Series 7 Ch. 5 &6
An investor purchases a 20-year 5.30% bond at par value that will yield 5.75% if called at the first call date in five years. The yield to maturity on the bond is: A. 5.30% B. More than 5.30% C. Between 5.30% and 5.75% D. 5.75%
A. 5.30% The bond has a coupon rate (nominal yield) of 5.30%. If the bond is purchased at its par value and is not called, but held to maturity, the bond's yield will be the same as the coupon rate, which is 5.30%.
An issuer currently has an S&P AA rating. If the ratings service notifies the firm that it has been downgraded by one notch, its new rating would be: A. AA- B. A C. BBB D. BBB+
A. AA- Standard & Poor's highest rating is AAA and its lowest rating is D. The company also uses a (+) or (-) to further distinguish between ratings. Each upgrade or downgrade is referred to as a notch. If an issuer currently has a AA rating, one notch below would be AA- and two notches below would be an A+ rating.
Which type of equity capital would have a delayed, diluted effect on a corporation? A. Convertible debt B. The sale of restricted stock under SEC Rule 144 C. A follow-on offering of common shares D. Nonconvertible debt
A. Convertible debt If the convertible debt is issued by a corporation and the securities are later converted, there will be more common shares outstanding, diluting the earnings of the shareholders. The sale of restricted stock under SEC Rule 144 is the sale of existing shares. It does not create additional shares. A follow-on offering of common shares has an immediate, not a delayed, dilutive effect. Nonconvertible bonds, also referred to as straight debt, do not produce a dilutive effect since no new common shares are issued.
Four municipal bonds have the same maturity date. Which of the following bonds will cost an investor the greatest dollar amount when purchased? A. A 4 3/4% coupon bond offered on a 5.10 basis B. A 5 1/4% coupon bond offered on a 5.00 basis C. A 5 3/4% coupon bond offered on a 6.00 basis D. A 6 1/4% coupon bond offered on a 6.50 basis
B. A 5 1/4% coupon bond offered on a 5.00 basis When bonds are purchased at a discount (below the $1,000 par value) the yield to maturity (basis) will be greater than the coupon rate (nominal yield). This is the case in all of the choices listed except where the coupon rate of 5 1/4% is greater than the yield to maturity of 5%. This would mean that an investor purchased the bond at a premium (above the $1,000 par value) and paid the greatest dollar amount.
An issuer currently has an S&P A- rating. If the ratings service notifies the firm that it has been upgraded by two notches, its new rating would be: A. AA B. A+ C. AA D. BBB
B. A+ Standard & Poor's highest rating is AAA and its lowest rating is D. The company also uses a (+) or (-) to further distinguish between ratings. Each upgrade or downgrade is referred to as a notch. If an issuer currently has an A- rating, one notch above would be A and two notches above would be an A+ rating.
Which of the following is the highest Moody's investment-grade bond rating? A. AAA B. Aaa C. BB D. Ba
B. Aaa The wording of this question is tricky, but Moody's highest investment grade rating is Aaa. Moody's highest speculative grade is Ba. Standard & Poor's highest investment grade rating is AAA and their highest speculative grade is BB.
Which of the following is the lowest Moody's investment grade bond rating? A. BBB B. Baa C. Ba D. A
B. Baa Moody's investment grade bond ratings, from highest to lowest, are Aaa, Aa, A, Baa. BBB is Standard & Poor's lowest investment grade rating. Use the following memory aide to distinguish Moody's ratings from S&P ratings. The name Moody's is a capital letter followed by small letters, just like their ratings (e.g, Baa). S&P consists of all capital letters, just like their ratings (e.g., BBB).
A bond is selling at a premium and yields have remained constant. As the bond gets closer to its maturity, what happens to its price? A. It increases B. It decreases C. It remains the same D. It will experience significant price changes
B. It decreases Although fixed income securities are subject to some degree of interest rate risk, that risk is of less concern if the security is being held to maturity. Assuming there is no default by the issuer, the price of a bond selling at a premium will decrease (move towards par value) as it gets closer to its maturity.
