sensitive to interest rate fluctuations
A corporate bond is purchased at a discount. Which of the following would best state its future rate of return?
Basis or yield to maturity When a bond is purchased at a discount, the yield to maturity will always be greater than the current yield or coupon rate because the calculation takes into consideration the difference between the price the investor paid and what the investor will receive at maturity which would increase the overall yield since the investor would have paid less than $1,000 (discount) but would receive $1,000 par value at maturity.
Two corporate bonds are about to be issued to the public: Bond A and Bond B. Bond A is a lower quality bond and the offering will be $5,000,000. Bond B is the higher quality bond and he offering will be $4,000,000. Which of the following is correct regarding these bonds?
Bond A is likely to have a higher yield because it is of a lower quality Lower quality bonds generally will offer higher yields because the company issuing the bond must attract buyers. Conversely, high quality bonds are able to offer lower yields because the bonds re considered less risky. With relatively similar ranges in the size of the offering the amount of bonds being offered is not a factor.
The "Call Protection" period on an outstanding callable bond would be most advantageous to which of the following?
Bond holder Call protection is the time period during which the bonds may not be called, which is most beneficial to the bond holders
What is a key factor that determines which CMO tranches receive principal payments from mortgages?
By maturity date Principal payments and pre-payment are paid in order of the tranches maturity date. Early maturities are paid first and then later maturities.
Which of the following statements regarding Collateralized Debt Obligations (CDOs) is correct?
CDOs are divided into tranches, generally based on risk CDOs are asset-backed debt securities. They can be backed by various assets such as mortgages, auto loans, corporate debt and credit card debt. They are structured into tranches, similar to CMOs and tranches are generally determined based upon risk.
Zero Coupon Bonds are purchased primarily by investors who are looking for
Capital accumulation Since all interest is paid at maturity with the principal payment, the investor would have capital accumulation
Which of the following securities may offer convertible features that allow the holders to exchange the securities for other issue of the company?
Corporate bonds Corporate bonds old be issued as convertible. It can be converted into shares of common stock. Common stock is never issued as convertible.
Which best describes municipal bonds priced at par?
Coupon rate for any given year equals the yield to maturity All yields (Nominal, Current, and Yield to Maturity) are equal when a bond is trading at par value.
Interest rate movements may affect all of the following regarding CMOs EXCEPT
Credit rating
When a conversion takes place, what occurs?
Existing bonds are tendered to the issuer for equity securities, most frequently common stock The most accurate description listed when it comes to conversion is the tender of bonds for equity securities. A conversion feature on a bond or preferred stock allows the holder to "tender" or turn in the bond or preferred stock in exchange for shares of common stock. Each of the other items listed applies to early retirement of existing bonds or refunding of existing bond issues.
A corporate bond was issued at par value and is now trading at premium. The investor can conclude that the bonds
Face value is lower than the market price
When general level of interest rates increase, the price of high-grade bonds will
Fall
When an investment grade corporate bond is downgraded to a junk bond, it is referred to as a
Fallen angel
Investors should consider bonds with long term maturities when interest rates
Have been high but are expected to drop If interest rates are high and expected to decline, investors should by bonds with long term maturities to lock in the higher rate for the longer term
The interest rate in collateralized mortgage obligation:
Is paid at the coupon rate over the life of a bond The interest rate on a CMO is a pre-determined fixed rate that is paid over the life of the bond.
A bond which carries a credit rating of BB or lower is referred to as a
Junk bond Junk bomds or high yield bonds are issued by companies that have little or no track record of sales or earnings, have a bb rating or lower or no rating, or are issued by companies that are in financial distress
Which of the following is an example of funded corporate debt?
Long-term bonds Corporate funded debt is referred to as corporate debt with one or more years to maturity
An investor who purchases a CMO can explain distributions of cash how frequently?
Monthly
Which of the following corporate bonds would be considered most secured?
Mortgage bonds Mortgage bonds would be considered the most secured bond of those listed because it is backed by some asset of the corporation.
Interest from which of the following bonds is exempt from federal tax?
Municipal bonds
An investor buys two bonds: a 7.5% bond and an 8.5% bond, maturing in 2030, and at a 6.00 basis (yam), The price of both of the bonds moves to 90.5. Which bond is likely to have the most price appreciation?
Neither, because the market price decreased The bonds were purchased with a 6% basis(yam) when the coupons were higher at 7.5% and 8.5%. This indicated that the bonds had been purchased at a premium, or at a value higher than $1,000 (the par value). The question states the price of both bonds goes to 90.5 or $905 which is quote at a discounted price (below par value) therefore the price of the bonds would have DECLINED.
Which security could be issued with conversion privileges?
Preferred Stock Preferred stock (and corporate bonds) could be issued with conversion privileges which is the right of the owner of these securities to convert them into another security, usually common stock.
