Series 7 UNIT 2 Debt Securities
The minimum face amount of a negotiable CD is: A) 10,000 B) 100,000 C) 50,000 D) 25,000
B. 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.
Which of the following is NOT part of the Federal Farm Credit System? A) The Federal Land Banks. B) The Federal Home Loan Banks. C) The Federal Bank for Cooperatives D) The FCIB
B. The Federal Farm Credit Bank system is for farms, not homes.
All of the following statements regarding Government National Mortgage Association (GNMA) pass-through securities are true EXCEPT A) investors own an undivided interest in a pool of mortgages B) investors receive a monthly check representing both interest and a return of principal C) GNMAs are considered to be the riskiest of the agency issues D) the minimum investment initial investment is $25,000
C. GNMA securities, which are backed by the full faith and credit of the US government, are considered to be the safest of the agency issues.
Which of the following is a debt instrument that pays no periodic interest? A) Treasury note. B) GNMA. C) STRIPS. D) Treasury bond.
C. STRIPS are Treasury bonds with the coupons removed. STRIPS do not make regular interest payments. Instead, they are sold at a deep discount and mature at par value.
Your customer wishes to lock in a long-term yield with minimal risk and is not interested in regular income. Which of the following securities should you recommend? A) Corporate A-rated zero coupon bond. B) Treasury Bill. C) Treasury STRIPS. D) Treasury Bond.
C. The Treasury STRIPS is long-term, no-interim income, and has a locked-in yield since it is purchased at a discount from par. The T-bill is short term, the T-bond provides semiannual interest, and the corporate zero is riskier than the STRIPS.
PDQ Corporation has a 6-1/4% convertible preferred stock (conversion ratio of 4) outstanding. The stock has an antidilution covenant. If PDQ declares a 10% stock dividend, the antidilution covenant will adjust: A) the par to $90 B) the conversion price to $27.50. C) the conversion price to $22.72 D) the par to $110.
C. The stock is convertible at $25 ($100 par / 4 shares). To determine the new conversion price, $100 / 4.4 shares = $22.72, or divide $25 by 110%.
A respected analyst reports that last week's T-bill rate at 6% is lower than the rate for the preceding week and lower than the average for the past month. Which of the following is TRUE? A) Prices are descending. B) The general level of interest rates is increasing. C) Investors are paying more for T-bills. D) Investors are paying less for T-bills.
C. When the rate is lower, the price has gone up; this means investors are paying more as interest rates are going down.
Interest income from all of the following are exempt from state and local taxation EXCEPT: A) Series EE savings bonds. B) Treasury bills. C) Treasury bonds D) FNMA mortgage-backed issues
D. As a general rule, the interest income from U.S. government and agency securities is subject to federal taxation only; it is generally exempt from state and local taxation. However, the interest income from mortgage-backed securities is fully taxable.
Planned amortization class (PAC) CMOs were designed to provide which of the following benefits compared to plain vanilla tranches? A) Increase prepayments to tranche holders. B) Match the prepayment risk of plain vanilla tranches. C) Eliminate prepayment risk for tranche holders. D) Reduce prepayment risk for tranche holders.
D. PACs reduce but cannot eliminate prepayment risk for tranche holders. The companion tranches will have higher prepayment risk than the PAC, as they were designed to absorb the bulk of the prepayment risk.
U.S. Treasury bills are issued for all of the following maturities EXCEPT: A) 13 weeks B) 26 weeks C) 4 weeks D) 39 weeks
D. Treasury bills are issued for terms of 4, 8, 13, 26, and 52 weeks. The Treasury auctions the 52-week bill every four weeks and the 4-week, 8-week, 13-week, and 26-week bills every week.
An investor wants to invest $20,000 but anticipates needing those funds in 5 years for a business investment. Currently, with inflation rising, the government is expected to take action to push interest rates up to reduce the money supply. Given these conditions, which of the following securities would be the least suitable for this investor who needs a specific amount of money in 5 years? A) Zero-tranche CMO with estimated 5 years life B) Zero-coupon bond maturing in 4 years C) U.S. Treasury bonds maturing in 6 years D) Corporate bonds maturing in 5 years
A. A zero-tranche CMO is subject to interest rate risk as well as extension risk when interest rates rise and therefore would not be suitable for a customer that needs her investment back at a specific point in the future. By contrast, A 4-year zero-coupon bond will mature within the anticipated time frame for needing the funds and would be the most suitable choice of the answers given.
