Series 65 - Unit 2 Questions to STUDY

A TIPS bond is issued in the principal amount of $1,000, paying 3.5%. Over the security's 5-year term, the inflation rate is 4%. What is the amount of the final semiannual interest check?

$21.33. The semiannual interest of a TIPS bond is computed on the basis of the inflation-adjusted principal. Because the principal increases with the inflation rate, at the end of the 5-year term, it has grown to $1,219 ($1,000 × 102% ten times). Therefore, the final interest check is for $1,219 × 1.75% (remember it is a semiannual check).

The DERP Corporation has an outstanding convertible bond issue that is convertible into 8 shares of stock. If the current market price of the bond is 80, the parity price of the stock is: A) $100 per share. B) $80 per share. C) $64 per share. D) $125 per share.

A) $100 per share. Parity means equal. With a conversion ratio of 8 shares per bond, the investor can convert the bond into 8 shares. If the bond is currently selling for $800, then, to be of equal value (parity), the 8 shares must be selling at $100 each. Reference: 5.2.2 in the License Exam Manual

Your client in the 25% federal income tax bracket lives in a state where his earnings place him in the 6% bracket for state income tax purposes. If he were to purchase a 4% bond issued by a political subdivision of his state, his total tax equivalent yield would be: A) Slightly more than 5.33%. B) Approximately 12.90%. C) 4%. D) Slightly less than 5.33%.

A) Slightly more than 5.33%. When an individual owns a municipal bond issued in his state of residence, not only is the interest tax-free on a federal basis, but, (at least in all cases on the exam), it is non-taxed in that state. Therefore, the tax equivalent yield here is slightly higher than it would be if we only computed using the federal tax rate. Since that would be 4.0% divided by .75 (100% minus the 25% tax bracket) or 5.33%, saving on state income taxes would increase the yield slightly. Reference: 5.3.1.5 in the License Exam Manual

An investor might expect to receive the greatest gain on an investment in a corporate bond by purchasing: A) long-term bonds when interest rates are high. B) short-term bonds when interest rates are low. C) short-term bonds when interest rates are high. D) long-term bonds when interest rates are low.

A) long-term bonds when interest rates are high. If an investor purchases bonds when market interest rates are high, a drop in interest rates will lead to a corresponding increase in bond value. Long-term debt instruments will fluctuate to a greater degree than those with short-term interest rates. Thus, long-term debt offers the greater chance at gain. Reference: 5.3.3 in the License Exam Manual

A TIPS bond is issued in the principal amount of $1,000, paying 3.5%. Over the security's 5-year term, the inflation rate is 4%. What is the principal value of the bond at the end of 5 years? A) $1,440. B) $1,219. C) $1,000. D) $1,200.

B) $1,219. In addition to paying interest, a TIPS bond increases its principal value semiannually by the amount of inflation. If the inflation rate is 4% for 5 years, the principal value of the bond increases semiannually by that inflation rate. Allowing for compounding, the best choice would be the $1,219. This is computed by multiplying $1,000 by 102% 10 times. Reference: 5.1.1.4 in the License Exam Manual

Which of the following choices offers the highest tax-equivalent yield? A) 5.5% municipal bond to an individual in the 28% tax bracket. B) 5% municipal bond to a corporation in the 39% tax bracket. C) 6% municipal bond to an individual in the 25% tax bracket. D) 4% municipal bond to an individual in the 35% tax bracket.

B) 5% municipal bond to a corporation in the 39% tax bracket. Corporations receive the same tax break on municipal bonds as do individuals. Therefore, receiving a 5% return in the 39% tax bracket is equivalent to 8.20% before tax. A 4% bond to someone in the 35% bracket is equivalent to 6.15%; a 5.5% coupon to someone in the 28% bracket is equivalent to 7.64%; and a 6% bond to someone in a 25% bracket is equivalent to 8.0%. Reference: 5.3.1.5 in the License Exam Manual

A client purchased an index annuity from you three years ago and made an initial deposit of $100,000. The contract calls for a 90% participation rate with a 15% cap. The index had a return of + 20% in the first year, - 5% the second year, and +10% the third year. The investor's current value is approximately A) $117,829 B) $128,620 C) $125,350 D) $126,500

C) $125,350 In the first year, the index gained 20%. With a 90% participation rate, the investor might have earned 18%, but was limited by the 15% cap. So, after one year the value was $115,000. In the second year, the index lost money. However, with an index annuity there are never any reductions in a down market so the account remained at $115,000. In the third year, the investor received 90% of the 10% growth and that increased the account value to $125,350. This resulted in an overall gain of 25.35%, or an average return of almost 8.5% per year. Reference: 8.1.2.3 in the License Exam Manual

A client is trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors are equal and your client is in a 28% marginal income tax bracket, which bond do you tell the client to purchase and why? A) The municipal bond because its equivalent taxable yield is 6.3%. B) The corporate bond because the after-tax yield is 4.5%. C) The municipal bond because its equivalent taxable yield is 6.6%. D) The corporate bond because the after-tax yield is 6.25%.

