SIE Ch 5: Debt Instruments

All of the following are used to properly evaluate the yield-to-maturity of a bond investment EXCEPT

Current price of the bond. The factors that are taken into account when calculating yield-to-maturity of a bond are annual coupon payment in dollars; number of years to maturity; par (or face) value realized at maturity; initial price paid. The current price of the bond is not taken into account.

Which of the following is an example of an unsecured corporate bond?

Debenture

Money market instruments

Debt security that matures in 1 year or less. high-quality, short-term debt.

What is the backing for a bond?

Every bond is backed by the full faith and credit of the issuer, which is simply the issuer's promise to repay. It is different that a secured bond, which is also backed by assets held for bondholders.

Calculating accrued interest.

Every month has 30 days and every year has 360 days. Regular way settlement for these bonds is T + 2.

On a discount bond, which of the following lists is correct from lowest to highest yield?

Nominal yield, current yield, yield to maturity.

callable bond

a bond that can be redeemed or paid off by the issuer pior to its maturity date

covenant

an agreement, a guarantee, a warrant

Par value

face amount. value written on front of bond. amount that bond issuers agreed to pay to bondholder on date bond matures.

Revenue Anticipation Notes (RAN)

issued in anticipation of facility revenues

Tax Anticipation Note (TAN)

municipal note issued in anticipation of a future tax collection

A municipal broker/dealer enters a bid wanted. This is a

nonbinding request for a likely bid

A municipal broker/dealer enters a bid wanted. This is a

nonbinding request for a likely bid.

Treasury bills are quoted

on a discount yield basis

Z-tranche

riskiest tranche, and therefore has the highest potential yield.

Tax and Revenue Anticipated Notes (TRAN)

tax and revenue anticipated notes

How are T-notes quoted?

Quoted in points as a percentage of par. Points are broken down into 1/32 increments and the fractional part is expressed as a decimal.

The lowest yielding CMO tranche is the

PAC - has lowest prepayment and extension risk and therefore lowest yield.

What is the best case on discount bonds?

Yield to call is the best case.

nominal yield

coupon rate.

VRDNs (Variable Rate Demand Notes)

long-term (20-30 yr) variable rate securities issued by municipalities.

Treasury notes (T-notes) are issued with maturities of

2 years, 3 years, 5 years, and 10 years.

Treasury notes (T-notes) are issued with denominations beginning at

$1,000

A US govt bond quoted at 108.06-109.09 has an asking price of

$1,099. Bond prices are quoted at $1000 par in 32nds with each point worth $10. The ask price (the last price quoted) would be $1090 + (9/32x$10) for a price of $1092.81

The last quotation of a US government bond is 98.08. An investor purchasing the bond would pay

$982.50. Bond prices are quoted at par in 32nds. The quote of 98.08 means $980.00 +8/32, which equals $2.50, making the bond price $982.50.

T-bills are currently issued with the following maturities:

4 weeks (1month); 13 weeks; 26 weeks; and 52 weeks (1yr)

A US govt bond quoted at 94.20-95.08 has a bid price of

946.25. Bonds are quoted at $1000 par in 32nds, with each point worth $10. The bid price (the first price listed) would be $940 + (20/32 x $10), which converts to $940 + $6.25 for a price of $946.25

Put option

A contract that gives the holder the right to sell 100 shares of the underlying security at the strike price, until expiration

Variable annuity

A contract that provides lifetime income and has payments that vary in dollar amount depending on the performance of the separate account

A portfolio manager purchases a bond on a yield-to-call basis. This bond was trading at

A premium. Bonds are always quoted on a "yield to worst" basis. This means that discount bonds are sold on a yield-to-maturity basis and premium bonds are sold on a yield-to-premium basis. When a bond is issued at par, all yields are the same.

The last transaction in ABC 6.00s 2025 was 103. This bond is selling at

A premium. This bond is quoted at 103, which is equal to a price of $1,030. (Remember to multiply 103 x 10 to arrive at the price of the bond). The bond is selling at a premium because the price of $1,030 is greater than its par value (or$1,000).

Which of the following issues equipment trust certificates?

A regional airline

Equipment trust certificates

An example is a regional airline. issued by the owner/operator of the equipment, not the manufacturer.

Asset-backed securities are traded based on

Average life. They are backed by a pool of assets: auto loans/leases, credit card receivables, and home equity loans. They are traded based on the average life of the pool of assets in which they have an interest.

Fannie Mae (FNMA)

Buys government guaranteed and insured mortgages, and conventional mortgages from the banks

Mortgage-backed issues are considered to be safe instruments. Which statement is INCORRECT concerning these securities?

