Part 3

Eurobonds

Bonds issued in a country not in that country's currency.

n contrast with a typical forwards contract, futures contracts have: A) greater counterparty risk. B) less liquidity. C) standardized terms. D) nonstandard terms.

C. Futures are contracts that trade on exchanges and have standardized terms, in contrast with forwards contracts, which are customized instruments. A futures clearinghouse reduces counterparty risk by guaranteeing the performance of buyers and sellers. Because futures contracts trade on organized exchanges and have standardized terms, they are more liquid than forwards contracts. U16LO4

A member of the investment banking department of ABC Securities is explaining some of the advantages and disadvantages of rights and warrants to the board of directors of XYZ Corporation. Which of the following statements could he make? I. The exercise prices of stock rights are usually below the current market price of the underlying security at time of issue. II. The exercise prices of warrants are usually above the current market price of the underlying security at time of issue. III. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. IV. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer.

All are true statements. The exercise prices of stock rights are usually below the current market price of the underlying security at time of issue. The exercise prices of warrants are usually above the current market price of the underlying security at time of issue. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer. U16LO3

Brady Bonds

Debt instruments, generally from third world countries, that may have a US Treasury bond as collateral. IMF and World Bank are partners

Which of the following are characteristics of commercial paper? I. Backed by money market deposits II. Negotiated maturities and yields III. Issued by insurance companies IV. Not registered with the SEC

II & IV. Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Both yield and maturity are open to negotiation. Because commercial paper is issued with maturities of no more than 270 days, it is exempt from registration under the Securities Act of 1933. U13LO13

Breakpoints

Large purchases of investment company shares receive reduced sales charges at given minimums of investment

Tax Equivalent Yield (TEY)

Municipal bond yield / (100%-tax bracket)

Yankee bonds

U.S. dollar-denominated debt securities issued by foreign governments or corporations and traded in U.S. securities markets

Louis owns an investment that is an unmanaged portfolio in which the money manager initially selects the securities to be included in the portfolio and then holds those securities until they mature or the investment portfolio terminates. This statement best describes which type of investment? A) Closed-end investment company B) Hedge fund C) Unit investment trust D) Open-end investment company

c. A unit investment trust (UIT) is a type of investment company whose units are sold in the secondary market and is generally unmanaged, or passively managed. The trust manager initially selects the securities to be included in the portfolio and then holds those securities until they mature or the UIT terminates. U14LO7

The Investment Company Act of 1940 states that: A) no more than 50% of the board of directors of an investment company may be officers or employees of the company or investment advisers to the company B) it is unnecessary for the prospectus to disclose the management fee C) open-end companies may issue common stock only D) an investment company must have $5 million capital before its securities can be offered to the public

c. Open-end companies may issue only common stock. The prospectus must state the management fee, and an investment company needs only $100,000 to offer itself to the public. In addition, no more than 60% of the board of directors can be made up of officers or employees of the company. U14LO1

Adam has a portfolio of bonds worth approximately $125,000. He is concerned that interest rates will increase in the near term. Which of the following would be the least desirable strategy for Adam? A) Sell long-term bonds and buy short-term bonds B) Sell bonds with lower coupons and buy those with higher coupons C) Sell bonds with a short duration and buy those with a longer duration D) Sell Treasury bonds and buy Treasury bills

c. Prices of bonds decline when interest rates rise. An investor expecting an increase in interest rates should sell more volatile bonds and purchase less volatile bonds. Bonds with higher coupons and shorter durations are less price volatile than low coupon, long-term, and long duration bonds. U13LO11

Market interest rates rise by 50 basis points. If each of these bonds has about the same maturity date, which of the following would decline the least? A) AA corporate bond carrying a 7% coupon B) AAA corporate bond carrying a 6% coupon C) Treasury bond issued at par carrying a 6% coupon D) Treasury bond issued at par carrying a 7% coupon

d. All other factors being equal, bonds of higher quality experience less price volatility than do bonds of lower quality. Treasury securities have higher quality than other debt securities due to the elimination of default risk. When market interest rates rise, bonds having higher coupons will decline less than bonds having lower coupons. U13LO11

You have a 70-year-old client who owns a whole life insurance policy. The face amount of the policy is $1 million and it currently has a cash value of $400,000. The client is interested in a life settlement. If the policy is accepted, the client would expect to receive A) less than $400,000. B) the face amount plus the cash value. C) the $1 million face amount. D) more than $400,000, but less than $1 million.

d. When a policy is sold through the life settlement process, the insured receives more than the cash value, but less than the face amount of the policy. U17LO4