Fixed Income
Which of the following bond types provides the most benefit to a bondholder when bond prices are declining? Callable Plain vanilla Multiple put
C is correct. A putable bond is beneficial for the bondholder by guaranteeing a prespecified selling price at the redemption date, thus offering protection when interest rates rise and bond prices decline. Relative to a one-time put bond that incorporates a single sellback opportunity, a multiple put bond offers more frequent sellback opportunities, thus providing the most benefit to bondholders.
Which of the following type of debt obligation most likely protects bondholders when the assets serving as collateral are non-performing? Covered bonds Collateral trust bonds Mortgage-backed securities
A is correct. A covered bond is a debt obligation backed by a segregated pool of assets called a "cover pool." When the assets that are included in the cover pool become non-performing (i.e., the assets are not generating the promised cash flows), the issuer must replace them with performing assets.
China Construction Development Corporation needs to finance a three-year construction project in Singapore. The corporation plans to issue a bond with coupon payments to be paid in Chinese yuan and principal to be repaid in Singapore dollars. This bond is most likely an example of a: dual currency bond. currency option bond. foreign currency bond.
A is correct. A dual currency bond makes coupon payments in one currency and pays the par value at maturity in another currency. B is incorrect because a currency option bond gives bondholders the right to choose the currency in which they want to receive interest payments and principal repayments. C is incorrect because a foreign currency bond is issued in foreign currency for both principal and interest payments.
Consider two bonds that are identical except for their coupon rates. The bond that will have the highest interest rate risk most likely has the: lowest coupon rate. coupon rate closest to its market yield. highest coupon rate.
A is correct. A lower coupon rate means that more of the bond's value comes from repayment of face value, which occurs at the end of the bond's life. B is incorrect because the relationship between the coupon rate and the yield of a bond affect the relationship between the price and face value of the bond, not its interest rate risk. C is incorrect because a higher coupon rate means that more of the bond's value comes from coupon payments, which occur earlier in a bond's life.
Which bond has the lowest ytm? A- PV: $101.886 B- PV: $100 C- PV: $97.327
A is correct. Bond A offers the lowest yield-to-maturity. When a bond is priced at a premium above par value the yield-to-maturity (YTM), or market discount rate is less than the coupon rate. Bond A is priced at a premium, so its YTM is below its 5% coupon rate. Bond B is priced at par value so its YTM is equal to its 6% coupon rate. Bond C is priced at a discount below par value, so its YTM is above its 5% coupon rate.
The variability of the coupon rate on a Libor-based floating-rate bond is most likely due to: periodic resets of the reference rate. market-based reassessments of the issuer's creditworthiness. changing estimates by the Libor administrator of borrowing capacity.
A is correct. Changes in the coupon rate of interest on a floating-rate bond that uses a Libor reference rate are due to changes in the reference rate (for example, 90-day Libor), which resets periodically. "Therefore, the coupon rate adjusts to the level of market interest rates (plus the spread) each time the reference rate is reset."
Q. Eurocommerical paper is most likely: negotiable. denominated in euro. issued on a discount basis.
A is correct. Commercial paper, whether US commercial paper or Eurocommercial paper, is negotiable—that is, investors can buy and sell commercial paper on secondary markets. B is incorrect because Eurocommercial paper can be denominated in any currency. C is incorrect because Eurocommercial paper may be issued on an interest-bearing (or yield) basis or a discount basis.
Which type of sovereign bond has the lowest interest rate risk for an investor? Floaters Coupon bonds Discount bonds
A is correct. Floaters are bonds with a floating rate of interest that resets periodically based on changes in the level of a reference rate, such as Libor. Because changes in the reference rate reflect changes in market interest rates, price changes of floaters are far less pronounced than those of fixed-rate bonds, such as coupon bonds and discount bonds. Thus, investors holding floaters are less exposed to interest rate risk than investors holding fixed-rate discount or coupon bonds.
A commercial mortgage-backed security (CMBS) does not meet the debt-to-service coverage at the loan level necessary to achieve a desired credit rating. Which of the following features would most likely improve the credit rating of the CMBS? Subordination Call protection Balloon payments
A is correct. If specific ratios of debt to service coverage are needed, and those ratios cannot be met at the loan level, subordination is used to achieve the desired credit rating. Call protection protects investors against prepayment risk. Balloon payments increase the risk of the underlying loans.