Structured products may: A. Only offer returns that are linked to equity securities B. Offer returns that are linked to commodities, securities, or interest rates C. Only offer returns that are linked to interest rates D. Cannot be formulated to provide principal protection
B. Offer returns that are linked to commodities, securities, or interest rates Structured products are securities that often combine investments, such as a bond with a derivative. Structured securities may be linked to equity securities, commodities, or interest rates. These products may also be structured to provide principal protection. The fact that structured products are not bank deposits and are not insured by the Federal Deposit Insurance Corporation (FDIC) should be disclosed by an RR when these products are offered to clients. (25053)
The call premium of a bond refers to the amount: A. An investor must pay above par to buy a callable bond B. Over par value that the issuer must pay to exercise the call privilege C. The issuer must add to the semiannual interest payments to offset the call feature D. Added to the price at issuance to compensate for the call privilege
B. Over par value that the issuer must pay to exercise the call privilege The call premium of a bond refers to the amount the issuer must pay in excess of par value to exercise the call privilege. The call privilege is the issuer's right to buy the bond from the holder prior to maturity. For example, if a bond is callable at 102, it has a two-point ($20) call premium. The issuer must pay $1,020 ($20 more than par) if it wishes to call in the bond.
Which of the following is a characteristic of reverse convertible securities? A. They're long-term securities. B. They're typically short-term securities. C. The investors are guaranteed to receive their original principal back at maturity. D. The investors may be required to sell shares of the issuer's stock if the price rises above a specified level.
B. They're typically short-term securities Reverse convertible securities are short-term notes which are issued by banks and broker-dealers and typically pay a coupon rate that's above prevailing market rates. In addition to receiving a higher coupon rate, the investors may be forced to purchase shares of the issuer at a fixed price. If the price of the stock stays above the specified price (referred to as the knock-in level), the investor will receive the high coupon and the full return of his principal. If the underlying asset falls below the knock-in level, the investor will be obligated to purchase shares of the underlying stock at the knock -in price. In that case, the investor may receive substantially less than the original principal.
Four municipal bonds will mature in 2044 and they're all selling at a 7.00 basis. Which of the following bonds is MOST LIKELY to be refunded? A. 5 1/2% callable in 2029 at 103 B. 6 1/2% callable in 2028 at 100 C. 7% callable in 2029 at 103 D. 7 1/2% callable in 2028 at 100
D. 7 1/2% callable in 2028 at 100 The most common reason for a municipality to refund an outstanding issue is to save interest costs. If a municipality can borrow money at a lower rate than the outstanding issue, it can use this money to refund the outstanding issue and thereby save interest cost. Since the bonds are selling at a 7.00% yield, the municipality can then expect to borrow new monies at a 7.00% interest rate. The municipality can only save money by refunding an issue with a higher interest rate (e.g., 7 1/2%).
In a discussion with a client, a registered representative refers to a bond yield that has been reduced by the inflation rate. This yield is known as the: A. After-tax yield B. Discount rate C. Real interest rate D. SOFR
C. Real interest rate The real interest rate is the yield of a security reduced by the inflation rate. While it represents earnings remaining once inflation is taken into account, the real interest rate does not factor in the tax consequences. The discount rate is the rate of interest that the Federal Reserve charges member banks for loans. The Secured Overnight Financing Rate (SOFR) is the rate of interest that banks in London charge each other for short-term loans. Prior to SOFR, the London Interbank Offered Rate (LIBOR) was used.
During a period of stable interest rates, which bond has the most potential to show a significant change in price? A. 7%, 30-year U.S. Treasury Bond B. An 8%, 5-year high-grade corporate bond C. A 6%, 6-month Revenue Anticipation Note D. A 7 1/2%, 10-year convertible subordinated debenture
D. A 7 1/2%, 10-year convertible subordinated debenture The key to this question is to recognize that if interest rates are stable, then most bond prices will experience little movement. However, to identify the bond that is still expected to fluctuate the most, find the answer that is the most unique. In this question, the convertible debenture may still experience a significant change in price based on the changing value of the underlying equity (i.e., the security into which the bond may be converted). For example, if the value of the underlying stock increases, the value of the bond will also increase to keep the bond's price in the vicinity of conversion parity. Parity is achieved when the value of the bond is equal to the value of the common stock which is able to be obtained at conversion.
Which of the following best describes a guaranteed bond? A. A bond where the trustee pays interest and principal. B. A bond on which the U.S. Treasury promises to pay interest and principal if necessary. C. A bond that's insured by SIPC. D. A bond for which another corporation promises to pay interest and principal if necessary.
D. A bond for which another corporation promises to pay interest and principal if necessary. A guaranteed bond is one that, along with its primary form of collateral, is secured by a guarantee of another corporation. The other corporation promises that it will pay interest and principal if necessary. A typical example is a parent company guaranteeing a bond that's issued by a subsidiary company.
