Debt Securities
Which of the following is equal to 9 basis points?
0.0009 (2.1.7) One basis point is equal to .01%, or .0001
An investor purchased 10 State of Nevada bonds at 104 5/8. The total price of the bonds is
10462.5
What does Accretion mean?
Accretion means that the cost basis of the bond must be adjusted upward toward par each year so that at maturity the investor's cost basis will equal par of $1,000. (2.5)
Current Yield
Annual Interest (Coupon) / Current Market Value
An investor should expect the greatest price increase in which of the following if interest rates decline? A) Long-term bonds selling at a premium B) Long-term bonds selling at a discount C) Short-term bonds selling at a discount D) Short-term bonds selling at a premium
B) Long-term bonds selling at a discount (2.3.5)
A corporate bond that has a sinking fund provision A) is usually retired in whole at the discretion of the trustee B) can be offered at a lower interest rate than other bonds C) has more default risk than other corporate bond issues without this provision D) is exempt from the Trust Indenture Act of 1939
B) can be offered at a lower interest rate than other bonds Bonds that are retired through a sinking fund have less default risk, because the issuer is making payments in advance to a trustee to buy bonds in the open market. This reduction of principal risk allows the issuer to offer these bonds at a lower interest rate. 2.1.8.1
An investor purchasing 2 GMAC ZR 12's at 53 1/2 would receive annual interest of A) $53.50 B) $12 C) $0 D) $120
C) $0 (2.1.5) ZR in the quote indicates that this bond is a zero
An investor purchased a 5 1/2% bond to yield 6 1/2%. If the company calls the bond at par before maturity, the investor's return would be A) 5.50% B) less than 5 1/2% C) greater than 6 1/2% D) 6.50%
C) greater than 6 1/2% For this bond, NY = 5.5% and YTM = 6.5%. With YTM>NY, this indicates that the bond is sold at a discount, and for a discount bond, YTC > YTM. 2.2.5
Call premiums perform which of the following? A) Require issuers to notify the sponsor when retiring a bond B) Require investors to notify the issuer when retiring a bond C) Protect issuers from having debt with an attractive yield refinanced long before maturity D) Protect investors from having debt with an attractive yield refinanced long before maturity
D) Protect investors from having debt with an attractive yield refinanced long before maturity Call premiums mitigate reinvestment risk in the event interest rates decline by requiring the issuer to pay a premium if refinancing the bonds prior to maturity. For example, a 10-year bond with a 10-year maturity might have a call premium of 105% after the first call date. This would require the issuer to pay investors 105% of par to call away the issue. 2.1.9
An investor buys a 6.0% coupon bond to yield 6.1%. What will most likely happen to the price of the bond as maturity approaches? A) The price will fall to zero. B) The price will decrease towards par. C) The price will remain constant. D) The price will increase towards par.
D) The price will increase towards par. 2.1.8
XYZ Corporation issued a 25-year bond, callable after 12 years. This means that the bond A) may be called in year 12 or 25. B) must be called after 12 years. C) must be called in year 12. D) may be called any time after 12 years
D) may be called any time after 12 years 2.1.9
Which of the following statements regarding debt securities are true? I. A purchaser of a bond is a creditor of the corporation II. The corporation is a creditor of a bondholder III. Bonds are generally issued with a par value of $100 IV. Bonds are generally issued with a par value of $1,000
I & IV (2.1)
Convertible Bond
Investor can convert the bond into a fixed number of common shares -usually this feature results in lower coupon pmts
Callable Bond
Issuer can "call" or redeem the bond at a set price before maturity
What features make a bond more sensitive to interest rate risk?
Low coupon & Long maturity
Call protection period
Provides the investor safety from call risk
Accrued Interest
The interest that is paid by the buyer of a bond to the seller when a bond is traded between coupon payment dates
Puttable Bond
The investor can demand early repayment of principal -usually this feature results in lower coupon pmts
Credit Risk
The risk of default, i.e., that an issuer cannot make interest payments and/or repay principal
Call Risk
The risk that a bond is redeemed before its maturity. Preventing the holder to receive interest payments
Coupon
the annual interest rate charged on face value of the bond.
Yield to Maturity (YTM)
the most widely quoted rate of return on a bond, accounting for the interest PMTs received and difference between their purchase price and principal received at maturity.
Which of the following is true regarding the impact of inflation on a U.S. Dollar-based fixed-income security? A) Deflation will increase the purchasing power of USD bonds. B) Inflation will likely lead to lower interest rates and therefore increasing the price of USD bonds. C) Inflation will increase the value of the dollar, thereby increasing demand and the price for USD bonds. D) Inflation will increase the purchasing power of interest payments and therefore increase the price.
A) Deflation will increase the purchasing power of USD bonds. 2.3.4
A municipal bond issue is structured whereby a portion of the issue is retired each year. This is an example of a A) serial bond B) term bond C) sinking fund D) balloon bond
A) serial bond In this scenario, outstanding bonds are retired at different intervals with a portion of the issue maturing each year. 2.1.8
How often is the interest income on zero-coupon bonds taxed? A) Every six months B) Annually C) At maturity D) The interest income is not taxable
B) Annually Although the interest (the difference between the discounted purchase price and par value) is not actually paid until maturity, investors must still pay tax each year on the annual accretion. 2.1.5
In a book-entry format, ownership of the security is recorded by A) Corporate counsel B) Central depository C) Clearing house D) The issuer
B) Central depository When a book-entry format is used, ownership is recorded by a central depository, rather than by the issuer. This has become the most common method of tracking ownership. 2.1.1
Which types of bonds are not callable? A) Corporate B) Federal government C) Municipal general obligation D) Municipal agency
B) Federal government Most corporate and municipal bonds with maturities of over 10 years are callable for a certain period. However, bonds issued by the federal government are not callable. 2.1.9
The accrued interest that is calculated for settlement of a Treasury bond A) Starts on the dated date. B) Is based on actual-day months. C) Includes interest paid on the settlement date. D) Is subtracted from the purchase price.