In major developed bond markets, newly issued sovereign bonds are most often sold to the public via a(n): auction. private placement. best efforts offering.
A is correct. In major developed bond markets, newly issued sovereign bonds are sold to the public via an auction. B and C are incorrect because sovereign bonds are rarely issued via private placements or best effort offerings.
The maturity effect is least likely to hold for a: low-coupon, long-term bond trading at a discount. zero-coupon bond. low-coupon, long-term bond trading at a premium.
A is correct. In some situations, the maturity effect may not hold for a low-coupon bond that is trading below par. B is incorrect because the maturity effect will always hold for a zero-coupon bond. C is incorrect because the maturity effect will hold for a low-coupon bond that is trading above par.
When underwriting new corporate bonds, matrix pricing is used to get an estimate of the: required yield spread over the benchmark rate. market discount rate of other comparable corporate bonds. yield-to-maturity on a government bond having a similar time-to-maturity.
A is correct. Matrix pricing is used in underwriting new bonds to get an estimate of the required yield spread over the benchmark rate. The benchmark rate is typically the yield-to-maturity on a government bond having the same, or close to the same, time-to-maturity. The spread is the difference between the yield-to-maturity on the new bond and the benchmark rate. The yield spread is the additional compensation required by investors for the difference in the credit risk, liquidity risk, and tax status of the bond relative to the government bond
Which of the following describes a typical feature of a non-agency residential mortgage-backed security (RMBS)? Senior/subordinated structure A pool of conforming mortgages as collateral A guarantee by a government-sponsored enterprise
A is correct. Non-agency RMBS are credit enhanced, either internally or externally, to make the securities more attractive to investors. The most common forms of internal credit enhancements are senior/subordinated structures, reserve accounts, and overcollateralization. Conforming mortgages are used as collateral for agency (not non-agency) mortgage pass-through securities. An agency RMBS, rather than a non-agency RMBS, issued by a GSE (government sponsored enterprise), is guaranteed by the respective GSE.
Which of the following is least likely to be a negative covenant associated with a coupon-paying corporate bond issue? A requirement to pay withholding taxes to foreign governments in a timely manner A prohibition from investing in long-term projects in emerging market countries A requirement to hedge at least 50% of the firm's revenues generated from foreign sales
A is correct. Requiring compliance with the existing rules and regulations of foreign governments is administrative in nature and thus an affirmative covenant. B and C are incorrect because this is a negative covenant that is likely to materially constrain the firm's operational decisions and is likely to be costly to the firm.
The yield spread of a specific bond over the standard swap rate in that currency of the same tenor is best described as the: I-spread. Z-spread. G-spread.
A is correct. The I-spread, or interpolated spread, is the yield spread of a specific bond over the standard swap rate in that currency of the same tenor. The yield spread in basis points over an actual or interpolated government bond is known as the G-spread. The Z-spread (zero-volatility spread) is the constant spread such that is added to each spot rate such that the present value of the cash flows matches the price of the bond.
Which of the following best describes a convertible bond's conversion premium? Bond price minus conversion value Par value divided by conversion price Current share price multiplied by conversion ratio
A is correct. The conversion premium is the difference between the convertible bond's price and its conversion value.
The repo margin on a repurchase agreement is most likely to be lower when: the underlying collateral is in short supply. the maturity of the repurchase agreement is long. the credit risk associated with the underlying collateral is high.
A is correct. The repo margin (the difference between the market value of the underlying collateral and the value of the loan) is a function of the supply and demand conditions of the collateral. The repo margin is typically lower if the underlying collateral is in short supply or if there is a high demand for it. B and C are incorrect because the repo margin is usually higher (not lower) when the maturity of the repurchase agreement is long and when the credit risk associated with the underlying collateral is high.
Corporate bond secondary market trading most often occurs: on a book-entry basis. on organized exchanges. prior to settlement at T + 1.
A is correct. The vast majority of corporate bonds are traded in over-the-counter (OTC) markets that use electronic trading platforms through which users submit buy and sell orders. Settlement of trades in the OTC markets occurs by means of a simultaneous exchange of bonds for cash on the books of the clearing system "on a paperless, computerized book-entry basis."
