Series 7 - Bonds Practice Questions

The yield curve shows the yields of: A different maturities of the same type of security B different types of securities with the same maturity C different risk classes of securities with the same maturity D different maturities of securities with different risk classes

The best answer is A. The yield curve compares the yields of all maturities for the same type of security (e.g., the yields for all maturities of U.S. Government securities; the yields for all maturities of AAA rated corporate securities, etc.)

In 2020, a customer buys 1 PDQ 10%, $1,000 par debenture, M '35, at 115. The interest payment dates are Jan 1st and Jul 1st. The current yield on the bond is: A 8.37% B 8.70% C 10.00% D 10.23%

The best answer is B. The current yield is the stated rate of interest on the bond, based on market value. $100/$1,150 = 8.70%

A bond is rated AA by Standard and Poor's. This bond is: A Highest Quality Investment Grade B High Quality Investment Grade C Low Quality Investment Grade D Highest Level Speculative Grade

The best answer is B. An AA rating is upper medium investment grade.

During a period when the yield curve is normal: A short term rates are more volatile than long term rates B long term rates are more volatile than short term rates C short term and long term rates are equally volatile D no relationship exists between short term and long term rate volatility

The best answer is A. Whether the yield curve is ascending (normal), flat or descending, the true statement always is that short term rates are more volatile than long term rates

A municipal dealer quotes a 2 year, 8% term revenue bond at 106. The yield to maturity is: A 1.88% B 4.85% C 7.54% D 8.00%

The best answer is B. The formula for yield to maturity for a premium bond is: YTM = $80 - $30 / $1030 = 4.85%

Political risk is generally associated with: A Corporate bond investments B International bond investments C Municipal bond investments D Treasury bond investments

The best answer is B. Political risk is the risk of investing internationally in countries that have weak political systems. Thus, the bondholder has very little in the way of legal protection. Political risk is an issue for consideration when making investments in 3rd World countries.

The current yield on a bond is: A stated interest rate / bond par value B stated interest rate / bond market value C market interest rate / bond par value D market interest rate / bond market value

The best answer is B. The current yield is the stated rate of interest on the bond, based on current market value. CY = annual income / market value

At which Standard and Poor's rating is a bond considered to be speculative ("junk bond")? A. AA B. BBB C. BB D. C

The best answer is C. The top 4 ratings are "investment grade" - AAA, AA, A, and BBB. Bonds below these ratings are speculative. The best speculative rating is, therefore, BB.

For bonds trading at a discount, rank the yield measures from lowest to highest? I Nominal II Current III Basis A I, II, III B III, II, I C II, I, III D I, III, II

The best answer is A. When bonds are trading at a discount, the stated (nominal) yield will be lowest. The current yield will be higher, since it is based on the discounted market price - not par value. The yield to maturity will be the next highest, since it includes the portion of the discount earned annually as part of the annual return in addition to the interest received. I. Nominal Yield II. Current Yield III. YTM

Which of the following rate commercial paper? I Standard and Poor's II Fitch's III Best's IV Moody's A I and II only B III and IV only C I, II and IV D I, II, III, IV

The best answer is C. The 3 major debt ratings agencies are 1)Moody's, 2) Standard and Poor's and 3) Fitch's. All three rate commercial paper. Best's is an insurance rating agency.

When the yield curve is inverted: I short term rates are higher than long term rates II long term rates are higher than short term rates III the Federal Reserve is loosening credit IV the Federal Reserve is tightening credit A I and III B I and IV C II and III D II and IV

The best answer is B. An inverted yield curve is one where short term rates are higher than long term rates. This is the typical yield curve shape during periods when the Federal Reserve is tightening short term credit to slow down the economy.

Municipal dollar bonds are generally: A term bonds B series bonds C serial bonds D short term maturities

The best answer is A. Municipal dollar bonds (quoted on a percentage of par basis) are term bonds. Municipal bonds quoted in basis points (yield quotes) are serial bonds.