GNMA, FNMA, and FHLMC are all fully backed by federal government. (Only GNMA is fully backed by the full faith and credit of the US government guaranteed agency. FNMA and FHLMC are government-sponsored enterprises that may borrow from the Treasury.)

Which describes a double-barreled bond?

General obligation. (but it possesses a revenue source which may or may not be adequate for debt service payments.

An investor who wants to purchase mortgage-backed securities fully guaranteed by the US govt should purchase

Government National Mortgage Association (Ginnie Mae). The only one with both principal and interest payments fully guaranteed by the US govt.

If a bond is bought at a discount, the yield-to-maturity is

Higher than the nominal yield. In addition to earning interest, the investor pays less than par value for the bond and receives full par value at maturity.

Discount Bond

Highest yield is CALL (cannot quote call), Next highest is MATURITY or BASIS, Third yield is CURRENT, and Lowest yield is NOMINAL.

Premium Bond

Highest yield is NOMINAL, Next highest yield is CURRENT, Third yield is MATURITY or BASIS, Lowest yield is CALL, Premium bonds MUST BE quoted to the CALL yield.

FHLB

Loan funds to savings and loans institutions with S&L mortgages as collateral

T-Bills

Min denomination is $1000. Quoted on a discounted yield basis. Are sold by means of a periodic auction. Do NOT pay periodic interest. Purchased at a discount and mature at face value.

A bond that sells above par is known as a premium bond. Which of the following statements are true?

Nominal yield is the highest yield. The nominal yield will always be the highest yield on a premium bond. The nominal yield is the same as the coupon rate.

When communicating with the public, a broker/dealer's advertisements must not be misleading. Which of the following communications is considered misleading?

Predicting future performance based on a 10-year performance chart. Ads can't predict or project performance. In addition, they cannot use a historical performance chart to imply that past performance is an indicator of future performance.

Variable rate demand note

Security with a stated maturity date, floating interest rate, and an option to put the security back to the financial intermediary daily or weekly. It is a long-term municipal bond with a floating (variable) interest rate and an option for the investor to put the security back to the financial intermediary on a daily or weekly basis. Variable rate securities issued by municipalities. They are long-term (20-30yrs) municipal bonds w/ a variable interest rate what adjusts to changes in the money market interest rate, usually every 1 to 7 days. Investors have an option to tender, or put, the securities back to the financial intermediary in return for repayment of the entire amount of the debt. This requires notice of between 1 and 7 days. VRDNs are usually supported by external credit enhancements, such as a Letter of Credit, to reduce the risk of loss of principal due to issuer default.

Treasury notes have stated (fixed) interest payments that are paid

Semiannually

Which of the following would NOT issue overlapping debt?

State. It has no direct role in the property tax.

The key difference between a T-note and a T-Bond is

T-Notes are issued with maturities of less than 10 years. The only difference b/w a T-note and a T-bond is the length of the maturity of the original issue. T-Notes have maturities ranging from 2 to 10 years while T-Bonds have maturities of 30 years. Both have a starting denomination of $1000 and can be purchased at a discount and/or premium depending on the interest rate environment of the market.

Which of the following statements is true about a municipal dealer who has an out firm quote from another municipal dealer?

The dealer has the right to buy the bonds at a fixed price for a certain period of time.

Government National Mortgage Association (GNMA)

backed by full faith and credit of the US government. pay interest monthly. They are collateralized by mortgages and homeowners pay their mortgages monthly.

A bond's call premium is defined as the amount

The issuer pays the bondholder to exercise the call.

What is the backing for a secured bond?

The pledge of collateral, a mortgage, or other lien.

When comparing two similar bonds,

The unsecured bond's yield will be higher than the secured bond. Because the debenture is riskier than the secured bond, investors will demand a higher yield. Income (adjustment) bonds are very risky and therefore trade at a significant discount, resulting in a higher potential yield than a secured bond.

True about treasury bills

They are issued in book entry form.

A municipality has issued a double-barreled revenue bond where the net revenues generated by the facility have proven to be insufficient to service the debt. All of the following are true EXCEPT

They are marketed as revenue bonds. "double-barreled" means general obligation, and GO Bonds can be backed by ad valorem or property taxes, assessments of additional taxes, and fines. They cannot be marketed as revenue bonds since GO backing is utilized when revenues fall short. Like other GO bonds, they must be underwritten by a competitive bidding process.

bond

key feature is its term to maturity.