The longest initial maturity for U.S. T-bills is: A) 52 weeks B) 39 weeks C) 13 weeks D) 2 years
A. As money market instruments, the longest initial maturity of Treasury Bills is 52 weeks. Those bills are auctioned once per month. T-bills of shorter maturities are auctioned weekly. The shortest initial maturity is 4 weeks.
Which of the following are characteristics of commercial paper? I.Registered with the SEC II.Short-term debt instrument. III.Issued by commercial banks. IV.Unsecured debt. A) II and IV B) I and II C) III and IV D) I and III
A. Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Because commercial paper is issued with maturities of less than 270 days, it is exempt from SEC registration under the Act of 1933.
A customer owns 10M of 7% U.S. Treasury bonds. He is in the 28% federal tax bracket and the 10% state tax bracket. What is his annual tax liability on these bonds? A) 196 B) 70 C) 266 D) 98
A. His tax liability is as follows: $1,000 × 7% = $70 annual interest per bond; $70 × 10 = $700 annual interest, which is taxable only by the federal government; $700 × 28% = a $196 tax liability.
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) 46 B) 28.75 C) 44 D) 34
A. 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).
When investor confidence in the economy is increasing, a technical analyst would anticipate that: I.yields on AAA-rated bonds will be higher than those on BBB-rated bonds. II.yields on BBB-rated bonds will be higher than those on AAA-rated bonds. III.the spread between yields on AAA-rated and BBB-rated bonds will increase. IV. the spread between yields on AAA-rated and BBB-rated bonds will decrease. A) II and IV B) I and III C) II and III D) I and IV
A. When investor confidence in the economy is increasing, yield spreads between the safest bonds and more speculative bonds decrease because investors are willing to take on greater risk. Yields on less safe bonds remain higher than those of AAA bonds. When investor confidence is declining the yield spreads will increase.
Yield quotes on CMOs are based on the: A) tranche's expected life B) underlying mortgages' average life. C) underlying mortgages' maturity. D) underlying mortgages' interest rate.
A. Yield quotes on CMOs are based on the tranche's expected life, not the average life of the mortgages in the pool backing all of the tranches.
Ginnie Mae pass-throughs will pay back both principal and interest A) monthly B) annually C) quarterly D) semiannually
A. Ginnie Mae (GNMA) securities are called pass-through certificates because the monthly home mortgage payments, which consist of both principal and interest, pass through to the GNMA investor monthly.
An investor purchases $10,000 worth of Treasury bills on November 27 and holds them until they mature on March 30 of the following year. For purposes of taxation, the interest from those Treasury bills is treated as: A) partially ordinary income and partially capital gain. B) ordinary income subject to federal income tax. C) tax-free income. D) a short-term gain.
B. Interest on Treasury bills, notes, and bonds is taxable as ordinary income at the federal level. It is exempt from state and local taxation.
Which of the following risks would impact CMO investors the least? A) Prepayment risk. B) Liquidity risk C) Extended maturity risk. D) Rate risk.
B. CMO investors are always subject to rate risk, which includes maturity and prepayment risk. Because CMOs trade OTC they are fairly liquid allowing investors to purchase or sell them easily at fair market value.
A customer interested in a collateralized mortgage obligation (CMO) might look to which of the following for historical data or projections regarding mortgage prepayments? A) FINRA B) PSA C) Daily Bond Buyer D) DEA
B. The Public Securities Association (PSA) uses historical data and projections of mortgage prepayments to estimate yield and maturity of different CMO tranches
T-bills are quoted: A) in 16ths. B) as a percentage of par C) in 32nds D) on an annualized discount yield basis
D. T-bills do not bear interest. T-bills trade and are quoted on an annualized discount yield basis.
Which of the following mortgage-backed securities would provide investors with the most predictable maturity date? A) PACs B) Ginnie Maes C) TACs D) Fannie Maes
A. PACs are planned amortization class CMOs and have established maturity dates. Prepayment risk is transferred to the PAC companion, or support, class bonds.