Which type of fixed-income security is most likely to have coupon payments that reset periodically? Callable bonds Floating-rate notes Convertible bonds
B is correct. A floating-rate bond does not have a fixed coupon rate over its life. Instead, its coupon payments reset periodically according to some reference rate, such as the one-month London interbank offered rate (Libor). A is incorrect because a callable bond gives issuers the ability to retire debt prior to maturity. It does not have a feature of resetting coupon payments periodically according to the reference rate. C is incorrect because a convertible bond gives the bondholder the right to convert the bond into a specified number of shares of the issuer's common shares.
Which type of bond most likely earns interest on an implied basis? Floater Conventional bond Pure discount bond
C is correct. A zero-coupon, or pure discount, bond pays no interest; instead, it is issued at a discount to par value and redeemed at par. As a result, the interest earned is implied and equal to the difference between the par value and the purchase price.
Which of the following is a type of external credit enhancement? Covenants A surety bond Overcollaterization
B is correct. A surety bond is an external credit enhancement, i.e., a guarantee received from a third party. If the issuer defaults, the guarantor who provided the surety bond will reimburse investors for any losses, usually up to a maximum amount called the penal sum. A is incorrect because covenants are legally enforceable rules that borrowers and lenders agree upon when the bond is issued. C is incorrect because overcollateralization is an internal, not external, credit enhancement. Collateral is a guarantee underlying the debt above and beyond the issuer's promise to pay, and overcollateralization refers to the process of posting more collateral than is needed to obtain or secure financing. Collateral, such as assets or securities pledged to ensure debt payments, is not provided by a third party. Thus, overcollateralization is not an external credit enhancement.
Which of the following statements describing a par curve is incorrect? A par curve is obtained from a spot curve. All bonds on a par curve are assumed to have different credit risk. A par curve is a sequence of yields-to-maturity such that each bond is priced at par value.
B is correct. All bonds on a par curve are assumed to have similar, not different, credit risk. Par curves are obtained from spot curves and all bonds used to derive the par curve are assumed to have the same credit risk, as well as the same periodicity, currency, liquidity, tax status, and annual yields. A par curve is a sequence of yields-to-maturity such that each bond is priced at par value.
Ted Nguyen is an investor domiciled in a country with an original issue discount tax provision. He purchases a zero-coupon bond at a deep discount to par value with the intention of holding the bond until maturity. At maturity, he will most likely face: a capital gain. neither a capital loss nor gain. a capital loss.
B is correct. An original issue discount tax provision allows the investor to increase the cost basis of the bond, so when the bond matures, the investor faces no capital gain or loss. A and C are incorrect because the investor will face neither a capital gain nor a loss as the original issue discount tax provision allows the investor to increase the cost basis of the bond.
A bond portfolio manager is considering three bonds—A, B, and C—for his portfolio. Bond A allows the issuer to call the bond before the stated maturity, Bond B allows the investor to put the bond back to the issuer before the stated maturity, and Bond C contains no embedded options. The bonds are otherwise identical. The manager tells his assistant, "Bond A and Bond B should have larger nominal yield spreads to a US Treasury than Bond C to compensate for their embedded options." Is the manager most likely correct? No, Bond A's nominal yield spread should be less than Bond C's No, Bond B's nominal yield spread should be less than Bond C's Yes
B is correct. Bond B's embedded put option benefits the investor, and the yield spread will therefore be less than the yield spread of Bond C, which does not contain this option or benefit. A is incorrect because Bond A's embedded call option benefits the issuer, not the investor, therefore investors will demand a higher yield spread than on Bond C in compensation. C is incorrect because Bond B should have a smaller yield spread.
If a bank wants the ability to retire debt prior to maturity in order to take advantage of lower borrowing rates, it most likelyissues a: convertible bond. callable bond. putable bond.
B is correct. Callable bonds give issuers the ability to retire debt prior to maturity. The most compelling reason for them to do so is to take advantage of lower borrowing rates. A is incorrect because convertible bonds give bondholders the ability to convert the bond to a predetermined number of shares of the company. C is incorrect because putable bonds give bondholders the ability to sell the bond at predetermined price to issuers.
Matrix pricing allows investors to estimate market discount rates and prices for bonds: with different coupon rates. that are not actively traded. with different credit quality.
B is correct. For bonds not actively traded or not yet issued, matrix pricing is a price estimation process that uses market discount rates based on the quoted prices of similar bonds (similar times-to-maturity, coupon rates, and credit quality).
