US government

When comparing a CMO Planned Amortization Class (PAC) to a CMO Targeted Amortization Class (TAC), all of the following statements are true EXCEPT: Correct answer A. You did not choose this answer. A Both PACs and TACs offer the same degree of protection against extension risk Incorrect answer B. You chose this answer. B PACs differ from TACs in that TACs do not offer protection against a decrease in prepayment speeds Incorrect answer C. You did not choose this answer. C PACs are similar to TACs in that both provide call protection against increasing prepayment speeds Incorrect answer D. You did not choose this answer. D TAC pricing will be more volatile compared to PAC pricing during periods of rising interest rates

The best answer is A. A Targeted Amortization Class (TAC) is a variant of a PAC. A PAC offers protection against both prepayment risk (prepayments go to the Companion class first) and extension risk (later than expected payments are applied to the PAC before payments are made to the Companion class). A TAC bond protects against prepayment risk; but does not offer the same degree of protection against extension risk. A TAC bond is designed to pay a "target" amount of principal each month. If prepayments increase, they are made to the Companion class first. However, if prepayment rates slow, the TAC absorbs the available cash flow, and goes in arrears for the balance. Thus, average life of the TAC is extended until the arrears is paid. Therefore, both PACs and TACs provide "call protection" against prepayments during period of falling interest rates. TACs do not offer the same degree of protection against "extension risk" as do PACs during periods of rising interest rates - hence their prices will be more volatile during such periods.

Price volatility of a CMO issue would most closely parallel that of an equivalent maturity: Correct answer A. You chose this answer A Treasury bond Incorrect answer B. You did not choose this answer. B Mortgage backed pass-through certificate Incorrect answer C. You did not choose this answer. C Treasury STRIP Incorrect answer D. You did not choose this answer. D Collateral trust certificate

The best answer is A. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower.

What risk is unique to holders of mortgage backed pass through securities? Correct answer A. You chose this answer A Prepayment risk Incorrect answer B. You did not choose this answer. B Interest rate risk Incorrect answer C. You did not choose this answer. C Credit risk Incorrect answer D. You did not choose this answer. D Reinvestment risk

The best answer is A. Pass-through certificates are mortgage-backed securities that represent ownership in a pool of underlying mortgages and that pass through the monthly mortgage payments to the certificate holders. If the homeowners prepay their mortgages because interest rates are declining, these are "passed-through" to the holders, who then must reinvest the proceeds at lower current rates. This is "prepayment risk" and is essentially a variation on call risk, but here there are no specified potential call dates in the bond offering. This is a "difficult to quantify" risk and is only associated with pass-through securities. Pass through securities have interest rate risk - if market interest rates rise, their value falls. If the pass-through is not backed by the U.S. Government (only Ginnie Maes are directly government backed), then they have some level of credit risk. Finally, any long-term fixed income security making periodic payments has reinvestment risk. If interest rates are falling over the lifetime of the investment, the periodic payments are reinvested at lower and lower rates - reinvestment risk.

Which of the following are TRUE statements regarding both Treasury Bills and Treasury Receipts? I Both securities are sold at a discount II Both securities are issued by the U.S. Government III Both securities pay interest at maturity IV Both securities are money market instruments A I and III only B II and IV only C I, II, III D I, II, III, IV

The best answer is A. T-Bills mature in 52 weeks or less, while Treasury Receipts are long term bonds stripped of coupons (long term zero coupon obligations). For both, interest is paid at maturity and both trade at a discount until maturity. However, T-Bills are directly issued by the U.S. Government; Treasury Receipts were created and issued by broker-dealers who held the underlying U.S. Government securities in trust and sold off the cash flows as zero-coupon obligations. Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, the market for broker-created T-Receipts evaporated. However, you still must know the basics of these securities for the exam.

Interest income received from a GNMA Pass-Through Certificate is: Correct answer A. You chose this answer A subject to both federal and state income tax Incorrect answer B. You did not choose this answer. B exempt from both federal and state income tax Incorrect answer C. You did not choose this answer. C subject to federal income tax and exempt from state and local tax Incorrect answer D. You did not choose this answer. D exempt from federal income tax and subject to state and local tax

The best answer is A. Unlike Treasury obligations and regular agency debt, where interest income is subject to federal income tax, but is exempt from state and local tax, interest income from mortgage backed securities is subject to both federal and state income tax. This is the law because the interest payments made on the underlying mortgages are deductible to the homeowner making the mortgage payments at both the federal and state level, therefore the recipient of these payments should be taxed at both the federal and state level.

New issues of Treasury Bonds, are issued by the U.S. Government in which form? A Book Entry B Bearer C Registered to Principal Only D Registered to Principal and Interest

The best answer is A. All Treasury debt obligations are issued in book entry form only.