Two conservative customers in their 50s are interested in preserving principal and high-current income from their investments. In which order, from first to last, are the following bonds ranked in meeting your customer's needs? I.A1 Fort Worth Gas 9¼s of '25. II.AA+ San Antonio Transit 9¼s of '25. III.Aaa Texas Telecom 9¼s of '25. IV.AA- Dallas Electric 9¼ of '25. A) III, IV, II, I B) III, II, IV, I C) IV, III, I, II D) I, II, III, IV
B. Because the maturity and coupon rates are all the same, we can rank the bonds by rating. Based on the ratings given, the highest-quality bond is the Texas Telecom, rated Aaa, followed in order by the bonds rated AA+, AA-, and A1.
If ABC Corporation reports a loss for the year, it is obligated to pay interest on all of the following EXCEPT: A) variable rate bonds. B) adjustment bonds. C) convertible bonds. D) nonconvertible bonds.
B. Even if a corporation reports a loss, the corporation is obligated to pay interest on all of its outstanding debt except for income (adjustment) bonds. Income, or adjustment bonds, require interest to be paid only if declared by the board of directors.
Corporate bonds that are guaranteed are: A) insured by Assured Guaranty Corp. (AGC). B) guaranteed as to payment of principal and interest by the U.S. government. C) guaranteed as to payment of principal and interest by another corporation. D) required to maintain a self-liquidating sinking or surplus fund.
C. A guaranteed corporate bond is one guaranteed by another corporation that typically has a higher credit rating than the issuing corporation, and is in a control relationship with it
KLM Company has 10 million convertible bonds outstanding that are convertible at $25. The bonds contain an anti-dilution feature. If KLM declares a 10% stock dividend, the new conversion price will be: A) 22.5 B) 45.45 C) 50.00 D) 22.73
D. Before the stock dividend, an investor would have received 40 shares of stock for each $1,000 bond ($1,000 / $25). A 10% stock dividend would now give an investor 44 shares on conversion (40 shares + 10% = 4 shares more). $1,000 / 44 shares = $22.73 per share for the new conversion price.
Income from all of the following securities is fully taxable at the federal, state, and local levels EXCEPT: A) Treasury Bonds B) Corporate bonds C) reinvested mutual fund dividends D) Ginnie Maes
A. Interest on Treasury bonds is not taxed at the state level or local level.
Which of the following statements are TRUE of Ginnie Maes? I.They are quoted in 1/8ths. II.They are quoted in 1/32nds. III.They are traded with an accrued interest computed on an actual day basis. IV.They are traded with an accrued interest computed on a 30/360 basis. A) II and IV B) II and III C) I and III D) I and IV
A. Like governments, Ginnie Maes are quoted in 32nds, but, like corporates, Ginnie Maes compute accrued interest on a 30/360 day basis.
Transactions in all of the following are affected in the money market, as opposed to the capital market, EXCEPT A) federal funds B) U.S. Treasury bills C) municipal revenue bonds D) commercial paper
C. The money market is the marketplace for short-term (less than one year) debt obligations. The capital market is where long-term capital is raised. Municipal bonds, being long term, are a part of the capital market.
The function of the Federal National Mortgage Association (FNMA) is to: A) issue conventional mortgages. B) guarantee the timely payment of interest and principal on FHA and VA mortgages. C) provide financing for government-assisted housing. D) purchase FHA-insured, VA-guaranteed, and conventional mortgages.
D. The FNMA buys FHA, VA, and conventional mortgages and uses them to back the issuance of debt securities. FNMA currently issues debentures, mortgage-backed securities, and certificates.
