3-Unit 2 - Debt Securities

The computation for accrued interest on corporate and municipal debt obligations is based on a(n): A) actual-day month and a 360-day year. B) 30-day month and an actual-day year. C) actual-day month and an actual-day year. D) 30-day month and a 360-day year.

Your answer, 30-day month and a 360-day year., was correct!. 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.

If an investor is faced with converting a bond into 20 shares of common stock with a CMV of $57.75 or allowing the bond to be called at 102, the investor is experiencing: A) a refunding call. B) a forced conversion. C) a hedge. D) an arbitrage.

Your answer, a forced conversion., was correct!. If the value of the stock to be received on conversion exceeds the call price, this is essentially forcing the bondholder to convert. Reference: 2.5.2.7 in the License Exam Manual.

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) $46. C) $28.75. D) $34.

Your answer, $28.75., was incorrect. The correct answer was: $46. 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). Reference: 2.5.2.5 in the License Exam Manual.

One of your customers buys a new issue municipal revenue bond on March 19. The trade settles on March 24, and the bond pays interest on February 1 and August 1. If the dated date of the bond is March 1, how many days of accrued interest are due? A) 23. B) 19. C) 55. D) 24.

Your answer, 23., was correct!. Interest started accruing from the dated date of the bond (March 1). Interest accrues up to, but not including, settlement. Therefore, 23 days of accrued interest are due. The customer's first interest payment, the following August, will represent interest that has accrued from the dated date. Reference: 2.7.1 in the License Exam Manual.

Debt instruments put up for auction by the U.S. treasury that offer intermediate maturities best describes: A) Anticipation notes. B) Treasury bonds. C) Treasury bills. D) Treasury notes.

Your answer, Anticipation notes., was incorrect. The correct answer was: Treasury notes. T-notes are the intermediate maturity (one to ten years). T-bills are short term (less than one year), Anticipation notes are short term revenue notes, and T-bonds are long term (ten years or more). Reference: 2.6.1.2.1 in the License Exam Manual.

If a bond has a basis price of 7%, which of the following would most likely be refunded? A) Coupon 6-½%, maturing in 2033, callable in 2013 at 100. B) Coupon 7-½%, maturing in 2033, callable in 2013 at 100. C) Coupon 6-½%, maturing in 2033, callable in 2013 at 103. D) Coupon 7-½%, maturing in 2033, callable in 2013 at 103.

Your answer, Coupon 6-½%, maturing in 2033, callable in 2013 at 103., was incorrect. The correct answer was: Coupon 7-½%, maturing in 2033, callable in 2013 at 100. An issuer is most likely to refund the issue that will cost it the most money over the life of the issue. Always use the following order in making this choice: (1) highest coupon, (2) lowest call premium, (3) earliest call date, and (4) longest maturity. Reference: 2.1.7.2 in the License Exam Manual.

Securities issued by private lending institutions approved by which of the following are directly backed by the federal government? A) Federal Home Loan Mortgage Corporation (FHLMC). B) Federal National Mortgage Association (FNMA). C) Government National Mortgage Association (GNMA). D) Federal Intermediate Credit Bank (FICB).

Your answer, Government National Mortgage Association (GNMA)., was correct!. The GNMA is a government agency backed by the full faith and credit of the federal government. The FNMA and FHLMC are government-sponsored corporations owned by public stockholders. FICB bonds are backed by the banks, not the U.S. government. Reference: 2.6.2.3 in the License Exam Manual.

Treasury Inflation Protection Securities (TIPS) offer which of the following benefits to an investor? Semiannual adjustments to principal based on the CPI. A Guarantee of profit upon sale. The interest payments will keep pace with inflation. TIPS provide investors with an income they can't outlive. A) I and III B) III and IV C) II and III D) I and II

Your answer, I and III, was correct!. Treasury Inflation Protection Securities (TIPS), are issued by the government and designed to offer investors inflation protection by adjusting the principal of the TIPS semiannually based on the Consumer Price Index (CPI). In times of inflation the interest payments increase and they decrease during times of deflation. No security guarantees a profit upon sale and only an annuity can guarantee an income for life. Reference: 2.6.1.5 in the License Exam Manual.

Twenty-five basis points on a par bond with 1 year to maturity are equal to: $.25 per $1,000. $2.50 per $1,000. 0.25%. 2.5%. A) I and III. B) II and III. C) I and IV. D) II and IV.

Your answer, I and III., was incorrect. The correct answer was: II and III. If 1 basis point equals .01%, 25 basis points equal .25%. .25% of $10 (which is the value of one full point for a bond) = $2.50. Reference: 2.1.5.1 in the License Exam Manual.