Holders of CMOs receive interest payments: Correct answer A. You chose this answer A monthly Incorrect answer B. You did not choose this answer. B quarterly Incorrect answer C. You did not choose this answer. C semi-annually Incorrect answer D. You did not choose this answer. D yearly

The best answer is A. CMO holders receive monthly payments derived from the underlying mortgage backed pass-through certificates. Thus, interest payments are made monthly.

Which of the following statements regarding collateralized mortgage obligations are TRUE? I Each tranche has a different level of market riskII Each tranche has the same level of market riskIII Each tranche has a different yieldIV Each tranche has the same yield Correct answer A. You chose this answer A I and III Incorrect answer B. You did not choose this answer. B I and IV Incorrect answer C. You did not choose this answer. C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is A. Each tranche of a CMO, in effect, represents a differing expected maturity, hence each tranche has a different level of market risk. Since each tranche represents a differing maturity, the yield on each will differ, as well.

A 5 year 3 1/2% Treasury Note is quoted at 101-4 - 101-8. The note pays interest on Jan 1st. and Jul. 1st. Which of the following statements are TRUE regarding these T-Notes? I Interest accrues on an actual day month; actual day year basisII Interest accrues on a 30 day month / 360 day basisIII The trade will settle in Fed FundsIV The trade will settle in Clearing House Funds Correct answer A. You chose this answer A I and III Incorrect answer B. You did not choose this answer. B I and IV Incorrect answer C. You did not choose this answer. C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is A. Government bond accrued interest is computed on an actual month/actual year basis. Trades settle through the Federal Reserve system in "Fed Funds."

The purchaser of a CMO tranche experiences extension risk during periods when interest rates: Correct answer A. You chose this answer A rise Incorrect answer B. You did not choose this answer. B fall Incorrect answer C. You did not choose this answer. C are stable Incorrect answer D. You did not choose this answer. D are volatile

The best answer is A. If interest rates rise, then homeowners will defer moving at the anticipated rate, since they have a "good" deal with their existing mortgage. Thus, the expected mortgage repayment flows from the underlying pass-through certificates slow down, and the expected maturity of the CMO tranches will lengthen. This is extension risk - the risk that the CMO tranche will have a longer than expected life, during which a lower than market rate of return is earned.

All of the following securities would be used as "collateral" for a collateralized mortgage obligation EXCEPT: Correct answer A. You chose this answer A "Sallie Maes" Incorrect answer B. You did not choose this answer. B "Freddie Macs" Incorrect answer C. You did not choose this answer. C "Ginnie Maes" Incorrect answer D. You did not choose this answer. D "Fannie Maes"

The best answer is A. Only mortgage backed pass-through certificates are used as the backing for CMOs - and Ginnie Mae (Government National Mortgage Assn.), Fannie Mae (Federal National Mortgage Assn.), and Freddie Mac (Federal Home Loan Mortgage Corp.) all issue pass-throughs. Sallie Mae issues debentures, and uses the funds to make a secondary market, buying student loans from originating lenders (Sallie Mae stands for Student Loan Marketing Association).

Which of the following is the most likely purchaser of STRIPS? A Pension fund B Money market fund C Individual seeking current income D Individual wishing to avoid purchasing power risk

The best answer is A. Pension funds and retirement accounts are the large purchasers of STRIPS. These zero-coupon bonds are purchased at a deep discount and are held to maturity to fund future retirement liabilities. There is little credit risk, because the U.S. Treasury is a top credit. There is no current income because they don't pay until maturity. They have a huge amount of purchasing power risk as a long-term zero coupon obligation, but this is not an issue if they are held to maturity. Retirement plan managers like STRIPS because they don't have to worry about reinvestment risk - there are no semi-annual interest payments to reinvest! It is an investment that can be "tucked away" for 20 or 30 years, with no further work or worry on the part of the retirement fund manager.

Which Collateralized Mortgage Obligation tranche has the MOST certain repayment date? Correct answer A. You did not choose this answer. A Planned Amortization Class Incorrect answer B. You did not choose this answer. B Targeted Amortization Class Incorrect answer C. You chose this answer. C Plain Vanilla Tranche Incorrect answer D. You did not choose this answer. D Zero Tranche

The best answer is A. Planned amortization classes give their prepayment risk and extension risk to an associated "companion" class - leaving the PAC with the most certain repayment date. TACs are like a "one-sided" PAC - they protect against prepayment risk, but not against extension risk. Plain vanilla CMO tranches are subject to both risks, while zero-tranches are like "wild cards" - whatever is left over is what you get!