The income from all of the following securities is taxable on the federal, state, and local income tax levels EXCEPT: A) GNMA certificates. B) corporate BBB bonds C) reinvested mutual fund dividends. D) Treasury bonds
D. The interest on U.S. government securities (such as Treasury bonds) is exempt from state and local income taxes, but not federal income taxes. Dividends (whether reinvested or not), Ginnie Maes, and corporate bonds of all types and/or ratings are taxable on all levels.
Which of the following expressions describes the current yield of a bond? A) Annual interest payment divided by current market price B) Annual interest payment divided by par value C) Yield to maturity divided by par value D) Yield to maturity divided by current market price
A. The current yield on a bond is calculated by dividing the annual interest payment by the current market price of the bond.
A couple with children ages 13 and 8 have $200,000 saved to put toward their children's college education. Which of the following would be most suitable for these investment dollars and objective? A)60% equities and equity funds, 30% T-bills, 10% corporate bonds B)80% zero-coupon bonds, 20% T-notes C)60% equities, 40% corporate bonds D)10% zero-coupon bonds, 90% corporate bonds
B. Of the portfolio mixes presented, zero-coupon bonds, which are purchased at a discount and mature at face value, are a suitable investment for future anticipated expenses such as college tuition. The T-notes, which are medium term U.S. government securities, would additionally be a suitable investment where risk of principal loss wouldn't be a concern as it would with equities.
A Treasury bond is quoted in "The Wall Street Journal" as follows: Bid 100:15 Asked 100:17 Bid Chg. -1 Yield 7.9 From this information, you know that the nominal yield is: A) 7.89% B) 7.9% C) greater than 7.9% D) less than 7.9%
C. The "Bid" and "Asked" prices show that the Treasury bond is being quoted at a premium (above par), with a yield to maturity of 7.9%. When bonds are trading at a premium, the nominal yield (coupon rate) is greater than the yield to maturity.
All of the following statements are true regarding the federal Farm Credit System securities EXCEPT: A) the proceeds are used to make loans to farmers. B) interest is tax exempt at the state and local levels. C) they issue short-term notes and long-term bonds. D) they are direct obligations of the U.S. government.
D. With the exception of Ginnie Mae, all agency securities are indirect obligations of the U.S. government.
Which of the following does NOT issue commercial paper? A) Finance companies. B) U.S. Treasury. C) Corporations. D) Broker/dealers.
B. The United States Treasury does not issue commercial paper. Its short term borrowing is done with Treasury bills.Commercial paper is unsecured, short-term corporate debt, most commonly issued by finance companies, but also by industrial corporations and broker-dealers.
A customer purchases an ABC 6-½% convertible preferred stock at $80. The conversion price is $20. If the common stock is trading 2 points below parity, the price of ABC common is: A) 12 B) 14 C) 18 D) 16
B. The conversion ratio is computed by dividing par value by the conversion price ($100 par / $20 = 5). Parity price of the common stock is computed by dividing the market price of the convertible by the conversion ratio ($80 / 5 = $16). $16 − 2 = $14.
All of the following statements regarding Treasury bills are correct EXCEPT A) Treasury bills trade at a discount to par B) most Treasury bill issues are callable C) 4, 13 and 26 week maturities are typical with the maximum sometimes changing D) Treasury bills are a direct obligation of the U.S. government
B. Treasury bills trade at a discount to par and are 4, 13, or 26 weeks in original maturity (maximum maturities are subject to change). They are a direct obligation of the U.S. government and are noncallable.
All of the following statements regarding the Federal National Mortgage Association (FNMA) are true EXCEPT A) FNMA pass-through certificates are not guaranteed by the U.S. government B) FNMA is a publicly held corporation C) FNMA is owned by the U.S. government D) interest on FNMA certificates is taxable at all levels
C. FNMA is a publicly held corporation. The interest income on all mortgage-backed securities is fully taxable. Though a government agency, FNMA pass through certificates are not guaranteed by the US government. The only U.S. agency whose securities are considered direct obligations of the U.S. government is the Government National Mortgage Association (GNMA).