In 2020, a customer buys 5 GE 10% debentures, M '30, at 85. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2025 at 103. The yield to maturity on the bonds is: A 10.00% B 10.81% C 11.76% D 12.43%

The best answer is D. The formula for yield to maturity for a discount bond is: YTM =· [(C + (F - P)/n] / (F+P)/2 C = $1000x10%=$100 F=$1000 P=$850 n=10 YTM = $100 +$15 / $925 = 12.43%

The nominal yield on a bond is: A stated interest rate / bond par value B stated interest rate / bond market value C market interest rate / bond par value D market interest rate / bond market value

The best answer is A. The nominal yield is the stated rate of interest on the bond, based on par value. NY = Annual Income / Par

A declining rate of inflation would lead to: A higher bond prices and higher bond yields B higher bond prices and lower bond yields C lower bond prices and lower bond yields D lower bond prices and higher bond yields

The best answer is B. A declining rate of inflation will lead to lower interest rates. If interest rates drop, then bond prices will rise. Inflation increases => interest rate increases Thus, if interest rate increases => bond prices decrease and bond yields increase The opposite is also true.

The amount by which the purchase price of a municipal bond exceeds the par value of the bond is termed the: A spread B discount C premium D takedown

The best answer is C. If the purchase price of a bond is higher than par, then the bond is selling for more than par. This is the bond's premium.

A 9%, $1,000 par corporate bond is trading at $1,100. What is the current yield? A 8.18% B 9.00% C 9.60% D 10.30%

The best answer is A. Since the bond is trading at a premium, its current yield must be lower than its coupon. The formula to find the current yield is: CY = $90/$1,100 = 8.18%

In 2020, a customer buys 1 GE 8%, $1,000 par debenture, M '35, at 110. The interest payment dates are Jan 1st and Jul 1st. The yield to maturity on the bond is: A 6.98% B 7.58% C 8.00% D 8.24%

The best answer is A. The formula for yield to maturity for a premium bond is: YTM =· [(C - (P - F)/n]/ (F+P)/2 YTM = ($80 - $100/15)/$1050 = 6.98%

A bond issue where every bond has the same issue date, interest rate, and maturity is a: A term bond offering B series bond offering C serial bond offering D combined serial and term bond offering

The best answer is A. A term bond issue is one where every bond has the same issue date, interest rate and maturity. Corporate issues and U.S. Government bond issues are typically term bonds.

Which rating would apply to municipal short term notes? A MIG 2 B P 1 C Aa D BBB

The best answer is A. MIG stands for Moody's Investment Grade and is the rating for short term municipal notes. "ABC" ratings are used for long term corporate and municipal bonds; P (Prime) ratings are used for commercial paper.

Regarding bonds with put options, which of the following statements are TRUE? I Exercise of the put is at the option of the bondholder II Exercise of the put is at the option of the issuer III Yields on bonds with put options are lower than similar bonds without this feature IV Yields on bonds with put options are higher than similar bonds without this feature A I and III B I and IV C II and III D II and IV

The best answer is A. Put options are exercisable at the option of the bondholder (not the issuer). Because the put option removes some of the market risk from the bond, this feature is valued by bondholders, who will accept lower yields on bonds having this option.

For bonds trading at a discount, rank the yield measures from lowest to highest? I Nominal II Current III Basis IV Yield to Call Basis A I, II, III, IV B IV, III, II, I C II, I, III, IV D I, III, II, IV

The best answer is A. When bonds are trading at a discount, the stated (nominal) yield will be lowest. The current yield will be higher, since it is based on the discounted market price - not par value. The yield to maturity will be the next highest, since it includes the portion of the discount earned annually as part of the annual return in addition to the interest received. Finally, yield to call will be highest, since the discount would be earned over a shorter period of time, increasing the annual yield on the security.

A bond that was originally sold at par is now trading in the market at a premium. The bond is called at par. This action will be a detriment to the: A issuer B bondholder C underwriter D broker

The best answer is B.

Which of the following are due interest from the corporation? A Common Shareholders B Convertible Bondholders C Preferred Shareholders D Warrant Holders

The best answer is B. Bondholders are creditors of a company and are due interest. Convertible bondholders are creditors of a company as long as they keep their bonds and do not convert to common shares. Common and preferred shareholders have an equity position. Warrant holders have a long term option to buy the stock. Warrants are considered equity-related securities, but they have neither an equity nor creditor stake in the corporation.