Of the choices offered, which security is least subject to purchasing power risk? Correct answer A. You chose this answer A 3-month Treasury Bill Incorrect answer B. You did not choose this answer. B 10-year Treasury Note Incorrect answer C. You did not choose this answer. C 30-year Treasury Bond Incorrect answer D. You did not choose this answer. D 30-year Treasury STRIP

The best answer is A. Purchasing power risk is the same as inflation risk. If there is inflation, then market interest rates rise. This causes the value of fixed income securities to fall, with longer term and lower coupon issues falling faster. Of the choices offered, the security most susceptible to purchasing power risk is a Treasury STRIP - a zero coupon Treasury security (one that has been "stripped" of its "coupons" - meaning its interest payments). It is the longest term and lowest coupon issue of the choices offered. Of the choices offered, the security that is least susceptible to purchasing power risk is a Treasury Bill - its value can't move much from par if interest rates rise since the fact is that it will be redeemed at par shortly.

Treasury Bills are issued by the U.S. Government in which form? Correct answer A. You chose this answer A Book Entry B. Bearer C Registered to Principal Only D Registered to Principal and Interest

The best answer is A. The U.S. Government issues Treasury Bills in book entry form only. No physical certificates are issued.

Treasury Notes are issued by the U.S. Government in which form? A Book Entry B Bearer C Registered to Principal Only D Registered to Principal and Interest

The best answer is A. The U.S. Government issues Treasury Notes in book entry form.

The smallest denomination available for Treasury Bills is: A $100 B $1,000 C $10,000 D $100,000

The best answer is A. The minimum denomination on a Treasury Bill is $100 maturity amount. The minimum denomination on Treasury Notes and Bonds is also $100 maturity amount. Note that this is different than the typical minimum $1,000 par amount for other debt issues.

If interest rates are rising rapidly, which U.S. Government debt prices would be LEAST volatile? Correct answer A. You chose this answer A Treasury Bills Incorrect answer B. You did not choose this answer. B Treasury Notes Incorrect answer C. You did not choose this answer. C Treasury Bonds Incorrect answer D. You did not choose this answer. D Treasury STRIPS

The best answer is A. The shorter the maturity, the lower the price volatility of a negotiable debt instrument. Of the choices listed, Treasury Bills have the shortest maturity. Treasury STRIPS are a zero-coupon T-Bond issue with a long maturity, and would be the most volatile of all the choices offered.

Treasury Bills: I mature in 1 year or less II mature in over 1 year III are issued by the United States Government IV are issued by United States Government Agencies A I and III B I and IV C II and III D II and IV

The best answer is A. Treasury bills mature in 52 weeks or less and are issued by the U.S. Government.

Treasury bonds: I are issued in minimum $100 denominations II are issued in minimum $10,000 denominations III mature at par IV mature at par plus accrued interest A I and III B I and IV C II and III D II and IV

The best answer is A. Treasury bonds are issued at par in minimum denominations of $100 each, and pay interest semi-annually. At maturity, the bondholder receives par.

Which security is considered to have a "risk-free" rate of return? Correct answer A. You did not choose this answer. A Treasury Bill Incorrect answer B. You did not choose this answer. B Treasury Note Incorrect answer C. You did not choose this answer. C Treasury Bond Incorrect answer D. You chose this answer. D Treasury STRIP

The best answer is A. Treasury securities are the safest investment - they have virtually no credit risk (default risk) and almost no marketability risk. They do have purchasing power risk (the risk of inflation eroding real returns), but this is only an issue for long-term maturities. Short-term Treasury Bills have almost no purchasing power risk as well, so they are considered to be a "risk-free" security.

Which of the following statements are TRUE regarding CMO "Planned Amortization Classes" (PAC tranches)? I PAC tranches reduce prepayment risk to holders of that trancheII PAC tranches increase prepayment risk to holders of that trancheIII Principal repayments made earlier than expected are applied to the PAC prior to being applied to the Companion trancheIV Principal repayments made later than expected are applied to the PAC prior to being applied to the Companion tranche Incorrect answer A. You did not choose this answer. A I and III Correct answer B. You chose this answer B I and IV Incorrect answer C. You did not choose this answer. C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is B. "Plain vanilla" CMOs are relatively simple - as payments are received from the underlying mortgages, interest is paid pro-rata to all tranches; but principal repayments are paid sequentially to the first, then second, then third tranche, etc. Thus, the earlier tranches are retired first. A newer version of a CMO has a more sophisticated scheme for allocating cash flows. Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a "Planned Amortization Class." Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments made earlier than that required to retire the PAC at its maturity are applied to the Companion class; while principal repayments made later than expected are applied to the PAC maturity before payments are made to the Companion class. Thus, the PAC class is given a more certain maturity date; while the Companion class has a higher level of prepayment risk if interest rates fall; and a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.