Which of the following statements are TRUE of CMO investors? They have interest rate risk. They do not have interest rate risk. They have little or no risk exposure. They can be exposed to extension and prepayment risk. A) II and III. B) I and III. C) I and IV. D) II and IV.

Your answer, I and IV., was correct!. Collateralized Mortgage Obligations are backed by mortgages. All mortgage-backed securities are subject to interest rate risk. If rates rise, extended maturity risk exists, which means the actual life of the underlying mortgage will be longer than the expected life. If rates fall, prepayment risk exists, which means mortgage holders will likely refinance their existing mortgages. As a result, the actual life of the underlying mortgages will be shorter than the expected life. Reference: 2.8.2.5 in the License Exam Manual.

Which of the following statements regarding negotiable CDs are TRUE? The issuing bank guarantees them. They are callable. Minimum denominations are $1,000. They can be traded in the secondary market. A) I and IV. B) I and III. C) II and III. D) II and IV.

Your answer, I and IV., was correct!. Negotiable CDs are issued primarily by banks and backed by the issuing bank. The minimum denomination is $100,000. These are sometimes referred to as jumbo CDs. Reference: 2.10.2.5.2 in the License Exam Manual.

From first to last, in what order would claimants receive payment in the event of bankruptcy? Holders of secured debt. Holders of subordinated debentures. General creditors. Preferred stockholders. A) I, II, III, IV. B) III, I, II, IV. C) IV, I, II, III. D) I, III, II, IV.

Your answer, I, II, III, IV., was incorrect. The correct answer was: I, III, II, IV. The liquidation order is as follows: wages, taxes, secured debt holders, unsecured debt holders (including general creditors), holders of subordinated bonds, preferred stockholders, and common stockholders. Reference: 2.3.2.3 in the License Exam Manual.

Rank the following from first to last in order of payment at liquidation of a corporation. General creditors. Preferred stock. Subordinated debentures. Accrued taxes. A) III, IV, I, II. B) III, IV, II, I. C) IV, III, I, II. D) IV, I, III, II.

Your answer, IV, I, III, II., was correct!. The complete order of liquidation is as follows: wages, taxes, secured debt, debentures and general creditors, subordinated debentures, preferred stock, common stock. Reference: 2.3.2.3 in the License Exam Manual.

Which of the following statements regarding callable municipal bonds is TRUE? A) As interest rates rise, callable bonds trading at a premium will generally rise in value. B) Noncallable bonds usually yield more than callable bonds. C) Bond call premiums generally compensate the bondholder for interest payments lost if the bond is called. D) Bonds are typically called when interest rates are rising.

Your answer, Noncallable bonds usually yield more than callable bonds., was incorrect. The correct answer was: Bond call premiums generally compensate the bondholder for interest payments lost if the bond is called. As callable bonds represent more risk to the investor, they generally trade at higher yields than comparable noncallable bonds. Bonds are called when rates are falling or have fallen, allowing the issuer to replace the called issue with one with a lower coupon. As rates rise, bond prices fall. The call premium on a callable bond, which represents the difference between the call price and par, compensates bondholders for lost interest if the bond is called. Reference: 2.2.7.4 in the License Exam Manual.

Which of the following is the FINRA approved trade reporting system for corporate bonds trading in the OTC secondary market? A) SIPC B) TRACE C) Nasdaq D) SDBK

Your answer, TRACE, was correct!. TRACE (Trade Reporting and Compliance Engine) is the FINRA approved trade reporting system for corporate bonds trading in the OTC secondary market. TRACE purpose is to add market transparency by disseminating trade details immediately to the investing public. Reference: 2.11.1.1 in the License Exam Manual.

Which of the following statements best describes banker's acceptances? A) They are used to satisfy short-term cash needs of broker/dealers. B) They are used primarily to finance imports and exports. C) They are an asset that provides a competitive rate of return, broad diversification, and liquidity. D) They are unsecured promissory notes with long term maturities issued by financially strong corporations

Your answer, They are an asset that provides a competitive rate of return, broad diversification, and liquidity., was incorrect. The correct answer was: They are used primarily to finance imports and exports. Banker's acceptances are used primarily to finance imports and exports. They are short-term time drafts with a specified payment date drawn on a bank—essentially lines of credit. Reference: 2.10.2.3 in the License Exam Manual.

