Quiz #2 (Missed Questions)
Which of the following statements are true regarding municipal broker's brokers? I Clients of municipal broker's brokers can maintain anonymity in their trading activities II Broker's brokers act as agents for their clients III All bids and offers placed by municipal broker's brokers must be disclosed on Kenney's "Broker's Wire" IV Broker's brokers can position trade for their own accounts
- I and II I Clients of municipal broker's brokers can maintain anonymity in their trading activities II Broker's brokers act as agents for their clients Municipal broker's brokers act as agents for institutional clients, helping to buy or sell large blocks of municipal bonds. They perform this activity without disclosing the identity of their clients. Broker's brokers do not trade for their own accounts - they act as agent only. There is no requirement that broker's brokers place their quotes on the broker's wire.
A convertible debenture is convertible into common at $40 per share. If the market price of the bond rises to a 10 point premium over par, which statements are true? I The conversion ratio is 20:1 II The conversion ratio is 25:1 III The parity price of the stock is $44 IV The parity price of the stock is $50
-II and III The conversion ratio is established when the bond is issued, and is: par value divided by the conversion price. In this case, the conversion price is set at $40 per share, so the conversion ratio is $1,000 par / $40 conversion price = 25:1 (25 shares per bond). If the bond moves to a 10 point premium over par, its new price will be 110, or $1,100 per bond. For the common stock to be valued at parity to the bond, the price per share must be $1,100 / 25 shares per bond = $44 per share parity price.
Which of the following money market instruments is rated on a "P" scale? A. Commercial Paper B. Municipal Short Term Notes C. Treasury Bills D. Federal Funds
Commercial paper is rated by Moody's on a P-1,2,3, and NP ("Not Prime") scale. Municipal short-term notes are rated by Moody's on an MIG-1,2,3, and SG ("Speculative Grade") scale. Treasury bills and Fed Funds are not rated because they have an implied AAA rating - the safest of instruments.
All of the following statements are true about commercial paper EXCEPT: A. Commercial paper is a funded debt of the issuer B. Commercial paper matures on a pre-set date and at a pre-set price C. Commercial paper is quoted on a yield basis D. Commercial paper is an unsecured promissory note
Correct Answer A. Commercial paper is a funded debt of the issuer
The yield to maturity of a bond: A. increases as bond market prices decline B. increases as bond market prices increase C. is unaffected by changes in market interest rates D. will vary with the earnings of the issuer
Correct Answer A. increases as bond market prices decline Yield to Maturity for a Discount Bond = [(Annual Interest + Annual Capital Gain) / (Bond Cost + Redemption Price) / 2] Since both the Annual Interest and Annual Capital Gain are fixed, as the cost of the bond falls, the Yield to Maturity must rise. Yield to Maturity for a Premium Bond = [(Annual Interest - Annual Capital Loss) / (Bond Cost + Redemption Price) / 2] Since both the Annual Interest and Annual Capital Gain are fixed, as the cost of the bond rises, the Yield to Maturity must fall.
The ratio of net direct debt plus overlapping debt to assessed valuation is used for all of the following EXCEPT: A. to evaluate the issuer's ability to collect taxes owed B. to evaluate the issuer's overall ability to service its debt burden C. to analyze general obligation bonds D. to evaluate the issuer's creditworthiness
Correct Answer A. to evaluate the issuer's ability to collect taxes owed The ratio of net direct debt plus overlapping debt to assessed valuation is used to evaluate general obligation bonds (which are typically paid by ad valorem taxes collected based upon property assessments). The lower the ratio, the better the creditworthiness of the issuer and the better able the issuer is to handle servicing the debt. However, the ratio does not indicate how good a job the municipality does collecting the taxes due. This is measured by the collection ratio - the ratio of taxes collected to taxes assessed.
All of the following investments give a rate of return that cannot be affected by "reinvestment risk" EXCEPT: A. Treasury Bill B. Treasury Bond C. Treasury Strips D. Treasury Receipts
Correct Answer B. Treasury Bond Treasury "STRIPS" and Treasury Receipts are bonds which have been stripped of coupons - essentially they are zero coupon Treasury obligations. The rate of return on the bonds is "locked in" at purchase since the discount represents the compounded yield to be earned over the life of the bond. Because no interest payments are received, the bond is not subject to reinvestment risk - the risk that interest rates will drop and the interest payments will be reinvested at lower rates. Conventional Treasury Bonds are subject to this risk, since interest payments are received semi-annually. Treasury Bills are not subject to reinvestment risk because they are essentially short term "zero-coupon" obligations.
A customer buys 5M of 3 1/2% Treasury Bonds at 101-16. How much will the customer receive at each interest payment? A. $17.50 B. $35.00 C. $87.50 D. $175.00
Correct Answer C. $87.50 "5M" means that 5-$1,000 bonds are being purchased (M is Latin for $1,000). Annual interest on the bonds is 3.5% of $5,000 face amount equals $175.00. Since interest is paid semi-annually, each payment will be for $87.50. Notice that the fact that the bond is trading at a premium is irrelevant - the interest payment is based on the stated interest rate times par value.
When an issuer refinances an outstanding debt issue, the bonds which are most likely to be refunded by the issuer are: I Bonds with the lowest interest rates II Bonds with the highest interest rates III Bonds with the lowest call premiums IV Bonds with the highest call premiums
Correct Answer C. II and III II Bonds with the highest interest rates III Bonds with the lowest call premiums The bonds most likely to be refunded are those with the highest interest rates (to be replaced by lower interest rate bonds) and low call premiums (so it will not be too expensive to the issuer to call in the debt for refunding). In a refunding, an issuer refinances an outstanding debt by issuing new bonds. The proceeds of the new issue are used to retire the old debt; or are placed in escrow to "pre-refund" an older issue that cannot be immediately repaid because the first call date or maturity date is years in the future. This is either done to reduce interest cost or to remove an onerous restrictive covenant.