Which statement is TRUE about IO tranches? Incorrect answer A. You did not choose this answer. A When interest rates rise, the price of the tranche falls Correct answer B. You chose this answer B When interest rates rise, the price of the tranche rises Incorrect answer C. You did not choose this answer. C When interest rates rise, the interest rate on the tranche falls Incorrect answer D. You did not choose this answer. D When interest rates rise, the interest rate on the tranche rises

The best answer is B. An IO is an Interest Only tranche. This is a tranche that only receives the interest payments from an underlying mortgage, and it is created with a corresponding PO (Principal Only) tranche that only receives the principal payments from that mortgage. The interest portion of a fixed rate mortgage makes larger payments in the early years, and smaller payments in the later years. These are issued at a discount to face and each interest payment made brings the "notional principal" of the bond closer to par. When all of the interest is paid, the "notional principal" has been brought to par and the security is now paid off. The price movements of IOs are counterintuitive! Unlike regular bonds, where when interest rates rise, prices fall, with an IO, when interest rates rise, prices rise! This occurs because when market interest rates rise, the rate of prepayments falls (extension risk) and the maturity lengthens. Because interest will now be paid for a longer than expected period, the price rises. Conversely, when interest rates fall (prepayment risk) the principal is being paid back at an earlier than expected date, so less interest is being received and the price falls (if interest rates fall drastically, the holder might get less interest back than what was originally invested).

A customer buys a $1,000 par 2 1/2% Treasury Note, maturing July 1, 2020, at 104-16 on Monday, February 3rd in a regular way trade. The bond pays interest on January 1st and July 1st. How many days of accrued interest are due? Incorrect answer A. You did not choose this answer. A 33 Correct answer B. You chose this answer B 34 Incorrect answer C. You did not choose this answer. C 39 Incorrect answer D. You did not choose this answer. D 40

The best answer is B. Interest on U.S. Government bonds accrues on an actual day month / actual day year basis. Interest accrues up to but not including settlement. Settlement on U.S. Governments is next business day. Since the last interest payment date covered the period up to January 1st and the bond was purchased on February 3rd, the buyer must pay the seller: January:31 daysFebruary:3 days (settlement takes place on the 4th of February) 34 days

A mortgage backed security that is backed by an underlying pool of 30 year mortgages has an expected life of 10 years. The fact that repayment is expected earlier than the life of the mortgages is based on the mortgage pool's: Incorrect answer A. You did not choose this answer. A standard deviation of returns Correct answer B. You chose this answer B prepayment speed assumption Incorrect answer C. You did not choose this answer. C Macaulay duration Incorrect answer D. You did not choose this answer. D loan to value ratio

The best answer is B. Mortgage backed pass-through certificates are "paid off" in a shorter time frame than the full life of the underlying mortgages. For example, 30 year mortgages are now typically paid off in 10 years - because people move. This "prepayment speed assumption" is used to "guesstimate" the expected life of a mortgage backed pass-through certificate. Note, however, that the "PSA" can change over time. If interest rates fall rapidly after the mortgage is issued, prepayment rates speed up; if they rise rapidly after issuance, prepayment rates fall. Duration is a measure of bond price volatility. Standard deviation is a measure of the "risk" based on the expected variation of return on investment. The loan to value ratio is a mortgage risk measure.

Private CMOs are: Incorrect answer A. You did not choose this answer. A rated AAA because the underlying mortgages are government backed Correct answer B. You chose this answer B assigned credit ratings by independent credit agencies based on their structure, issuer, and collateral Incorrect answer C. You did not choose this answer. C not rated by independent credit agencies because they are private placements that cannot be traded in the market Incorrect answer D. You did not choose this answer. D not rated by independent credit agencies because of the uncertainty surrounding the quality of the mortgage loans collateralizing the issue

The best answer is B. Private CMOs (Collateralized Mortgage Obligations) are also called "private label" CMOs. They are created by bank issuers, using a mix of mortgage-backed securities as collateral. The "mix" includes both mortgage-backed securities issued by agencies (Fannie, Freddie, Ginnie) and "private label" mortgages - meaning mortgages that do not qualify for sale to these agencies (either because the dollar amount of the mortgage is above their purchase limit or they do not meet Fannie, Freddie or Ginnie's underwriting standards). If the bank issuer wants to offer a CMO with a higher yield, it will increase the proportion of "private label" mortgages included in the CMO. Of course, along with a higher yield comes higher risk. Whereas CMOs backed solely by Fannie, Freddie or Ginnie mortgage-backed securities are rated AAA, the rating of "private label" CMOs is dependent on the credit quality of the underlying mortgages.