A customer buys an 8% bond on an 8.20 basis. If the bond is callable in 5 years at par and matures in 10 years, which of the following statements is TRUE? A) Nominal yield is higher than YTM. B) YTC is higher than YTM. C) YTC is lower than YTM. D) Nominal yield is higher than YTC.

Your answer, YTC is higher than YTM., was correct!. A bond with a YTM (basis) greater than its coupon is trading at a discount. When a bond is trading at a discount, the YTC is greater than the YTM. Nominal yield is lower than both YTM and YTC. Reference: 2.2.7.3 in the License Exam Manual.

Corporate bonds are considered safer than common stock issued by the same company because: A) bonds and similar fixed-rate securities are guaranteed by SIPC. B) if there is a shortage of cash, dividends are paid before interest. C) the par value of bonds is generally higher than that of stock. D) bonds place the issuer under an obligation but stock does not.

Your answer, bonds place the issuer under an obligation but stock does not., was correct!. A bond represents a legal obligation to repay principal and interest by the company. Common stock carries no such obligation. Reference: 2.1 in the License Exam Manual.

All of the following are money market instruments EXCEPT: A) commercial paper. B) Treasury bills. C) newly issued Treasury notes. D) jumbo CDs.

Your answer, newly issued Treasury notes., was correct!. Money market securities have a maximum maturity of 1 year. Treasury notes are issued with maturities of 2 to 10 years. Treasury bills are money market instruments with maturities of 6 months or less. Jumbo CDs are issued by banks and have maturities of 1 year or less. Commercial paper (issued by corporations) is unsecured short-term debt with maturities of 270 days or less. Reference: 2.10 in the License Exam Manual.

If interest rates increase, the interest payable on outstanding corporate bonds will: A) increase. B) remain unchanged. C) decrease. D) change according to the inverse payout theory.

Your answer, remain unchanged., was correct!. The interest payable is the nominal yield, which is stated on the face of the bond. It is the percentage of face value the bond will pay each year regardless of the prevailing interest rates in the market. It is the market price of bonds, not the interest payable, that responds inversely to changes in interest rates. Reference: 2.2.7.6 in the License Exam Manual.

When assets are pooled into financial instruments such as Collateralized Mortgage Obligations (CMOs) to better facilitate selling them to the general public the process is know as: A) best efforts. B) structuring. C) securitization. D) diversification.

Your answer, securitization., was correct!. Asset backed securities represent a pool of assets that were combined into a financial instrument such as a CMO for the purpose of better facilitating sales to the general investing public. The process of pooling assets into a single financial instrument for this purpose is known as securitization. Reference: 2.8 in the License Exam Manual.

Libby sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an 11-1/4% coupon, are convertible into common stock at $10.50, and are being issued to the public at 100. The proceeds of the issue will be used specifically for purchasing new Southwest barges. Libby's concerns about the issue could include: A) the new barges might sink, and the collateral would be gone. B) she should not be concerned as the bonds will be first in liquidation. C) the issue may be junior-in-lien to another security issue. D) the company might demand that she accept common stock for her bond.

Your answer, the company might demand that she accept common stock for her bond., was incorrect. The correct answer was: the issue may be junior-in-lien to another security issue. The word "subordinated" is the key to the question. A subordinated bond has other debt holders ahead of it in the event of liquidation. The barges do not serve as collateral as the bonds are identified as debentures, and having to convert to common stock is not a threat since she is the one that will, if she desires, exercise the conversion privilege. Reference: 2.3.2.2 in the License Exam Manual.

The minimum face amount of a negotiable CD is: A) $50,000. B) $10,000. C) $25,000. D) $100,000.

Your answer, $100,000., was correct!. Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are traded in blocks of $1 million. Reference: 2.10.2.5.2 in the License Exam Manual

Which of the following is NOT true of the Interbank market? A) It is unregulated. B) It deals in currencies. C) It is susceptible to central bank intervention. D) It is based in London.

Your answer, It is based in London., was correct!. The interbank market deals primarily in currencies and is unregulated. It is an over-the-counter market whose participants are major currency dealers, such as banks. Central banks, such as the Federal Reserve, use the market to try to influence exchange rates. Reference: 2.10.4.3 in the License Exam Manual

The effective Fed funds rate is: A) the lowest rate charged by any bank. B) the rate charged by the largest bank. C) the highest rate charged by any bank. D) the daily average rate charged by banks.

Your answer, the lowest rate charged by any bank., was incorrect. The correct answer was: the daily average rate charged by banks. Each week, banks have to report their daily Fed funds rate. The published rate is the average of all reporting banks over the course of the week. Reference: 2.10.3.1 in the License Exam Manual.