For both U.S. Treasury notes and Ginnie Maes A) interest is computed on an actual-day basis B) settlement is next business day C) quotes are as a percentage of par, in 32nds D) interest income is taxed at the federal level only
C. Interest from U.S. T-notes is taxed at the federal level only, while interest on Ginnie Maes is taxed at all levels. GNMA bonds are treated like corporate bonds in many ways. T-notes settle next day; Ginnie Maes normally settle T+2. Interest on T-notes is computed on an actual day basis; Ginnie Mae interest is computed on a 30 day month/360 day year basis. Both Ginnie Maes and T-notes are quoted in 32nds.
Which of the following securities is an original issue discount obligation? A) GNMA certificates. B)FNMA bonds. C)13-week U.S. Treasury bills. D)Corporate bonds.
C. U.S. Treasury bills are always originally issued at a discount and mature at par, with the investor making the appreciation between the original discounted amount and the par value at maturity. This appreciation is treated as interest, however, as opposed to a capital gain.
Most rating services rate which of the following? A) Durability B) Reinvestment risk C) Quality D) Marketability
C. The rating services are concerned with quality, which is defined as the ability of the issuer or guarantor to pay (default risk).
XYZ Corporation has outstanding a 7% convertible bond currently trading at 102. The bond, which has a conversion price of $50, was issued with an antidilution covenant. If XYZ declares a 10% stock dividend, the new conversion price, as of the ex-date, will be: A) 45.00 B) 55.00 C) 45.45 D) 55.55
C. To compute a new conversion price, divide the current conversion price by 100% plus the percent increase in shares. $50 / 110% = $45.45.
For both U.S. Treasury notes and Ginnie Maes A) quotes are as a percentage of par, in 32nds B) interest income is taxed at the federal level only C) settlement is next business day D) interest is computed on an actual-day basis
A. Interest from U.S. T-notes is taxed at the federal level only, while interest on Ginnie Maes is taxed at all levels. GNMA bonds are treated like corporate bonds in many ways. T-notes settle next day; Ginnie Maes normally settle T+2. Interest on T-notes is computed on an actual day basis; Ginnie Mae interest is computed on a 30 day month/360 day year basis. Both Ginnie Maes and T-notes are quoted in 32nds.
Bond trust indentures are required for: A) corporate debt securities. B) municipal revenue bonds. C) municipal general obligation bonds. D) Treasury securities.
A. Municipal and government bonds are exempt from the trust indenture requirement of the Trust Indenture Act of 1939. Revenue bonds are frequently issued with a trust indenture, but no legal requirement to do so exists. The Trust Indenture Act of 1939 requires that corporate bond issues of $50 million or more sold interstate must be issued with a trust indenture.
Treasury STRIPS and Treasury receipts are quoted based on A) yield to maturity B) amortization of premiums C) 0.125 (1/8 of a point in dollars) D) 0.03125 (1/32 of a point in dollars)
A. Noninterest-bearing securities, like zeroes, are quoted based on their yield to maturity. They are sold at a discount and mature at par.
If an investor watches the latest T-bill auction fall to 4.71% from 4.82%, the best interpretation is that: A) investors who purchased bills at this auction paid more for them than purchasers last week. B) the federal funds rate and other short-term interest rate indicators are probably rising. C) the decline in yields indicates the Federal Reserve Board has raised the discount rate. D) investors who purchased T-bills 12 weeks ago paid less than subsequent purchasers
A. The rates on the T-bills fell, so prices rose, and the investor paid more for the bills this week than last week. The decline in yields indicates there was good demand for the securities because the price rose, driving the yields down. The question does not indicate the price of T-bills 12 weeks ago; it is unclear if the investor paid less for the T-bills then. The federal funds rate and other short-term interest rates would decline, not rise, in line with those of T-bills.
If interest rates fall, which of the following statements regarding CMOs are TRUE? I.Prepayment risk will increase. II.Prepayment risk will decrease. III.Prices of each tranche will rise. IV.Prices of each tranche will fall. A) I and IV B) I and III C) II and III D) II and IV
B. Prepayment risk is the risk that the underlying mortgages will be paid off sooner than expected. If rates fall, mortgage holders will refinance, paying off the existing high rate mortgages with lower rate mortgages. Thus, a tranche with an expected average life of 5-½ years may be extinguished in 2 years because of an acceleration in prepayments. As rates fall, prices of the underlying mortgages will rise.