Which bond will exhibit the greatest price volatility? A 11-year bond; 7% coupon; 8% yield; duration of 7.71 B 9-year bond; 0% coupon; 7% yield; duration of 9.00 C 5-year bond; 4% coupon; 3.50% yield; duration of 4.59 D 3-year bond; 2% coupon; 1.50% yield; duration of 2.93

The best answer is B. The longer the expiration, the more volatile a bond's price movements, which narrows the Choices to either A or B. The lower the coupon, the more volatile the bond's price movements, with the lowest coupon being "0." A 9-year zero coupon bond will actually be more volatile in price movements than a slightly longer maturity bond (11 years) with a fairly high coupon (7% in this case). The higher coupon means that more of the bond's value is represented by the interest stream than comes in early and this stabilizes the bond's price as market interest rates move. Duration is a concept that is tested as a "basic" idea on Series 7. It represents the amount of time that it will take for an investor to recoup his or her purchase price. The longer the duration, the longer it will take for an investor to get his or her money back and longer term bonds are more volatile. So the higher the duration number, the greater the bond volatility, and duration is often used as a measure of bond price volatility.

An 8% corporate bond with 20 years left to maturity is currently trading at 120. The bond is callable in 4 years at 104. If a client buys the bond and then the issuer calls it in 4 years, the yield to call will be: A 2.98% B 3.57% C 3.63% D 6.66%

The best answer is B. YTC for premium bond = (C-(MP-CP)/4) / (CP+MP)/2 =$40 / $1,120 = 3..57%

If investors expect an economic expansion, the best investment strategy would be to: I sell U.S. Government bonds II sell corporate bonds III buy U.S. Government bonds IV buy corporate bonds A I and III B I and IV C II and III D II and IV

The best answer is B. If the economy expands, people sell U.S. Government bonds (lowering prices and raising yields); and buy corporate bonds for extra yield (raising prices and lowering yields).

During periods when interest rates are rising, which of the following statements are TRUE? I Bonds with low coupon rates exhibit the greatest price volatility II Bonds with high coupon rates exhibit the greatest price volatility III To minimize price volatility, low coupon bonds are appropriate investments IV To minimize price volatility, high coupon bonds are appropriate investments A I and III B I and IV C II and III D II and IV

The best answer is B. Bonds with the lowest price volatility will be ones with the highest coupon rate. Bonds with low coupon rates exhibit greater price volatility, with the most volatile bond being a zero-coupon bond. Thus, to minimize price volatility due to interest rate movements ("interest rate risk"), high coupon bonds are more appropriate than low coupon bonds.

Two 20-year corporate bonds are issued at par, with stated interest rates of 10%. One issue is callable at par in 5 years, while the other is callable at par in 10 years. If interest rates drop by 200 basis points shortly after issuance, which statement is TRUE? A The bond callable in 5 years will appreciate more than the bond callable in 10 years B The bond callable in 10 years will appreciate more than the bond callable in 5 years C Both bonds will appreciate by equal amounts D The rate of appreciation depends on the credit rating of the bonds

The best answer is B. If a bond is callable at par in the near future, any price rise due to falling interest rates will be suppressed since the issuer is likely to call in the debt and refund at lower interest rates. Thus, the bond callable in 10 years will appreciate more than the bond callable in 5 years if interest rates fall.

Which statements are TRUE regarding market risk for bondholders? I As interest rates rise, the price of long term bonds falls faster than that of short term bonds II As interest rates rise, the price of short term bonds falls faster than that of long term bonds III To avoid market risk, a customer would invest in bonds with long term maturities IV To avoid market risk, a customer would invest in bonds with short term maturities A I and III B I and IV C II and III D II and IV

The best answer is B. Market risk for a bondholder is the risk of rising interest rates forcing the price of a bond to drop. As interest rates rise, the price of a long term bond falls faster than that of a short term bond. To avoid market risk, a bondholder would want to invest in the shortest maturity possible.