Which investment does NOT have purchasing power risk? A STRIPS B TIPS C Treasury Bonds D Treasury Receipts

The best answer is B. Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher total payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. STRIPS are zero-coupon Treasury obligations - these have the highest level of purchasing power risk. If there is inflation, market interest rates are forced upwards, and zero-coupon bonds such as STRIPS fall dramatically in price (Treasury Receipts are broker-created zero-coupon bonds). Long term T-Bonds are also susceptible to purchasing power risk, though not as badly as long-term zero-coupon bonds. The bonds that have the lowest purchasing power risk are short term money market instruments and TIPS.

What type of bond offers a "pure" interest rate? Incorrect answer A. You did not choose this answer. A Zero coupon bond Correct answer B. You chose this answer B U.S. Government bond Incorrect answer C. You did not choose this answer. C Municipal bond Incorrect answer D. You did not choose this answer. D AAA rated bond

The best answer is B. The "pure" interest rate is a theoretical interest rate that will be paid when there is no marketability risk and no credit risk. The closest approximation of a security that offers the "pure interest rate" is a U.S. Government obligation. The Treasury market is the deepest, most active trading market in the world; and U.S. Government securities are considered to be free of credit risk. Also note that a "better" answer that is not given in the question is a T-Bill. This security is considered to be free of credit risk; free of market risk; and is also free of interest rate risk. But you must select the "best" of the choices offered!

All of the following investments give a rate of return that cannot be affected by "reinvestment risk" EXCEPT: Incorrect answer A. You did not choose this answer. A Treasury Bill Correct answer B. You chose this answer B Treasury Bond Incorrect answer C. You did not choose this answer. C Treasury Strips Incorrect answer D. You did not choose this answer. D Treasury Receipts

The best answer is B. Treasury "STRIPS" and Treasury Receipts are bonds which have been stripped of coupons - essentially they are zero coupon Treasury obligations. The rate of return on the bonds is "locked in" at purchase since the discount represents the compounded yield to be earned over the life of the bond. Because no interest payments are received, the bond is not subject to reinvestment risk - the risk that interest rates will drop and the interest payments will be reinvested at lower rates. Conventional Treasury Bonds are subject to this risk, since interest payments are received semi-annually. Treasury Bills are not subject to reinvestment risk because they are essentially short term "zero-coupon" obligations.

When comparing the effect of changing interest rates on prices of a CMO issues versus the prices of regular bond issues, which of the following statements are TRUE? I When interest rates rise, mortgage backed pass through certificates fall in price faster than regular bonds of the same maturityII When interest rates rise, mortgage backed pass through certificates fall in price slower than regular bonds of the same maturityIII When interest rates fall, mortgage backed pass through certificates rise in price faster than regular bonds of the same maturityIV When interest rates fall, mortgage backed pass through certificates rise in price slower than regular bonds of the same maturity Incorrect answer A. You chose this answer. A I and III Correct answer B. You did not choose this answer. B I and IV Incorrect answer C. You did not choose this answer. C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is B. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the expected life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the expected maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the expected life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the expected maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower.

Sallie Mae debentures are backed by: Incorrect answer A. You did not choose this answer. A the full faith and credit of the U.S. Government Correct answer B. You did not choose this answer. B the full faith and credit of the Student Loan Marketing Association Incorrect answer C. You did not choose this answer. C designated pooled mortgages Incorrect answer D. You chose this answer. D designated pooled student college loans

The best answer is B. "Sallie Mae" is the Student Loan Marketing Association. Sallie Mae raises money to lend to college students. It does this primarily by issuing debentures to the public. These debentures are backed by the faith and credit of this agency. Sallie Mae is another agency that is "privatized." Sallie Mae stock is listed and trades on NASDAQ.

Collateralized mortgage obligation issues have: Incorrect answer A. You did not choose this answer. A termstructures Correct answer B. You chose this answer B serialstructures Incorrect answer C. You did not choose this answer. C seriesstructures Incorrect answer D. You did not choose this answer. D combined serial and series structures

The best answer is B. A CMO divides the cash flow from a pool of underlying mortgages into a number of tranches, each with a different maturity. All of the tranches are issued on the same date; but the maturities extend over a sequence of years. This is a serial structure.