A customer purchased a 5% U.S. government bond yielding 6%. A year before the bond matures, new U.S. government bonds are being issued at 4%, and the customer sells the 5% bond. The customer probably did which of the following? I.Bought it at a discount. II.Bought it at a premium. III.Sold it at a discount. IV.Sold it at a premium. A) I and III. B) I and IV. C) II and III. D) II and IV
B. The customer purchased the 5% bond when it was yielding 6% (at a discount). The customer sold the bond when other bonds of like kind, quality, and maturity were yielding 4%. The bond is now at a premium. Therefore, the customer realized a capital gain.
A customer bought a bond that yields 6-½% with a 5% coupon. If the bond matures at this point, the customer will receive A) 1,050 B) 1,025 C) 1,000 plus a call premium D) 1,065
B. Upon redemption of a bond, whatever current interest rates may be, the investor receives par ($1,000) plus the final semiannual interest payment ($25 in this case), for a total of $1,025.
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. A) II and III B) I and III C) I and IV D) II and IV
C. 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.
Which of the following statements regarding Treasury bills are TRUE? I.They are sold in minimum denominations of $10,000. II.They are offered with maturities ranging up to 52 weeks. III.Their interest is exempt from taxation at the state level. IV.They are callable by the U.S. Treasury at any time before maturity. A) I and III B) II and IV C) II and III D) I and II
C. Treasury bills are sold in minimum denominations of $100 and are not callable before maturity. T-bills are regularly offered with maturities from 4 weeks to as long as 52 weeks from issuance and are issued at a discount. Interest on Treasury bills is taxable at the federal level only.
Which of the following statements regarding Treasury receipts are TRUE? I.Interest is paid annually. II.Interest is paid at maturity. III.Interest is taxed annually. IV.Interest is taxed at maturity. A) II and IV. B) I and III C) II and III D) I and IV
C. Treasury receipts are zero-coupon bonds issued by broker/dealers. Zero coupon bonds pay all of their interest at maturity. They are issued at a discount and redeemed at par, and the difference represents the interest earned. For zeroes with a maturity of more than one year, the interest (or discount) must be accreted each year-and is taxable that year as income. This is termed imputed interest.
Which of the following is NOT true regarding Treasury Receipts? A) Treasury securities held in trust collateralize the Receipts. B) They are not backed by the faith and credit of the U.S. government C) Interest income is taxed at maturity. D) They pay interest at maturity.
C. Unlike Treasury STRIPS, which are issued directly by the U.S. government, Treasury Receipts are indirect obligations of the government. Treasury Receipts are issued by investment bankers who buy Treasury securities, place them in trust at a bank, and sell separate receipts against the principal and interest payments. Like most zeroes, interest must be accreted and taxed annually even though it is not received until maturity.
In a rising interest-rate environment which of the following risks associated with mortgage-backed securities such as a collateralized mortgage obligation (CMO) is of least consequence to a potential investor? A) Interest rate risk B) Extension risk C) Prepayment risk D) Credit risk
C. Prepayment risk is the risk that mortgage holders will refinance or repay their mortgages early as a result of falling interest rates. Therefore in a rising interest rate environment it would be less of a concern for a CMO investor. Extension risk is the risk that mortgage payments will be missed or slower than anticipated in a faltering economic environment. Credit and interest rate risks are always of concern with CMOs.
From first to last, in what order would claimants receive payment in the event of bankruptcy? I.Holders of secured debt. II.Holders of subordinated debentures. III.General creditors. IV.Preferred stockholders. A) IV, I, II, III. B) I, II, III, IV. C) I, III, II, IV. D) III, I, II, IV
C. 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.
If an investor keeps $100,000 invested in U.S. Treasury bills at all times during a 10-year period, he is subject to which of the following? I.Stable principal. II.Unstable principal. III.Stable interest. IV.Unstable interest. A) II and IV. B) I and III. C) I and IV. D) II and III.
