Unit 2 - Individual Securities Debt

A call feature attached to a bond allows A) an issuer to call in a bond before maturity at times that will benefit the issuer. B) a bondholder to call the issuer for a redemption before the maturity date. C) a bondholder to hold a bond beyond the maturity date benefitting the bondholder. D) an issuer to call in a bond before maturity at times that will benefit the bondholder.

A call feature attached to a bond allows an issuer to call in a bond before maturity. Issuers will do this when interest rates have fallen. For example, if an issuer has an outstanding bond paying 6% and interest rates have fallen to 4%, why pay out 6% when prevailing market rates are only 4%? Better to call in the 6% bond and reissue a new bond at the current rate of 4%. Obviously, the ability to call in the bond benefits the issuer.

Which of the following are true of municipal revenue bonds? They are secured by a specific pledge of property. They are a type of general obligation bond. They are not subject to statutory debt limits. They are backed by a facilities ability to generate revenue. A) II and III B) III and IV C) I and IV D) I and II

A) II and III The two types of municipal bonds are general obligation (GO) and revenue bonds. Revenue bonds are not secured by a specific pledge of property; instead they are backed by project revenue. Unlike GO bonds, they are not subject to any statutory debt limits.

A new customer tells you that her objective is to incur little risk because she is anticipating a new home within the next 12 months. Which of the following would be a suitable recommendation? A) T-bills B) T-bonds C) High-yield corporate bonds D) Growth stocks

A) T-bills The investor's time frame for needing the funds (within 12 months) and low-risk objective are the key factors to consider. With such a short time horizon, any equity investment involves too much risk, as does an investment in a high-yield bond fund (higher the yield, greater the risk to attain it). Of the choices, T-bills are the shortest fixed term and are issued by the U.S. government, entailing little to no risk.

All of the following are issuer transactions where the proceeds of the offering go to the issuing company except A) a repurchase agreement (REPO). B) a subsequent public offering (SPO). C) an initial public offering (IPO). D) an additional public offering (APO).

A) a repurchase agreement (REPO) APOs, IPOs and SPOs all result in funds going to the issuer and are, therefore, issuer transactions. A REPO is a money market instrument where money changes hands between the buyer and the seller.

T-bonds and T-notes A) are both priced at a discount to par. B) have interest paid on an annual basis. C) are both priced as a percentage of par. D) have interest that accrues until paid at maturity.

A) are both priced at a discount to par Both Treasury notes and bonds are priced as a percentage of par. Interest on these is paid semiannually. Comparatively, T-bills are priced at a discount to par with the interest not paid until maturity (the difference between the discount paid and par value received).

An investor is able to purchase a bond at $725, well below par value. Buying the bond so cheaply tells us that the investors return at maturity A) increases. B) will be low, reflecting the low price paid. C) decreases. D) is unaffected.

A) increases A $1000 par value bond purchased at $725 is bought at a discount to par. Whenever a bond is purchased for an amount less than will be received at maturity ($1000 par), the discount initially paid increases the return. In other words, in addition to receiving the coupon interest payments, the investor will also receive at maturity an additional $275 more than the $725 paid when the bond matures.

When an investor purchases a corporate bond, the investor is A) lending money to and becoming an owner of the corporation. B) lending money to and becoming a creditor of the corporation. C) borrowing money from and becoming an owner of the corporation. D) borrowing money from and becoming a creditor of the corporation.

A) lending money to and becoming an owner of the corporation While stock represents ownership, a bond represents a loan. When investors purchase bonds, they are lending money to the borrowing entity and thus become creditors of the entity.

With interest rates in the marketplace at 7%, it could be expected that in the secondary market, a bond carrying a 5% coupon would trade A) upward in price. B) unaffected by the changing interest rates. C) only in accordance to supply and demand. D) downward in price.

A) upward in price While bond prices like those of other securities are impacted by supply and demand, they also have a unique inverse relationship to interest rates. As interest rates rise in the marketplace, the prices of bonds trading in the secondary market will fall, and as interest rates fall in the marketplace, the prices of bonds trading in the secondary market will rise.

Which of the following statements regarding bond interest is true? A) Bond prices have an inverse relationship to interest rates. B) The par value of a bond will increase as market interest rates fall. C) Bond prices have a direct relationship to interest rates. D) The par value of a bond will decrease as market interest rates fall.

B) The par value of a bond will increase as market interest rates fall. Bond prices have an inverse relationship to interest rates. If interest rates go up, bond prices for those bonds trading in the secondary markets will go down. Conversely, if interest rates decline, bond prices rise. Par value is a fixed number for the life of the bond.

When purchasing a bond, the investor is taking on A) a debtor position. B) a creditor position. C) an equity position. D) an obligation.