B) Is based on actual-day months. For government bonds, interest starts accruing on the interest payment date before settlement. Interest payable on the settlement date is not included. Dated date applies only to new issues of municipal bonds. Government bond interest is based on actual-day months. Accrued interest is added to the price paid by the purchaser and received by the seller. 2.4
Which of the following best describes duration? A) It is a measure of how the Treasury yield curve will adjust when general interest rates change. B) It is a measure of how much a bond's price will change when interest rates fluctuate. C) It is the length of time that a bond remains outstanding prior to it being called or redeemed by the issuer. D) It is the length of time between call dates or interest payment dates on a bond.
B) It is a measure of how much a bond's price will change when interest rates fluctuate. Duration is a commonly used method of gauging a bond's sensitivity to changing interest rates. 2.3.1
Two bonds have relatively equal credit quality and terms to maturity. Which of the following statements is true? A) The bond with the lower coupon is more liquid. B) The bond with the higher coupon is more marketable. C) The bond with the higher coupon will trade at a lower price. D) The bonds will have equal coupon rates.
B) The bond with the higher coupon is more marketable. Investors will pay more for the bond with the higher coupon unless it is more risky. Bonds of equal credit quality and terms to maturity will likely have similar yields, but their coupon rates of interest may be very different. 2.1.4
On Friday September 1st a customer purchases a municipal bond for regular way settlement. The bond pays semi-annual interest on December 1 and June 1. How many days of accrued interest are added to the buyer's price? A) 95 days B) 93 days C) 94 days D) 96 days
C) 94 days Regular way settlement for municipal bonds is T+2 business days, and the accrued interest calculation is based on 30-day months. There are 30 days in June, 30 days in July, 30 days in August, and 4 in September due to the weekend (settlement date is Tuesday September 5th). The buyer's price includes interest that goes up to, but does not include the settlement date. 2.4
For a bond that Moody's rates Aa1, what is the corresponding S&P rating? A) AAA B) Baa C) AA+ D) Baa
C) AA+ Moody's ratings use upper and lower case letters (Aa), while S&P uses all caps. Remember that "The poor wear caps." Moody's uses a 1 to indicate higher quality within a given rating. S&P uses a +. 2.3.5.1
A company with a Ba1 rating from Moody's and a BB+ rating from S&P would be classified as which of the following? A) Investment grade B) Highest quality C) Non-investment grade D) Medium grade
C) Non-investment grade Issuers rated 'Ba1' and below by Moody's Investor Service and 'BB+' and below by S&P are referred to as non-investment grade or high yield. Due to having greater default risk, high yield bonds pay more interest than investment grade debt. Issuers rated 'Baa3' and above by Moody's Investor Service and 'BBB-' and above by S&P are referred to as investment grade. 2.3.5.1
All of the following statements regarding variable rate bonds are true EXCEPT A) the lender assumes interest rate risk B) the amount of interest paid varies over the life of the loan C) they typically have greater price volatility than fixed rate bonds D) an index or other common base rate such as LIBOR is usually used to determine the rate payable for each period
C) they typically have greater price volatility than fixed-rate bonds The price of a variable rate bond remains relatively stable because the interest rate adjusts to prevailing conditions. 2.1.4.1
Which of the following call dates would be LEAST beneficial for an investor? A) 20 years B) 15 years C) 10 years D) 5 years
D) 5 years Investors prefer a longer call date in order to better protect themselves from call and reinvestment rate risk. (2.1.9)
Which type of bond must be accreted towards par each year? A) A municipal bond B) A bond purchased at par C) A bond purchased at a premium D) A bond purchased at a discount
D) A bond purchased at a discount (2.5)
An investor purchased a City of Seattle 4% municipal bond that matures 3-25-2019, at 98 3/8. From this information you can tell that the bond A) Will yield less than 4% if it is called. B) Is priced at $980.38 C) Is trading at par value D) Has a yield to maturity that is greater than its nominal yield.
D) Has a yield to maturity that is greater than its nominal yield. (2.2.5)
All of the following statements are true about bonds that trade flat EXCEPT A) The bond is settled on an interest payment date. B) The issuer may be in default. C) No accrued interest is added at settlement. D) The bond is trading "and interest".
D) The bond is trading "and interest". Bonds that trade flat do not include accrued interest in their settlement price. This could be because the issuer is in default and interest is not being paid, or because the bond is settling on an interest payment date. "And interest" means that accrued interest is included in the settlement price. 2.4
In the fixed income market, the risk that is created by a downward trend in interest rates is referred to as A) principal risk B) interest rate risk C) market risk D) reinvestment rate risk
D) reinvestment rate risk Downward trends in interest rates cause reinvestment risk because it may be difficult to find comparable yields for reinvestment of principal or interest payments. Interest rate risk occurs as interest rates increase, causing a subsequent decline in bond prices. 2.3.3
Reinvestment Rate Risk
The risk that an investor is unable to reinvest capital at a previously earned rate of return
Interest Rate Risk
The risk that as interest rates increase, bond prices decrease.
Bond
a security issued by a corporation or governmental entity to raise capital, representing a loan to a borrower in return for PMT of interest and principal to the lender
