Unit 2 Series 7 Exam
A May and November Treasury bond is traded the regular way on Wednesday, June 8th. The number of days of accrued interest is: A) 39. B) 45. C) 44. D) 38.
A Accrued interest on government bonds is based on actual days in a year. Settlement occurs on the next business day. This bond pays interest in May and November, with the most recent payment on May 1st. Interest has accrued on this bond for 31 days in May and 8 days in June, for a total of 39 days. Settlement date is Thursday, June 9th. Reference: 2.7.2.1.2 in the License Exam Manual
A customer purchased a callable XYZ Corporation 5% debenture to yield 4.5%. The price paid for the bond would most likely be: A) 100½. B) 99½. C) 95. D) 97½.
A In this example the stated coupon is greater than the yield or yield to maturity. This relationship exists when a bond is trading at a premium to par. Reference: 2.2.7.6 in the License Exam Manual
The computation for accrued interest on corporate and municipal debt obligations is based on a(n): A) 30-day month and a 360-day year. B) actual-day month and an actual-day year. C) 30-day month and an actual-day year. D) actual-day month and a 360-day year.
B Accrued interest on corporate and municipal bonds is computed on a 30-day month and a 360-day year. Reference: 2.7.2 in the License Exam Manual
The result of declining inflation on outstanding bonds would be: A) higher prices and higher yields. B) higher prices and lower yields. C) lower prices and lower yields. D) lower prices and higher yields.
B Declining inflation means declining interest rates. If interest rates decline, bond prices rise. Reference: 2.2.7.6 in the License Exam Manual
For Eurodollar bonds, all of the following are accurate statements EXCEPT A) U.S. investors are not exposed to currency risk B) interest and principal payments are made in U.S. dollars C) non-U.S. investors would not be subject to currency risk D) they are issued outside of the United States
C Eurodollar bonds are issued outside the United States, but principal and interest are paid in U.S. dollars. Therefore, a U.S. investor bears no currency risk, although a foreign issuer or investor does.
Which of the following usually does NOT pay interest semiannually? A) Treasury bonds. B) Public utility bonds. C) GNMA. D) Treasury notes.
C GNMA pass-through certificates pay principal and the interest monthly. All other choices usually pay interest semiannually.
All of the following may be included in an advertisement for a CMO issue EXCEPT a: A) disclosure of the CMO's coupon rate and final maturity date. B) disclosure that payment assumptions may or may not be met. C) statement that the CMO is guaranteed by the U.S. government. D) generic description of the CMO tranche.
C The U.S. government does not issue or back CMOs. It is also misleading to state or imply that a CMO's anticipated yield or average life is guaranteed. CMOs must include the coupon rate and the final maturity date, a generic description of the CMO tranche, and disclosure that payment assumptions may or may not be met. Reference: 2.8.2.5 in the License Exam Manual
A customer owns a 7-½% ABC convertible bond currently trading at 115. The conversion price is $40. What is the parity price of the common? A) $44. B) $28.75. C) $46. D) $34.
C To compute the parity price of common stock, divide the market price of the convertible bond by the conversion ratio. $1,150 / 25 (the number of common shares that the bond is convertible into) = $46 (115% × $40 = $46).
Which of the following investments is the most liquid? A) Foreign stock funds. B) Common stock. C) Variable annuities. D) Money market funds.
D Money market funds are the most liquid investment. Reference: 2.10.1.1 in the License Exam Manual
DMF Company has $50 million of convertible bonds (convertible at $50) outstanding. The current market value of DMF's stock is $42. The bond indenture contains a nondilution feature. If DMF declares a 10% stock dividend, the new conversion price will be: A) higher than $50. B) $50. C) the stock's current market price. D) lower than $50.
D With an antidilution feature, the issuer will increase the number of shares available upon conversion if the company declares a stock split or stock dividend. This means the bondholder must be able to convert it to more shares, which requires a lower conversion price. Reference: 2.5.2.5 in the License Exam Manual
Which of the following are characteristics of commercial paper? I. It represents a loan by the holder to the issuer. II. It is a certificate of ownership in the corporation. III. It is commonly issued to raise working capital for a corporation. IV. It is junior in preference to convertible preferred stock.
I & III Commercial paper instruments are debt securities; they represent loans to the issuing corporation by the holder. They are commonly issued to raise working capital and, as debt obligation, are senior in preference to preferred stock in claims against an issuer. Reference: 2.10.2.4 in the License Exam Manual
A convertible bond has a conversion price of $40 per share. If the market value of the bond rises to a 12½ point premium over par, which of the following are TRUE? I. Conversion ratio is 25:1. II. Conversion ratio is 28:1. III. Parity price of the common stock is $42. IV. Parity price of the common stock is $45.
I & IV The conversion ratio is computed by dividing par value by the conversion price ($1,000 par / $40 = 25). Parity price of the common stock is computed by dividing the market price of the convertible bond by the conversion ratio ($1,125 / 25 = $45). Or, 112½% × $40 = $45. Reference: 2.5.2.5 in the License Exam Manual
If interest rates are rising, which statements are TRUE regarding CMOs? I. Prepayment risk increases. II. Prepayment risk decreases. III. Extended maturity risk increases. IV. Extended maturity risk decreases.
II & III If rates are rising, homeowners are less likely to refinance. Therefore, prepayment risk will decrease. Similarly, if prepayments are declining, the estimated life of the underlying mortgages should increase. Reference: 2.8.2 in the License Exam Manual