Which of the following factors will most likely drive the repo margin lower? Lower quality of the collateral Shorter supply of the collateral Lower credit quality of the counterparty
B is correct. If the collateral is in short supply or if there is a high demand for it, repo margins are lower. Repo margin is the difference between the market value of the security used as collateral and the value of the loan. A is incorrect because the lower the quality of the collateral, the higher the repo margin. C is incorrect because the lower the creditworthiness of the counterparty, the higher the repo margin.
In a mortgage pass-through security, the pass-through rate: is adjusted as market rates rise or fall. adjusts the rate on the underlying pool of mortgages by a servicing fee. is equal to the mortgage rate on the underlying pool of mortgages.
B is correct. In a mortgage pass-through security, the pass-through rate is less than the mortgage rate on the underlying pool of mortgages by an amount equal to the servicing (and other administrative) fees. A and C are incorrect because in a mortgage pass-through security, the pass-through rate is less than the mortgage rate on the underlying pool of mortgages by an amount equal to the servicing (and other administrative) fees.
Which one of the following is least likely to be an example of a Eurobond? A Japanese company issuing euro-denominated bonds to investors domiciled in the United Kingdom A UK-based company issuing Japanese yen-denominated bonds to investors domiciled in Japan An Australian company issuing US$-denominated bonds to investors domiciled in Japan
B is correct. It is an example of a foreign bond, that is, a bond issued by a foreign company in the domestic market of the country in whose currency the bond is denominated. A is incorrect because this is an example of a euro-denominated Eurobond. C is incorrect because this is an example of a Eurodollar bond.
Relative to negative bond covenants, positive covenants are most likely: legally enforceable. cheaper for the issuers. enacted at the time of the bond issue.
B is correct. Positive (or affirmative) covenants are typically administrative in nature and do not impose additional costs on the issuer, whereas negative covenants are frequently costly.
Securitization is beneficial for banks because it: repackages bank loans into simpler structures. increases the funds available for banks to lend. allows banks to maintain ownership of their securitized assets.
B is correct. Securitization increases the funds available for banks to lend because it allows banks to remove loans from their balance sheets and issue bonds that are backed by those loans. Securitization repackages relatively simple debt obligations, such as bank loans, into more complex, not simpler, structures. Securitization involves transferring ownership of assets from the original owner—in this case, the banks—into a special legal entity. As a result, banks do not maintain ownership of the securitized assets.
The rate, interpreted to be the incremental return for extending the time-to-maturity of an investment for an additional time period, is the: add-on rate. forward rate. yield-to-maturity.
B is correct. The forward rate can be interpreted to be the incremental or marginal return for extending the time-to-maturity of an investment for an additional time period. The add-on rate (bond equivalent yield) is a rate quoted for money market instruments such as bank certificates of deposit and indexes such as Libor and Euribor. Yield-to-maturity is the internal rate of return on the bond's cash flows—the uniform interest rate such that when the bond's future cash flows are discounted at that rate, the sum of the present values equals the price of the bond. It is the implied market discount rate.
To obtain the spot yield curve, a bond analyst would most likely use the most: recently issued and actively traded corporate bonds. recently issued and actively traded government bonds. seasoned and actively traded government bonds.
B is correct. To obtain the spot yield curve, a bond analyst would prefer to use the most recently issued and actively traded government bonds. Such bonds will have similar liquidity as well as fewer tax effects because they will be priced closer to par value. A is incorrect because the spot yield curve is derived from the most recently issued and actively traded government, not corporate, bonds. C is incorrect because seasoned government bonds tend to be less liquid than newly issued ones because they are typically owned by buy-and-hold investors.
Which of the following sources of return is most likely exposed to interest rate risk for an investor of a fixed-rate bond who holds the bond until maturity? Capital gain or loss Redemption of principal Reinvestment of coupon payments
C is correct. Because the fixed-rate bond is held to maturity (a "buy-and-hold" investor), interest rate risk arises entirely from changes in coupon reinvestment rates. Higher interest rates increase income from reinvestment of coupon payments, and lower rates decrease income from coupon reinvestment. There will not be a capital gain or loss because the bond is held until maturity. The carrying value at the maturity date is par value, the same as the redemption amount. The redemption of principal does not expose the investor to interest rate risk. The risk to a bond's principal is credit risk.
when compared with an option-free bond, which type of bond most likely offers a higher yield to bondholders? Putable Convertible Callable
C is correct. A callable bond gives the issuer the right to buy back the bond prior to maturity. This feature increases the reinvestment risk faced by bondholders, causing them to require a higher yield than for a similar non-callable bond. A is incorrect because a putable bond gives the bondholder the right to sell the bonds back to the issuer prior to maturity. As a result, a putable bond will offer a lower yield compared with a similar non-putable bond. B is incorrect because a convertible bond gives the bondholder the right to convert the bond into the common stock of the issuer. As a result, a convertible bond will offer a lower yield compared with a similar non-convertible bond.