Securities subject to reinvestment risk are those that: I make periodic payments to investors II do not make periodic payments to investors III are held for short time horizons IV are held for long time horizons A I and III B I and IV C II and III D II and IV

The best answer is B. Reinvestment risk occurs when an investor is holding fixed income securities over a long time horizon during a time period when interest rates have been declining. As payments are received from these investments, they must be reinvested to maintain the overall rate of return on that portfolio - and if interest rates have been dropping, these payments are reinvested at lower and lower interest rates, lowering the overall rate of return on the portfolio

Most of the value of a bond is established by the: A present value of the first payment B present value of the last payment C expected volatility of the bond's price D expected volatility of market interest rates

The best answer is B. The actual dollar price of a bond is computed by taking the yearly income stream and principal repayment at maturity and discounting it back to today's "present value" based on the current market interest rate. Most of the value of the bond comes not from the yearly interest payments, but rather from the final payment when the principal is being returned.

As interest rates rise, which of the following statements are TRUE? I Bonds trading at large discounts fall faster in price than bonds trading at small discounts. II Bonds trading at small discounts fall faster in price than bonds trading at large discounts. III Bonds trading at large premiums fall faster in price than bonds trading at small premiums. IV Bonds trading at small premiums fall faster in price than bonds trading at large premiums. A I and III B I and IV C II and III D II and IV

The best answer is B. The general rule is the lower the price of the bond, the faster that bond's price will move as market interest rates change. Deep discount bonds have a lower price than small discount bonds, hence their prices move faster. Small premium bonds have a lower price than large premium bonds, hence their prices move faster as well.

When a recession is expected, yields on: I corporate bonds will increase II U.S. Government bonds will increase III corporate bonds will decrease IV U.S. Government bonds will decrease A I and III B I and IV C II and III D II and IV

The best answer is B. When a recession is expected, investors sell corporate bonds (increasing their yields) and buy government bonds (decreasing their yields). Thus, the spread between corporate and government bond yields will widen.

Which characteristics make a security most subject to liquidity risk? I Short term maturity II Long term maturity III Low credit rating IV High credit rating A I and III B I and IV C II and III D II and IV

The best answer is C. · The risk that the security can only be sold by incurring large transaction costs. · Generally, short-term high quality issues are liquid · The longer the term and lower the quality, the lesser the liquidity

Which of the following affect the marketability of corporate bonds? I Bond rating II Maturity III Block size IV Bond denominations A I only B II only C I, II, III D II, III, IV

The best answer is C. Bond rating, maturity, and block size affect marketability. The higher rated a bond, the more marketable it is. The shorter the maturity, the more marketable it is. For corporate bonds, the most marketable blocks are 5 bonds up to 100 bonds. Under 5 is an odd lot; over 100 is a large block which is more difficult to trade. The bond denominations have no effect on marketability.

A bond with a "C" rating is considered to be: A lower medium grade B lowest investment grade C one having credit risk D one having market risk

The best answer is C. A bond rated "C" is considered to be speculative and would have substantial credit risk. The ratings agencies cannot rate bonds for market risk - only for credit risk. The lowest investment grade rating is BBB. BB, and B ratings are considered to be medium grade. CCC, CC, and C are all speculative, with a C rating being the most speculative.

All of the following callable municipal bonds are trading at an 8% basis. Which is MOST likely to be called? A. 6 3/4% coupon rate callable at 103 in 2020 B. 7 1/2% coupon rate callable at 103 in 2020 C. 8 3/4% coupon rate callable at 100 in 2020 D. 8 3/4% coupon rate callable at 105 in 2020

The best answer is C. An issuer is most likely to call bonds which have high interest rates (high financing cost to the issuer) and low call premiums (the least expensive for the issuer to call in these bonds) Thus, option C is the best answer because 8 3/4% is a higher interest rate, and its call premium is 100 (which is less than option D's 105 call premium)

A customer has purchased three different bonds, each yielding 9%, with 5 year, 10 year, and 15 year maturities. If prevailing interest rates drop by 20 basis points, which will show the greatest percentage price change? A 5 year maturity B 10 year maturity C 15 year maturity D The bonds will all move by the same percentage

The best answer is C. As interest rates move, long term maturities will change in price at a faster rate than will short term obligations. This is due to the fact that the "compounding effect" is more acute as maturities lengthen. As interest rates move up, long term maturities fall faster in price than do short term maturities.