Which statements are TRUE about CMO Targeted Amortization Class (TAC) tranches? I TAC tranches protect against prepayment risk II TAC tranches do not protect against prepayment risk III TAC tranches protect against extension risk IV TAC tranches do not protect against extension risk Incorrect answer A. You did not choose this answer. A I and III Correct answer B. You chose this answer B I and IV Incorrect answer C. You did not choose this answer. C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is B. A Targeted Amortization Class (TAC) is a variant of a PAC. A PAC offers protection against both prepayment risk (prepayments go to the Companion class first) and extension risk (later than expected payments are applied to the PAC before payments are made to the Companion class). A TAC bond protects against prepayment risk; but does not offer the same degree of protection against extension risk. A TAC bond is designed to pay a "target" amount of principal each month. If prepayments increase, they are made to the Companion class first. However, if prepayment rates slow, the TAC absorbs the available cash flow, and goes in arrears for the balance. Thus, average life of the TAC is extended until the arrears is paid

Which CMO tranche is LEAST susceptible to interest rate risk? Incorrect answer A. You did not choose this answer. A Z-tranche Correct answer B. You chose this answer B Floating rate tranche Incorrect answer C. You did not choose this answer. C PAC tranche Incorrect answer D. You did not choose this answer. D TAC tranche

The best answer is B. A floating rate CMO tranche has an interest rate that varies, tied to the movements of a recognized interest rate index, like LIBOR. Therefore, as interest rates move up, the interest rate paid on the tranche goes up as well; and when interest rates drop, the interest rate paid on the tranche goes down as well. There is usually a cap on how high the rate can go and a floor on how low the rate can drop. Because the interest rate moves with the market, the price stays close to par - as is the case with any variable rate security.

Which of the following agencies may issue securities? I FHLMC II FHLB III TVA IV FRB Incorrect answer A. You did not choose this answer. A II, III, IV Correct answer B. You did not choose this answer. B I, II, III Incorrect answer C. You chose this answer. C I, II, IV Incorrect answer D. You did not choose this answer. D I, III, IV

The best answer is B. FHLMC (Federal Home Loan Mortgage Corporation), FHLB (Federal Home Loan Bank), and TVA (Tennessee Valley Authority) all issue debt securities. The FRB - Federal Reserve Bank does not issue bonds.

Which of the following statements are TRUE about the Federal National Mortgage Association (FNMA)? I FNMA is a publicly traded corporation II FNMA is owned by the U.S. Government III FNMA pass through certificates are guaranteed by the U.S. Government IV FNMA pass through certificates are not guaranteed by the U.S. Government A I and III B I and IV . C II and III D II and IV

The best answer is B. Fannie Mae performs the same functions as Ginnie Mae except that its pass through certificates are not guaranteed by the U.S. Government; and it has been "sold off" as a public company. Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets.

All of the following statements are true regarding GNMA "Pass Through" Certificates EXCEPT: Incorrect answer A. You did not choose this answer. A the certificates are quoted on a percentage of par basis in 32nds Correct answer B. You chose this answer B the certificates are available in $1,000 minimum denominations Incorrect answer C. You did not choose this answer. C certificates trade "and interest" Incorrect answer D. You did not choose this answer. D accrued interest on the certificates is computed on a 30 day month/360 day year basis

The best answer is B. GNMA certificates are quoted on a percentage of par basis in 32nds, with the minimum denomination of a certificate being $25,000. Unlike Governments on which interest accrues on an actual day month / actual day year basis, accrued interest on "agency" securities is computed on a 30 day month / 360 day year basis. All debt instruments that make periodic interest payments trade "and interest," meaning they trade with accrued interest.

Regarding Ginnie Mae Pass Through Certificates: I The certificates pay holders on a monthly basisII The certificates pay holders on a semi-annual basisIII Each payment consists of interest onlyIV Each payment consists of a combination of interest and principal A I and III B I and IV C II and III D II and IV

The best answer is B. Ginnie Mae Pass Through Certificates "pass through" monthly mortgage payments to the certificate holders. Each payment is a combination of both interest and principal paid from the underlying mortgage pool.

The "modification" of Ginnie Mae modified pass through certificates is: Incorrect answer A. You chose this answer. A the pooling of mortgages of similar maturities to back the security Correct answer B. You did not choose this answer. B the guarantee of the U.S. Government Incorrect answer C. You did not choose this answer. C guarantee of the financial institution from which the mortgages were purchased Incorrect answer D. You did not choose this answer. D the setting of a fixed interest rate for the pool of mortgages backing the security

The best answer is B. Ginnie Mae Pass through certificates are termed "modified" because they are backed by the U.S. Government as well as the agency. Fannie Mae and Freddie Mac offer pass through certificates that are not modified because there is no government guarantee.

Which of the following are direct obligations of the U.S. Government? Incorrect answer A. You did not choose this answer. A Treasury Receipts Correct answer B. You chose this answer B Ginnie Maes Incorrect answer C. You did not choose this answer. C Government Bond Mutual Funds Incorrect answer D. You did not choose this answer. D Fannie Maes

The best answer is B. Ginnie Maes (Government National Mortgage Association issues) are directly backed by the faith and credit of the U.S. Government, since Uncle Sam owns the agency. Fannie Maes (Federal National Mortgage Association issues) are implicitly backed by the Federal Government - Fannie Mae is a publicly held government sponsored corporation listed on the NYSE. Treasury receipts are issued by broker-dealers. The receipts are not backed by the U.S. Government - however the government securities in the underlying portfolio that back the receipt are government guaranteed. Government bond fund shares or units are also not backed by the U.S. Government. However, the securities in the underlying portfolio are government guaranteed.