C. Treasury bills are purchased at a discount and mature at face value. This feature provides principal stability to investors who own them. The discount on bills is determined by current market interest rates and fluctuates accordingly.
Which of the following statements regarding Treasury receipts are TRUE? I.Interest is paid annually. II.Interest is paid at maturity. III.Interest is taxed annually. IV.Interest is taxed at maturity. A) I and IV B) II and IV C) II and III D) I and III
C. Treasury receipts are zero-coupon bonds issued by broker/dealers. Zero coupon bonds pay all of their interest at maturity. They are issued at a discount and redeemed at par, and the difference represents the interest earned. For zeroes with a maturity of more than one year, the interest (or discount) must be accreted each year-and is taxable that year as income. This is termed imputed interest.
Reggie owns a convertible bond that converts into 20 shares of common stock. The current market value of the bond was 118-½ at the close on Friday, April 1. A 30-day call is announced prior to the opening on Monday, April 4, at a price of 102. The stock is trading at $57.75. What should Reggie do? A) Sell the bond B) Hold the bond to maturity C) Redeem the bond at the call price D) Convert the bond into the stock
D. Reggie will not be allowed to hold the bond to maturity because it is being called. The real question is whether he should sell the bond, allow it to be called, or convert it to the underlying stock. Now that the call has been announced, the market value of the bond will fall to meet the call price. This occurs as a result of declining demand. (Who wants to buy a bond that is about to be called at a lower price?) Thus, redeeming the bond at the call price and selling the bond would both yield the same results: $1,000 × 102% = $1,020. If he converts the bond, he will get the following results: 20 shares × $57.75 = $1,155. Therefore, it makes the best sense to convert the bond.
ABC Corporation has an outstanding 8% convertible bond that is callable at 102. Currently, the bond is trading at 101. The conversion price is $40, and the common stock is currently trading at $39.50. ABC announces a call at 102. To realize the greatest profit, a bondholder should: A) continue to hold the bonds B) sell the bonds at the current market price. C) convert the bonds into common and sell the converted shares. D) tender the bonds.
D. The investor would realize the greatest sales proceeds by tendering the bond to the corporation for 102. Selling the bond at its current market value of 101 is not an attractive option. Converting the bond to common stock would result in 25 shares ($1,000 par converted at $40 = 25 shares) sold at $39.50 per share (39.50 × 25 = $987.50).
Which of the following risk factors would be least important to disclose in recommending CMO securities to public customers? A) Prepayment risk B) Extended payment risk. C) Interest rate risk D) Credit risk.
D. The majority of CMOs offered to the public are backed by mortgages held by government-sponsored corporations: Fannie Mae, Ginnie Mae, Freddie Mac, etc. Credit risk would be a minimal consideration. The other risks are inherent to mortgage-backed securities.
U.S. government securities that are deposited with a trustee against which certificates are sold representing principal payments only on the securities are: I.clipped bonds. II.stripped bonds. III.subject to annual taxation on the per year accreted amount. IV.subject to taxation at maturity. A) I and III. B) II and IV C) I and IV D) II and III
D. U.S. government securities that are deposited with a trustee and against which certificates are sold representing principal payments only on the securities are referred to as Treasury STRIPS. These are zero-coupon bonds issued by the U.S. government and are subject to annual taxation on the per-year accreted amount.
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) the stock's current market price. B) 50 C) higher than $50. 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.
All of the following trade with accrued interest EXCEPT: A) convertible bonds B) jumbo certificates of deposit. C) Treasury bonds. D) zero-coupon bonds.
D. Zero-coupon bonds are issued at a deep discount from face value instead of providing semiannual interest payments. T-bonds, convertible bonds, and CDs all make periodic interest payments; thus the seller receives any accrued interest from the buyer.
If a customer sells a zero-coupon bond before maturity, gain or loss will be the difference between sales proceeds and: A) par value. B) discounted value C) original cost D) accredited value
D. Zero-coupon bonds must be accreted for tax purposes. Each year, the annual accretion is taxable to the holder. In addition, the customer may adjust the cost basis of the zero upward by the amount of the annual accretion.