Which bond portfolio with a 20-year life would be expected to give the highest long-term return? A. Portfolio #1 with an expected rate of return of 6% and a default risk of 5% over the portfolio life B. Portfolio #2 with an expected rate of return of 8% and a default risk of 10% over the portfolio life C. Portfolio #3 with an expected rate of return of 10% and a default risk of 20% over the portfolio life D. Portfolio #4 with an expected rate of return of 12% and a default risk of 40% over the portfolio life
Correct Answer C. Portfolio #3 with an expected rate of return of 10% and a default risk of 20% over the portfolio life The "default risk" represents the loss of return that is likely due to making higher risk investments. If Portfolio #1 has an expected annual rate of return of 6% over 20 years; but there is the probability that 5% of those bonds will default, so the net return will be 95% of 6% = 5.7%. If Portfolio #2 has an expected annual rate of return of 8% over 20 years; but there is the probability that 10% of those bonds will default, so the net return will be 90% of 8% = 7.2%. If Portfolio #3 has an expected annual rate of return of 10% over 20 years; but there is the probability that 20% of those bonds will default, so the net return will be 80% of 10% = 8.0%. If Portfolio #4 has an expected annual rate of return of 12% over 20 years; but there is the probability that 40% of those bonds will default, so the net return will be 60% of 12% = 7.2%.
Types of funds used to back revenue bond issues include all of the following EXCEPT: A. excise taxes B. lease rentals C. ad valorem taxes D. enterprise activity income
Correct Answer C. ad valorem taxes Ad valorem taxes back general obligation bonds. Revenue bonds can be backed by any source of revenue other than ad valorem taxes. These sources include revenue from facility operations, grants, excise taxes, or other non-ad valorem taxes.
Periodic deposits of monies to the sinking fund are required to cover: A. required interest payments only B. required principal payments only C. required interest and principal payments D. required interest payments and principal payments; and optional principal payments
Correct Answer C. required interest and principal payments Debt service is defined as payment of interest and principal as due. There is no requirement to fund optional deposits to a sinking fund. An issuer might make additional optional payments into the sinking fund to retire bonds by open market purchase, tender or call, if such would be advantageous to the issuer.
Which of the following statements are true regarding a municipal bond issue that is advance refunded? I The security that backs the refunded bonds will change after the issue is refinanced II The bondholder's lien on pledged revenues will be defeased in accordance with the terms of the bond contract III The marketability of the refunded bonds will increase IV The funds to pay the debt service requirements on the refunded bonds are set aside in escrow
Correct Answer D. I, II, III, IV All of the statements are true regarding advance refunding of a municipal bond issue. In an advance refunding, the issuer floats a new bond issue and uses the proceeds to "retire" outstanding bonds that have not yet matured. These funds are deposited to an escrow account and are used to buy U.S. Government securities. The escrowed Government securities become the pledged revenue source backing the refunded bonds. These bonds no longer have claim to the original revenue source. Since there is a new source of backing for the bonds (and an extremely safe one!), the credit rating on the pre-refunded bonds increases, as does their marketability. The pre-refunded bonds no longer have any claim to the original pledged revenues - and thus have been "defeased" - that is, removed as a liability of the issuer.
Which of the following are true regarding an institution using its endowment as a source of revenues pledged to bondholders? I The endowment fund itself is usually the source of revenue pledged II The earnings on the endowment fund are usually the source of revenue pledged III A water and sewer revenue bond is likely to have an endowment fund IV A hospital revenue bond is likely to have an endowment fund
Correct Answer D. II and IV II The earnings on the endowment fund are usually the source of revenue pledged IV A hospital revenue bond is likely to have an endowment fund Hospitals are often given large monetary gifts - known as "endowments". The hospital invests the endowment funds to generate interest and dividend income. It usually agrees not to invade the principal amount. Thus, the earnings on the endowment funds (NOT the endowment fund itself) are a source of revenue that can be pledged to bondholders under a revenue pledge.
An investor in the 28% tax bracket buys a 6% municipal bond quoted on an 8.00 basis. To calculate the equivalent taxable yield: A. multiply 6% by 72% B. divide 6% by 72% C. multiply 8% by 72% D. divide 8% by 72%
D. divide 8% by 72% Equivalent Taxable Yield = Tax Free Yield / 100% - Tax Bracket 8% / (100%-28%) = 11.11%
U.S. Treasury securities are considered subject to which of the following risks? I Credit Risk II Purchasing Power Risk III Marketability Risk IV Default Risk
II Purchasing Power Risk Securities issued by the U.S. Government represent the largest securities market in the world (remember, the national debt is $16 trillion and rising) and the most actively traded. Therefore, very little marketability risk exists. Default risk and credit risk are the same - U.S. Government securities are considered to have virtually no default risk. (The government can always tax its citizens to pay the debt or can print the money to do it). All debt obligations are susceptible to purchasing power risk - the risk that inflation raises interest rates, devaluing existing obligations.
Yield to Maturity for a Discount Bond=
Yield to Maturity for a Discount Bond = [(Annual Interest + Annual Capital Gain) / (Bond Cost + Redemption Price) / 2] Since both the Annual Interest and Annual Capital Gain are fixed, as the cost of the bond falls, the Yield to Maturity must rise.
Yield to Maturity for a Premium Bond =
Yield to Maturity for a Premium Bond = [(Annual Interest - Annual Capital Loss) / (Bond Cost + Redemption Price) / 2] Since both the Annual Interest and Annual Capital Gain are fixed, as the cost of the bond rises, the Yield to Maturity must fall.