Yields on 3 month Treasury bills have declined to 1.84% from 2.21% at the prior week's Treasury auction. This indicates that: Incorrect answer A. You did not choose this answer. A Treasury bill prices are falling Correct answer B. You chose this answer B market interest rates are falling Incorrect answer C. You did not choose this answer. C demand for Treasury bills is weakening Incorrect answer D. You did not choose this answer. D the Federal Reserve may have to loosen credit

The best answer is B. If Treasury bill yields are dropping at auction, then interest rates are falling and debt prices must be rising.

Which statements are TRUE regarding the principal repayments for Companion CMO tranches? I Principal repayments made earlier than expected are applied to the Companion class prior to being applied to the Planned Amortization classII Principal repayments made earlier than expected are applied to the Planned Amortization class prior to being applied to the Companion classIII Principal repayments made later than expected are applied to the Companion class prior to being applied to the Planned Amortization classIV Principal repayments made later than expected are applied to the Planned Amortization class prior to being applied to the Companion class Incorrect answer A. You did not choose this answer. A I and III Correct answer B. You did not choose this answer. B I and IV Incorrect answer C. You did not choose this answer. C II and III Incorrect answer D. You chose this answer. D II and IV

The best answer is B. Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a "Planned Amortization Class." Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments made earlier than that required to retire the PAC at its maturity are applied to the Companion class; while principal repayments made later than expected are applied to the PAC maturity before payments are made to the Companion class. Thus, the PAC class is given a more certain maturity date; while the Companion class has a higher level of prepayment risk if interest rates fall; and a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.

When compared to plain vanilla CMO tranches, Planned Amortization Classes have: Incorrect answer A. You did not choose this answer. A higherprepayment risk Correct answer B. You chose this answer B lower prepayment risk Incorrect answer C. You did not choose this answer. C the same level of prepayment risk Incorrect answer D. You did not choose this answer. D no prepayment risk

The best answer is B. Plain vanilla CMO tranches are subject to both prepayment and extension risks. PACs protect against prepayment risk, by shifting this risk to an associated Companion tranche. Thus, PACs have lower prepayment risk than plain vanilla CMO tranches.

All of the following agencies may issue securities EXCEPT: Incorrect answer A. You did not choose this answer. A TVA Correct answer B. You chose this answer B FRB Incorrect answer C. You did not choose this answer. C FHLMC Incorrect answer D. You did not choose this answer. D FHLB

The best answer is B. The FRB - Federal Reserve Bank does not issue bonds. It is the nation's central bank. TVA (Tennessee Valley Authority). FHLMC (Federal Home Loan Mortgage Corporation), and FHLB (Federal Home Loan Bank) all issue debt securities.

Treasury Bills, Bonds, and Notes Date Rate Bid Ask Yield Jan 21 3 5/8 98 -27 98 -31 3.67 Feb 21 3 1/2 94 -14 95 3.68 Feb 25 3 7/8 95 -01 95 -06 4.07 Feb 27 4 3/4 119 -07 119 -13 3.98 The Feb 27 4 3/4% bonds are trading at: Incorrect answer A. You did not choose this answer. A a discount Correct answer B. You chose this answer B a premium Incorrect answer C. You did not choose this answer. C par Incorrect answer D. You did not choose this answer. D a price that cannot be determined

The best answer is B. The Feb 27 - 4 3/4% bonds have a bid and ask which is higher than par, so the bonds are trading at a premium. Thus, interest rates must have declined after bond issuance.

Which of the following designates "primary" U.S. Government securities dealers? Incorrect answer A. You did not choose this answer. A Securities and Exchange Commission Correct answer B. You chose this answer B Federal Reserve Incorrect answer C. You did not choose this answer. C Office of the Comptroller of Currency Incorrect answer D. You did not choose this answer. D Congress

The best answer is B. The Federal Reserve designates a dealer as a "primary" dealer - meaning one entitled to trade with the Federal Reserve trading desk. There are about 20 primary dealers (such as Cantor Fitzgerald, Nomura Securities, Citibank, Goldman Sachs, Royal Bank of Scotland, etc.) The rest of the government dealers are termed "secondary" dealers. They do not enjoy a special relationship with the Federal Reserve.