C) The municipal bond because its equivalent taxable yield is 6.6%. If we compute the tax equivalent yield of the muni, we see that it is 6.6%, which is a higher return than the 6.25% on the corporate bond. The formula to get this starts by taking the investor's tax bracket and subtracting that from 100%. 100% − 28% = 72%. We then divide the muni coupon of 4.75% by the 72% and the result rounds off to 6.6%. Reference: 5.3.1.5 in the License Exam Manual

Your customer owns $100 par 5-½% callable convertible preferred stock convertible into 4 shares of common stock at $25. What should she be advised to do if the board of directors were to call all the preferred at 106 when the common stock is trading at $25.50? A) Place irrevocable instructions to convert the preferred stock into common stock and sell short the common stock immediately. B) Hold the preferred stock to continue the 5-½% yield. C) Present the preferred stock for the call because the call price is $4 above the parity price. D) Convert her preferred stock into common stock because it is selling above parity.

C) Present the preferred stock for the call because the call price is $4 above the parity price. If the preferred stock is called, the client will receive $106. Tendering the preferred stock will provide the highest value. The value of converting the preferred stock into 4 shares of common is worth $102 (4 × $25.50 = $102), which is less than the call value of $106. The dividends will cease on the call date if the preferred stock is held beyond the call date.

Your client in the 35% federal income tax bracket currently owns some corporate bonds with a coupon yield of 7%. In order to receive the same income after taxes, he would need to buy municipal bonds with a coupon of: A) 7.00%. B) 2.45%. C) 9.45%. D) 4.55%.

D) 4.55%. Because the 7% on the corporate bond is fully taxable, the client receives a net of 4.55% ($70 per bond less 35% in taxes {$24.50}, or $45.50 per year). Interest on municipal bonds is tax-free so a 4.55% coupon will result in the same amount of after tax income. Reference: 5.3.1.5 in the License Exam Manual

The term" eurodollars "refers to: A) a worldwide currency system that is expected to someday replace existing currency systems. B) European currency held in U.S. banks. C) obsolete currency that was formerly backed by the gold standard. D) American dollars held by banks in other countries, especially in Europe.

D) American dollars held by banks in other countries, especially in Europe.

A bond with a par value of $1,000 and a nominal yield of 6% paid semi-annually is currently selling for $1,300. The bond matures in 25 years and is callable in 15 years at $1,080. In the computation of the bond's yield to call, which of these would be a factor? A) Present value of $1,080 B) Future value of $1,300 C) 50 payment periods D) Interest payments of $30

D) Interest payments of $30

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) Treasury bond issued at par carrying a 7% coupon. When market interest rates rise, bonds having higher coupons will decline less than bonds having lower coupons. Reference: 5.3.3 in the License Exam Manual

A client in the 28% marginal federal income tax bracket invests in a corporate bond with an 8% coupon. To calculate the client's after-tax rate of return: A) divide .08 by .28. B) multiply .08 by .28. C) divide .08 by .72. D) multiply .08 by .72.

D) multiply .08 by .72. To determine a taxable bond's after-tax rate of return, multiply the coupon rate by the compliment of the client's marginal federal income tax bracket. The client's tax bracket is 28% (.28), so the complement is 100% - 28% (1.00 - .28) = .72. Reference: 5.3.1.5 in the License Exam Manual

A high-coupon bond is selling at a premium. Call of this bond is most beneficial to the: A) broker-dealer. B) bondholder. C) issuer. D) underwriter.

issuer When bonds are selling at a premium, it means interest rates are low. The issuer should be able to refinance the bonds by calling in the bonds at the preset call price (invariably below the current market) and save interest costs. Reference: 5.2.1 in the License Exam Manual

Which of the following is used in technical analysis in an attempt to modify fluctuations of stock prices over the long term into a smoothed trend? A) consolidation. B) support and resistance. C) trend lines. D) moving averages.

moving averages.