If interest rates are expected to increase, the coupon payment structure most likely to benefit the issuer is a: step-up coupon. inflation-linked coupon. cap in a floating-rate note.
C is correct. A cap in a floating-rate note (capped FRN) prevents the coupon rate from increasing above a specified maximum rate. This feature benefits the issuer in a rising interest rate environment because it sets a limit to the interest rate paid on the debt. A is incorrect because a bond with a step-up coupon is one in which the coupon, which may be fixed or floating, increases by specified margins at specified dates. This feature benefits the bondholders, not the issuer, in a rising interest rate environment because it allows bondholders to receive a higher coupon in line with the higher market interest rates. B is incorrect because inflation-linked bonds have their coupon payments and/or principal repayment linked to an index of consumer prices. If interest rates increase as a result of inflation, this feature is a benefit for the bondholders, not the issuer.
A sovereign bond has a maturity of 15 years. The bond is best described as a: perpetual bond. pure discount bond. capital market security.
C is correct. A capital market security has an original maturity longer than one year. A is incorrect because a perpetual bond does not have a stated maturity date. Thus, the sovereign bond, which has a maturity of 15 years, cannot be a perpetual bond. B is incorrect because a pure discount bond is a bond issued at a discount to par value and redeemed at par. Some sovereign bonds (e.g., Treasury bills) are pure discount bonds, but others are not.
Which of the following instruments is most likely to offer investors some protection against increases in the market interest rate? Inverse floating-rate notes Fixed-rate bonds Floating-rate notes
C is correct. A floating-rate note will be less affected when market interest rates increase because the coupon rate varies directly with market interest rates and is reset at regular intervals. A is incorrect because in an inverse floating-rate note the coupon rate has an inverse relationship to the reference rate. When market interest rates increase, the coupon rate on an inverse floating-rate note will fall. B is incorrect because fixed-rate bonds will decline in value when the market interest rate increases.
A BBB rated corporation wishes to issue debt to finance its operations at the lowest cost possible. If it decides to sell a pool of receivables into a special purpose vehicle (SPV), its primary motivation is most likely to: receive a guaranty from the SPV to improve the corporation's credit rating. allow the corporation to retain a first lien on the assets of the SPV. segregate the assets into a bankruptcy-remote entity for bondholders.
C is correct. A key motivation for a corporation to establish a SPV is to separate it as a legal entity. In the case of bankruptcy for the corporation, the SPV is unaffected because it is not a subsidiary of the corporation. Given this arrangement, the SPV can achieve a rating as high as AAA and borrow at lower rates than the corporation. A is incorrect because the SPV does not receive a guaranty. B is incorrect because the corporation does have a lien on those assets.
Which of the following is the best example of an embedded option granted to bondholders? An increasing sinking fund provision A prepayment option A put if the issuer's rating changes
C is correct. A put allows the bondholder to sell the security back to the issuer if the bondholder chooses to do so. A is incorrect because this is an embedded option granted to the issuer who can call more than is necessary to meet the sinking fund requirement. B is incorrect because this is an embedded option granted to the issuer who can call a portion of the issue.
A 10-year, capital-indexed bond linked to the Consumer Price Index (CPI) is issued with a coupon rate of 6% and a par value of 1,000. The bond pays interest semi-annually. During the first six months after the bond's issuance, the CPI increases by 2%. On the first coupon payment date, the bond's: coupon rate increases to 8%. coupon payment is equal to 40. principal amount increases to 1,020.
C is correct. Capital-indexed bonds pay a fixed coupon rate that is applied to a principal amount that increases in line with increases in the index during the bond's life. If the consumer price index increases by 2%, the coupon rate remains unchanged at 6%, but the principal amount increases by 2% and the coupon payment is based on the inflation-adjusted principal amount. On the first coupon payment date, the inflation-adjusted principal amount is 1,000 × (1 + 0.02) = 1,020 and the semi-annual coupon payment is equal to (0.06 × 1,020) ÷ 2 = 30.60.