A corporation has issued 10% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 8%. Which of the following are TRUE statements about the outstanding 10% issue? I The current yield will be higher than the nominal yield II The current yield will be lower than the nominal yield III The dollar price of the bond will be at a premium to par IV The dollar price of the bond will be at a discount to par A I and III B I and IV C II and III D II and IV

The best answer is C. The bond was issued with a coupon of 10%. Currently, the yield for a similar issue is 8%. Therefore, interest rates have dropped. When interest rates drop, yields on bonds already trading must also drop. What causes this is a rise in the dollar price of the issue - the bond now trades at a premium.

In 2020, a customer buys 1 PDQ 10%, $1,000 par debenture, M '35, at 115. The interest payment dates are Jan 1st and Jul 1st. The nominal yield on the bond is: A 8.37% B 8.69% C 10.00% D 10.23%

The best answer is C. The nominal yield is the stated rate of interest on the bond, based on par value. NY = ($1,000 x 10%) / $1,000 = $100 / $1,000 = 10%

During periods when the yield curve has a "normal" shape, as market interest rates change, which statement is TRUE? A Both short and long term bond prices move equally in response B Short term bond prices move more sharply than long term bond prices C Long term bond prices move more sharply than short term bond prices D No relationship exists between the relative price movements of short and long term bonds

The best answer is C. When a normal yield curve exists (an ascending curve), long term bond prices are more volatile than short term bond prices in response to market interest rate movements.

Exchange rate risk is a factor to consider when investing in debt issues: I within the U.S. II outside the U.S. III that are denominated in U.S. dollars IV that are denominated in a foreign currency A I and III B I and IV C II and III D II and IV

The best answer is D. When an investment is made outside the U.S. that is denominated in a foreign currency, the investor assumes exchange rate risk. This is the risk that the foreign currency weakens against the U.S. dollar (which is the same as the U.S. dollar strengthening).

A customer has heard about the explosive growth in China and wants to make investments in Chinese companies. The customer should be informed about which risks? I Political risk II Exchange Rate risk III Marketability risk IV Default risk A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is D. How about telling the customer about all of these risks!

The risk that rising interest rates will cause bond prices to fall is: A Credit Risk B Purchasing Power Risk C Legislative Risk D Interest Rate Risk

The best answer is D. Interest Rate Risk is the risk that rising interest rates will cause fixed income securities' prices to fall.

The yield to maturity for a discount bond is: A stated interest rate - annual capital loss / bond par value B stated interest rate + annual capital gain / bond par value C stated interest rate - annual capital loss / bond average value D stated interest rate + annual capital gain / bond average value

The best answer is D. The formula for yield to maturity for a discount bond is: YTM (discount) = Annual Interest + Annual Capital Gain / ((bond cost + redemption price)/2)

Which bond will exhibit the greatest price volatility? A 2% coupon bond with a 2 year maturity B 0% coupon bond with a 1 year maturity C 6% coupon bond with a 10 year maturity D 0% coupon bond with a 9 year maturity

The best answer is D. The longer the expiration, the more volatile a bond's price movements, which narrows the Choices to either C or D. The lower the coupon, the more volatile the bond's price movements, with the lowest coupon being "0." A 9-year zero coupon bond will actually be more volatile in price movements than a slightly longer maturity bond (10 years) with a fairly high coupon (6% in this case).

When the price of a bond increases, which of the following statements regarding yields are TRUE? I Yield to call increases II Yield to call decreases III Yield to maturity increases IV Yield to maturity decreases A I and III B I and IV C II and III D II and IV

The best answer is D. When the price of a bond increases, yield to maturity drops. Similarly, because the bond is more expensive, yield to call will also fall.