Sam owns a security with a $10,000 face value that matures in 6 months and will pay interest only at maturity. The interest earned is not subject to state or local taxation. Sam owns a

Treasury bill - have maturities 1 year or less. T-Bonds and T-notes have maturities greater than 1 year. All of the facts mentioned are characteristics of T-bills.

An investor anticipates interest rates will rise sharply over the next 2 years. In this scenario, which investment below would allow the investor to profit with the least amount of risk?

Treasury bills. They are a good hedge against interest rate risk. As the bills mature, the investor can earn higher rates of return by rolling these short-term securities into new bills. Long-term maturities have a high degree of volatility in interest rate fluctuation periods and should be treated with some caution.

Which of the following instruments trades on a discount yield basis?

Treasury bills. Treasury notes and bonds trade at dollar prices which are expressed in points and fractions of points. The fractions are in 1/32 increments and denoted with a period (96.16 = 96 16/32). Treasury stock is previously outstanding stock which the issuer has purchased in the secondary market and is holding in its treasury.

US Treasury Bills

traded and quoted at a discount

Debenture

unsecured bond. backed only by the good faith of the issuer.

Which of the following are issued with a specified, fixed rate of interest?

US government bonds and notes

According to MSRB rules, under which of the following conditions may a municipal dealer share in the losses of a customer's account?

Under no circumstances. Dealers may not share in profits or losses of customer accounts

What is the worst-case scenario for premium bonds?

Yield to call must be quoted on premium bonds because of their call risk.

Which of the following is the highest yield when a bond is trading at a discount?

Yield-to-maturity. It represents the overall yield no a bond. The calculation incorporates the coupon rate plus the par value received at maturity, which is greater than the discounted price paid.

mortgage securities are issued and/or guaranteed by any one of the following

an agency of the US govt, GNMA, GSE/FNMA, and FHLMA, FHLMC

coupon value

annual interest payment made by bond issuers to bond owners during the life of the bond. Generally paid semiannually. Coupon rate calculated based on bond's face or par value and quoted as a percentage of par.

Bond Anticipation Notes (BAN)

anticipation of issuing a bond in the future

Collateral Trust Certificates

are backed by the securities of a different issuer. For example, suppose Dell Computer owns several shares of Intel stock. If Dell issued a collateral trust certificate, it might use the Intel stock to secure the bond. If Dell defaulted on its collateral trust certificate, the Intel would be sold to satisfy the bondholder's claim. Of all secured corporate debt, first mortgage bonds are considered the most senior.

T-bills

are short-term debt instruments, making them less volatile than Treasury bonds. Issued with a min of $1,000 with $1000 increments. They are issued in book-entry form; no certs issued.

Treasury bills

dependent on the amount purchased, as they are always purchased at discount.

current income

derived from the steady stream of semiannual income, also known as the coupon paid by the issuer of the bond during the life of the bond.

capital gains

earned when a bond matures at a price above the amount that the bondholder originally paid.

Ad valorem tax

from Latin for "according to value", a tax the amount of which is based on value of a transaction or of a property.

short-term bonds

generally have lower interest rates

long-term bonds

greater risk, issuers must pay a higher rate to compensate investors for assuming risk.

TIPS

have a CPI- adjusted, fluctuating principle and a fixed interest rate is applied to a fluctuating principal each semiannual interest period, the interest payments fluctuates.

Quasi-governmental agencies

have a line of credit from the US Treasury, but not full backing. Examples include Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC); and Student Loan Mortgage Corporation (SLMC).

Guaranteed bond

is a debenture or an unsecured bond. It is backed not only by the issuer's promise, but by an additional promise, usually from a parent or affiliate.

Treasury notes

issued with maturities of 2 years, 3 years, 5 years, and 10 years.

Government National Mortgage Association (GNMA)

long-term instruments that are collateralized by mortgages.

term to maturity

number of years during which the borrower has promised to meet the conditions of the debt. on the maturity date, is when the debt will be repaid. borrower redeems the isue by paying the face value or principal.

Book entry

securities issued only as electronic records, without physical certificates of ownership

variable rate demand note (VRDN)

security with a stated maturity date, floating interest rate, and an option to put the security back to the financial intermediary daily or weekly. it is a long-term municipal bond with a floating (variable) interest rate and an option for the investor to put the security back to the financial intermediary on a daily or weekly basis.

Municipal notes / short-term munis

short-term notes issued by municipalities in anticipation of tax receipts, proceeds from a bond issue, or other revenues. Maturity is one year or less. Rated by Moody's rating service as MIG 1, 2, or 3 with MIG 1 being the highest.

Treasury notes have

stated (fixed) interest payments that are paid semi-annually