Which of the following statements relating to commercial paper is most accurate? There is no secondary market for trading commercial paper. Only the strongest, highly rated companies issue commercial paper. Commercial paper is a source of interim financing for long-term projects.
C is correct. Companies use commercial paper not only as a source of funding working capital and seasonal demand for cash, but also as a source of interim financing for long-term projects until permanent financing can be arranged. A is incorrect because there is a secondary market for trading commercial paper, although trading is limited except for the largest issues. B is incorrect because commercial paper is issued by companies across the risk spectrum, although only the strongest, highly rated companies issue low-cost commercial paper.
Maersk Corp. issued bonds that are secured by its shipping containers. These bonds are most likely a type of: mortgage-backed security. collateral trust bond. equipment trust certificate.
C is correct. Equipment trust certificates are bonds secured by specific types of equipment or physical assets, such as shipping containers. A is incorrect because mortgage-backed securities are debt obligations that represent claims to the cash flows from pools of mortgage loans. B is incorrect because collateral trust bonds are secured by securities such as common shares, other bonds, or other financial assets.
ABL Ltd. is an Australian company that has financed a joint venture project in Singapore using a 15-year, fixed-rate bond paying semi-annual coupons that are denominated in Singapore dollars. The bond's par value, to be paid at maturity, is denominated in US dollars. This bond is an example of a: global bond. currency option bond. dual-currency bond.
C is correct. In a dual-currency bond, coupon payments are denominated in one currency, and the par value is denominated in a different currency. A is incorrect because a global bond is issued simultaneously in the Eurobond market and in at least one domestic bond market. B is incorrect because a currency option bond gives bondholders the right to choose the currency in which they wish to receive coupon payments and principal repayments.
Which of the following statements is most accurate? An interbank offered rate: is a single reference rate. applies to borrowing periods of up to 10 years. is used as a reference rate for interest rate swaps.
C is correct. Interbank offered rates are used as reference rates not only for floating-rate bonds, but also for other debt instruments including mortgages, derivatives such as interest rate and currency swaps, and many other financial contracts and products. A and B are incorrect because an interbank offered rate such as Libor or Euribor is a set of reference rates (not a single reference rate) for different borrowing periods of up to one year (not 10 years).
A liquid secondary bond market allows an investor to sell a bond at: the desired price. a price at least equal to the purchase price. a price close to the bond's fair market value.
C is correct. Liquidity in secondary bond markets refers to the ability to buy or sell bonds quickly at prices close to their fair market value. A and B are incorrect because a liquid secondary bond market does not guarantee that a bond will sell at the price sought by the investor, or that the investor will not face a loss on his or her investment.
Proceeds for repaying securitized bonds most likely come from the: claims-paying ability of the operating entity. cash flows of the project the bond is financing. cash flows of the underlying financial assets.
C is correct. Securitized bonds typically rely on the cash flows generated by one or more underlying financial assets as the primary source of the contractual payments to bondholders rather than on the claims-paying ability of the operating entity. A is incorrect because the claims-paying ability of an operating entity is the source of payment for corporate bonds. These cash flows depend on the issuer's financial strength and integrity. B is incorrect because the cash flows of the project the bond issue is financing are a major source for payment of non-sovereign government debt issues.
Which of the following are most likely a kind of supranational bonds? Bonds issued by the: Federal Farm Agency of the United States. Government of Malaysia. European Investment Bank.
C is correct. Supranational bonds are bonds issued by such supranational agencies as the European Investment Bank and the International Monetary Fund. A is incorrect because bonds issued by Federal Farm Agency of the United States are a type of quasi-government bonds. B is incorrect because bonds issued by the government of Malaysia are a type of government bonds.
A company has issued a floating-rate note with a coupon rate equal to the three-month Libor + 65 basis points. Interest payments are made quarterly on 31 March, 30 June, 30 September, and 31 December. On 31 March and 30 June, the three-month Libor is 1.55% and 1.35%, respectively. The coupon rate for the interest payment made on 30 June is: 2.00%. 2.10%. 2.20%.
C is correct. The coupon rate that applies to the interest payment due on 30 June is based on the three-month Libor rate prevailing on 31 March. Thus, the coupon rate is 1.55% + 0.65% = 2.20%.
Support tranches are most appropriate for investors who are: concerned about their exposure to extension risk. concerned about their exposure to concentration risk. willing to accept prepayment risk in exchange for higher returns.