Which of the following Moody's ratings is the most speculative? A. Aa B. A C. Baa D. Ba
D. Ba Of the choices given, Ba is the most speculative. The highest Moody's rating is Aaa.
Which of the following securities assist in the financing of import and export operations? A. Treasury bills B. American depositary receipts (ADRs) C. Eurodollar CDs D. Bankers' acceptances (BAs)
D. Bankers' acceptances (BAs) Of the choices given, a banker's acceptance (BA) is the only instrument that's used as a means of financing foreign trade. Don't confuse a BA with an ADR (American depositary receipt), which facilitates the trading of foreign securities in U.S. markets. Eurodollar certificates of deposit pay interest and principal in Eurodollars (U.S. dollars deposited in non-domestic banks) and are not used to finance import and export operations.
The purpose of a sinking fund is to redeem a corporation's: A. Common stock B. Warrants C. Rights D. Bonds
D. Bonds A sinking fund is used by an issuer to set aside funds that will be used for the purpose of redeeming a corporation's bonds prior to or at maturity.
A tombstone ad states that the McGee Oil Company is offering $200,000,000 of 8 1/2% bonds due July 1, 2038 at 99 1/2% of par value. The yield to maturity on the bonds is: A. 8% B. Less than 8 1/2% C. 8 1/2% D. Greater than 8 1/2%
D. Greater than 8 1/2% The 8 1/2% bonds are being offered at a discount at 99 1/2% of their $1,000 par value. An investor who purchased the bonds at the offering (at $995) and held the bonds to maturity will receive the par value of $1,000. The investor will, therefore, have a yield to maturity that is greater than the coupon rate (nominal yield) of 8 1/2%.
What type of call provision permits an issuer to redeem an entire bond issue prior to maturity? A. Continuous call B. Catastrophe call C. Lottery call D. In-whole call
D. In-whole call Call provisions allow an issuer to redeem (i.e., buy back) a bond issue at a fixed (i.e., call) price prior to maturity. In-whole calls represent an issuer's ability to buy back an entire bond issue. Partial calls involves buying some, but not all, of the bonds back. The bonds that will be redeemed in a partial call are chosen through a lottery, which is why this is also referred to as a lottery call. Catastrophe calls are only used when a natural disaster harms the issuer's ability to generate funds to back the bondholders. Continuous calls allow an issuer to exercise its right to repurchase a bond issue at any time after the call protection ends.
A company currently has $125,000,000 of 3 1/4% convertible bonds. The company is going to offer bondholders $125,000,000 of 3 1/4% nonconvertible bonds plus cash of $15,000,000 for the convertible bonds. How will this transaction, if successful, affect the company's financial status? A. It will reduce the cash and debt position and reduce the potential dilutive effect on the common stock B. It will reduce the cash position and increase the debt position C. It will increase the cash position and reduce the potential dilutive effect on the common stock D. It will reduce the cash position and the potential dilutive effect on the common stock
D. It will reduce the cash position and the potential dilutive effect on the common stock The effect of the transaction will be to reduce the cash position and the potential dilutive effect on the common stock. The company is paying out cash and is also issuing nonconvertible bonds in place of convertible bonds (which could have been converted into common stock). This will reduce the cash position and the potential dilutive effect on the common stock.
A 7% convertible bond has a conversion ratio of 40. The bond has a nondilutive feature and the common is selling at $43 a share. If the company distributes a 10% stock dividend, which of the following statements is TRUE regarding the convertible bond? A. The conversion ratio remains at 40, but the conversion price is reduced B. The conversion ratio increases to 45.50 and the conversion price remains constant C. The conversion price decreases to $22.73 and the conversion ratio remains the same D. The conversion price decreases to $22.73 and the conversion ratio increases to 44
D. The conversion price decreases to $22.73 and the conversion ratio increases to 44 A nondilutive feature requires that the conversion features be adjusted should there be a stock split or stock dividend. The conversion ratio will be increased and the conversion price will be reduced. The new conversion ratio will be 44 [the old ratio (40) plus the old ratio times the percentage dividend (40 x 10% = 4)]. The new conversion price will be the par value of the bond divided by the new conversion ratio ($1,000 divided by 44 equals $22.73).
If a bond is selling at a premium and is callable at par, how is the yield calculated? A. As a percentage of the par value B. By dividing the annual income by the current price C. To the final maturity date D. To the call date
D. To the call date The yield for a bond that is selling at a premium and is callable at par is calculated to the call date. The yield to call measures the yield that would be earned if the bonds were called at the call price, rather than held to the maturity date. Industry rules require broker-dealers to quote the lower estimate of the yield to call or the yield to maturity. If the bond had been selling at a discount, it would have been quoted on a yield to maturity basis. If a bond is selling at a premium and callable at a premium, the yield may be to the final maturity or the call date, whichever is less. In each case, the investor would receive a quote based on the most conservative scenario. This is referred to as the yield to worst.