Which of the following statements related to Collateralized Mortgage Obligation (CMOs) is FALSE?
Private mortgage issuers are prohibited from pooling and collateralizing mortgages to create CMOs Each of the statements is true except for the statement about private mortgage issuers. Private mortgage issuers can pool and collateralize mortgage debt to sell CMO products
Fannie Mae commonly securities which of the following forms of debt to create CMO products?
Residential Mortgages Though many forms of debt can be "securitized" Fannie Mae is a government agency that commonly securities residential mortgage debt into CMO products
Collateral Mortgage Obligations are collateralized by all of the following EXCEPT:
Sally Maes CMO pools are issued and collateralized (secured with collateral) with mortgage loans from: Ginnie Mae Fannie Mae Freddie Mae FHA Mortgage Loans Conventional/Private mortgage Issuers CMOs are NOTY collateralized by Sally Mae (student loans)
Which statement is correct if a sinking fund provision is included in a corporate bond indenture?
Such provision requires a mandatory retirement of debt by the issuer Not all bond issues have sinking fund provisions but, if they do, the sinking fund provisions are attractive to investors because they require mandatory retirement of debt by the issuer on a specified date or dates. This adds to the safety of the bond issuance because the issuer is requires to have money on hand and available to retire the securities at the times specified. A sinking does not make a bond more volatile.
Which of the following best describes the "Call Premium" of a bond?
The amount above par value which the issuer must pay to call the bond in for redemption A call premium is the amount over par that an issuer has to pay to an investor for redeeming the security early
The public offering price of a bond is $1,000 and the bond has a coupon of %5. If interest rates remain unchanged, what could you expect regarding the price of the bond.
The bond would remain at par value Bonds that trade for $1,000 are said to trade at "par". Bonds that trade for a price above $1,000 are said to trade at a premium.Bonds that trade below $1,000 are said to trade at a discount. Depreciation refers to an accounting practice for physical assets, such as equipment.
When analyzing the investment quality of a mortgage bond, which of the following would be least useful to the analyst?
The name of the trustee that holds title to the collateral Investors will decide to purchase a mortgage bond based on several factors, including the rating, how the bonds are secured, and by general trends in the business cycle. The name of the trustee has little or no bearing on this decision.
Which of the following amounts is typically paid to the holder of a normal corporate bond at maturity?
The par or face value that is printed on the bond With normal corporate bond, the bonds par or face value is repaid to the bond holder at maturity.
Concerning the taxation of Collateralized Mortgage Obligations (CMO's) which of the following decreases the yield of the bond?
The return is taxable at the Federal, State, and Local levels Since the income would be subject to federal, state and local tax the net yields to the investor would be less
The Trust Indenture Act of 1939 regulates corporate debt issues and requires the designation of a trustee. What duty does the trustee have?
The trustee is charged with acting on behalf of bond holders and ensuring that the rights of these bond holders are not infringed upon. The Trust Indenture act of 1939 pertains to corporate debt issues and requires that each corporate debt issue has an indenture and a trustee. The trustees main function is the representation of bond holders and ensuring the safeguarding of bond holders rights.
A regular way settlement on US Government Treasury Bonds purchased in the secondary market is
Trade day plus one business day
A CMO has 4 tranches. Interest rates have dropped significantly recently and mortgage holders are starting to prepay their loans because they are refinancing at lower rates. Which of the following tranches is most affected but the prepayments?
Tranche 1 Principal payments and prepayments from the mortgage loans in the CMO pool pay off one tranche at a time in order of maturity (1,2,3, etc.)
It is TRUE to state that junk bonds
Typically have higher price volatility when compared to investment grade bonds Junk bonds typically have higher price volatility when compared to investment grade bonds. This means that junk bonds have greater price fluctuations than investment grade bonds. Junk bonds: - can be rated as BB or lower, or can be unrated. There is no requirement of rating. -normally will have higher coupon rates and lower market prices when compared to investment grade bonds, leading to higher yields. -can start as investment grade and be downgraded (fallen angels) or can be upgraded from junk bond status to investment grade status.
If an investor is primarily seeking capital gains, when would be the best time to buy bonds?
When interest rates are high and are expected to drop A decline in interest rates causes prices to rise. An investor seeking capital gains would want to buy when interests rates are high and sell when they are low and prices have been driven up.
The effect of steadily declining interest rates on bonds trading in the secondary market is
Yields decrease and prices increase When interest rates decline, yields decline, and prices rise. Think about the see-saw diagram.
Which bond would be most suitable for an investor who invests for maximum liquidity?
a bond with one year to maturity Short term investments are considered the most liquid
Which of the following types of bonds secures its income from fees charged to users?
revenue bond Revenue bonds are paid for by user fees from the project. An example of a project for which a revenue bond would be issued would be a toll road.
Which of the following would not be related to equity securities that a corporation would distribute?
subordinated debentures