C is correct. The greater predictability of cash flows provided in the planned amortization class (PAC) tranches comes at the expense of support tranches. As a result, investors in support tranches are exposed to higher extension risk and contraction risk than investors in PAC tranches. Investors will be compensated for bearing this risk because support tranches have a higher expected return than PAC tranches.
An investor in a country with an original issue discount tax provision purchases a 20-year zero-coupon bond at a deep discount to par value. The investor plans to hold the bond until the maturity date. The investor will most likelyreport: a capital gain at maturity. a tax deduction in the year the bond is purchased. taxable income from the bond every year until maturity.
C is correct. The original issue discount tax provision requires the investor to include a prorated portion of the original issue discount in his taxable income every tax year until maturity. The original issue discount is equal to the difference between the bond's par value and its original issue price. A is incorrect because the original issue discount tax provision allows the investor to increase his cost basis in the bond so that when the bond matures, he faces no capital gain or loss. B is incorrect because the original issue discount tax provision does not require any tax deduction in the year the bond is purchased or afterwards.
Which of the following conditions is not required for the realized horizon yield to equal the original yield to maturity on an option-free, fixed-coupon bond? The coupon payments are reinvested at the same interest rate as the original yield to maturity. The bond is sold at a price on the constant-yield price trajectory. The bond is held to maturity.
C is correct. The realized horizon yield will equal the original yield to maturity if the coupon payments are reinvested at the original yield to maturity and the bond is sold at a price on the constant-yield price trajectory. The latter condition ensures that the investor does not have any capital gains or losses when the bond is sold. A and B are incorrect because this condition is required for the realized horizon yield to equal the original yield to maturity.
The spread component of a specific bond's yield-to-maturity is least likely impacted by changes in: its tax status. its quality rating. inflation in its currency of denomination.
C is correct. The spread component of a specific bond's yield-to-maturity is least likely impacted by changes in inflation of its currency of denomination. The effect of changes in macroeconomic factors, such as the expected rate of inflation in the currency of denomination, is seen mostly in changes in the benchmark yield. The spread or risk premium component is impacted by microeconomic factors specific to the bond and bond issuer including tax status and quality rating.
Compared with an otherwise identical option-free bond, when interest rates fall, the price of a callable bond will: rise more. fall less. rise less.
C is correct. When interest rates fall, the price of the embedded call option increases. The price of a callable bond equals the price of an option-free bond minus the price of the embedded call option. The price of the callable bond will not increase as much as an option-free bond because the price of the call option is increasing. As interest rates fall, the bond is more likely to be called, limiting the upside price increase potential. A is incorrect because the value of the callable bond cannot rise too much before the bond is called. B is incorrect because the value of the bond will rise, not fall.
Which of the following is a source of wholesale funds for banks? Demand deposits Money market accounts Negotiable certificates of deposit
C is correct. Wholesale funds available for banks include central bank funds, interbank funds, and negotiable certificates of deposit. A and B are incorrect because demand deposits (also known as checking accounts) and money market accounts are retail deposits (not wholesale funds).
In a securitization, the special purpose entity (SPE) is responsible for the: issuance of the asset-backed securities. collection of payments from the borrowers. recovery of underlying assets from delinquent borrowers.
In a securitization, the special purpose entity (SPE) is responsible for the: issuance of the asset-backed securities. collection of payments from the borrowers. recovery of underlying assets from delinquent borrowers.
An option-adjusted spread (OAS) on a callable bond is the Z-spread: over the benchmark spot curve. minus the standard swap rate in that currency of the same tenor. minus the value of the embedded call option expressed in basis points per year.
The option value in basis points per year is subtracted from the Z-spread to calculate the option-adjusted spread (OAS). The Z-spread is the constant yield spread over the benchmark spot curve. The I-spread is the yield spread of a specific bond over the standard swap rate in that currency of the same tenor.
Which of the following statements related to secondary bond markets is most accurate? Newly issued corporate bonds are issued in secondary bond markets. Secondary bond markets are where bonds are traded between investors. The major participants in secondary bond markets globally are retail investors.
is correct. Secondary bond markets are where bonds are traded between investors. A is incorrect because newly issued bonds (whether from corporate issuers or other types of issuers) are issued in primary (not secondary) bond markets. C is incorrect because the major participants in secondary bond markets globally are large institutional investors and central banks (not retail investors).