B) a creditor position When an investor is purchasing a bond, he is lending money to the issuer and becomes a creditor of the issuer.

Securities issued by the U.S. government are backed by A) its full faith and credit, based on the value of real assets owned by the government. B) its full faith and credit, based on its power to tax the people. C) the assets of government agencies. D) only the value of real assets owned by the government.

B) its full faith and credit, based on its power to tax the people. Securities issued by the U.S. government are backed by its full faith and credit. The promise to pay is based on the federal government's power to tax the people, as well as to print currency when it needs to.

A bank trustee holds the titles to assets a corporation has purchased and utilizes in its day-to-day business. The corporation issues debt securities backed by these assets. These securities are A) equipment trust certificates. B) mortgage bonds. C) debentures. D) collateral trust bonds.

B) mortgage bonds Debt securities issued by corporations backed by the assets the corporation owns and uses in its daily b business are known as equipment trust certificates.

Which of the following statements regarding bond interest is true? A) The par value of a bond will increase as market interest rates fall. B) Bond prices have a direct relationship to interest rates. C) Bond prices have an inverse relationship to interest rates. D) The par value of a bond will decrease as market interest rates fall.

C) Bond prices have an inverse relationship to interest rates. Bond prices have an inverse relationship to interest rates. If interest rates go up, bond prices for those bonds trading in the secondary markets will go down. Conversely, if interest rates decline, bond prices rise. Par value is a fixed number for the life of the bond.

If a company files for bankruptcy, which of the following investors would be most likely to be paid first? A) Preferred stock B) Common stock C) Mortgage bonds D) Debentures

C) Mortgage bonds Mortgage bonds are senior securities. Those who hold mortgage bonds expect to receive any assets from the dissolution of a bankrupt company before the holders of junior securities such as debentures and equity securities.

A guaranteed bond is usually guaranteed by which of the following entities? A) The U.S. Guarantee Association B) The broker-dealer who sold it C) The U.S. government D) A parent company

C) The US government A guaranteed bond is backed by a third party, normally a parent company backing the debt of a subsidiary company.

For collateral trust bonds, all of the following are true except A) a trust serves as a depository holding the securities to serve as collateral. B) the issuer deposits securities it owns into a trust. C) securities backing the debt can be securities of either fully or partially owned subsidiaries. D) these are unsecured debt securities.

C) securities backing the debt can be securities of either fully or partially owned subsidiaries. For a collateral trust certificate, the issuer deposits securities of other corporations that it owns, or securities of fully or partially owned subsidiaries into a trust. The securities help in the trust are the collateral backing the certificates, and thus with this backing the certificates are considered secured debt instruments.

It would be expected that a repurchase (repo) agreement contract would include A) the repurchase price and the maturity date. B) the maturity date only. C) the repurchase price and the rate of return. D) the rate of return and maturity date.

C) the repurchase price and the rate of return A repurchase (repo) agreement contract would include the repurchase price (the price that the securities initially sold would be bought back at) and the maturity date (the date that the initial sale would be reversed). The return would be the difference between the initial sale price and the repurchase price.

A corporate bankruptcy liquidation took place. Of the following—general creditors, secured bondholders, subordinated debenture holders, accrued taxes—who was paid first and who was paid last? A) Secured bondholders first, subordinated bondholders last B) Secured bondholders first, accrued taxes last C) Secured bondholders first, general creditors last D) General creditors first, secured bondholders last

D) General creditors first, secured bondholders last The liquidating priority is as follows: secured debt, unsecured debt and general creditors, then subordinated debt, and then equity holders with preferred shareholders first, followed by common shareholders. Therefore, of those that are listed here, secured bondholders would be paid first, and subordinated bondholders last. General creditors and taxes are paid at the same level.

Which of the following bonds trade flat (without interest) unless interest payments are declared by the board of directors (BOD)? A) Income bonds B) Callable bonds C) Debentures D) Mortgage bonds

D) Mortgage bonds Bonds that trade flat (without interest), unless the payments are declared by the BOD, are income bonds (also known as adjustment bonds).

Which of the following regarding Treasury STRIPS, receipts, bills, notes and bonds is true? A) They are all sold at a discount to par. B) They are all backed by the good faith and credit of the U.S. government. C) They all pay semiannual interest payments. D) They all mature at par value.

D) They all mature at par value The only commonality for all of these is that each matures at par. Only T-bills, receipts and STRIPS are sold at a discount to par. Only T-notes and bonds make semiannual interest payments, and though STRIPS, bill, notes, and bonds are all backed by the good faith and credit of the U.S. government, Treasury receipts issued by broker-dealers are not.