The nominal interest rate on a TIPS is: A the same as the rate on an equivalent maturity Treasury Bond B less than the rate on an equivalent maturity Treasury Bond . C more than the rate on an equivalent maturity Treasury Bond D unrelated to the rate on an equivalent maturity Treasury Bond

The best answer is B. The interest rate placed on a TIPS (Treasury Inflation Protection Security) is less than the rate on an equivalent maturity Treasury Bond. For example, a 30 year Treasury Bond might have a coupon rate of 4%; but a 30 year TIPS has a coupon rate of 2.75%. The "difference" between the two is the current market expectation for the inflation rate (1.25% in this example). The reason why the TIPS sells at a lower coupon rate is that, every year, the principal amount is adjusted upwards by that year's inflation rate. So there are really 2 components of return on a TIPS - the lower coupon rate plus the principal adjustment equal to that year's inflation rate.

A security which gives the holder an undivided interest in a pool of mortgages is known as a: Incorrect answer A. You did not choose this answer. A unit investment trust Correct answer B. You chose this answer B pass through certificate Incorrect answer C. You did not choose this answer. C first mortgage bond Incorrect answer D. You did not choose this answer. D face amount certificate

The best answer is B. The question defines a pass through certificate - an undivided interest in a pool of mortgages, where the mortgage payments are passed through to the certificate holders.

A 5 year 3 1/2% Treasury Note is quoted at 101-4 - 101-8. The note pays interest on Jan 1st and Jul 1st. If a customer buys 5 T-Notes on Friday, April 4th, when does the settlement occur? Incorrect answer A. You did not choose this answer. A Friday, April 4th Correct answer B. You chose this answer B Monday, April 7th Incorrect answer C. You did not choose this answer. C Tuesday, April 8th Incorrect answer D. You did not choose this answer. D Wednesday, April 9th

The best answer is B. Trades of U.S. Government and agency securities settle "regular way" on the next business day. Trades of corporate and municipal securities settle "regular way" 2 business days after trade date.

Which statements are TRUE regarding Treasury Inflation Protection securities? I In periods of deflation, the amount of each interest payment will decline II In periods of deflation, the amount of each interest payment is unchanged III In periods of deflation, the principal amount received at maturity will decline below par IV In periods of deflation, the principal amount received at maturity is unchanged at par A I and III . B I and IV C II and III . D II and IV

The best answer is B. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. In periods of deflation, the principal amount is adjusted downwards. Even though the interest rate is fixed, the holder receives a lower interest payment, due to the decreased principal amount. In this case, when the bond matures, the holder receives par - not the decreased principal amount.

Which characteristic is NOT common to both Treasury STRIPS and Treasury Bills? A Minimum $100 denominations B Quoted as a percent of par in 32nds . C Pay interest at maturity . D Guaranteed by the U.S. Government

The best answer is B. Treasury Bills and STRIPS have a minimum $100 par value; are zero coupon original issue discount obligations that do not have a stated interest rate, paying interest at maturity; and are directly backed by the U.S. Government. T-STRIPS are quoted in 32nds, as are all other long term Treasuries and Agency securities. T-Bills are quoted on a discount yield basis since they are a short term money market instrument.

A customer buys 5M of 3 1/2% Treasury Bonds at 101-16. How much will the customer receive at each interest payment? Incorrect answer A. You did not choose this answer. A $17.50 Incorrect answer B. You did not choose this answer. B $35.00 Correct answer C. You chose this answer C $87.50 Incorrect answer D. You did not choose this answer. D $175.00

The best answer is C. "5M" means that 5-$1,000 bonds are being purchased (M is Latin for $1,000). Annual interest on the bonds is 3.5% of $5,000 face amount equals $175.00. Since interest is paid semi-annually, each payment will be for $87.50. Notice that the fact that the bond is trading at a premium is irrelevant - the interest payment is based on the stated interest rate times par value.

Which statements are TRUE about PO tranches? I Payments are larger in the early years II Payments are smaller in the early years III Payments are larger in the later years IV Payments are smaller in the later years Incorrect answer A. You did not choose this answer. A I and III Incorrect answer B. You did not choose this answer. B I and IV Correct answer C. You chose this answer C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is C. A PO is a Principal Only tranche. This is a tranche that only receives the principal payments from an underlying mortgage, and it is created with a corresponding IO (Interest Only) tranche that only receives the interest payments from that mortgage. The principal portion of a fixed rate mortgage makes smaller payments in the early years, and larger payments in the later years. Because of this payment structure, it is most similar to a long-term bond, which pays principal at the end of its life. These are issued at a deep discount to face. Its price moves just like a conventional long term deep discount bond. When market interest rates rise, the rate of prepayments falls (extension risk) and the maturity lenghtens. Because the principal is being paid back at a later date, the price falls. Conversely, when market interest rates fall, the rate of prepayments rises (prepayment risk) and the maturity shortens. Because the principal is being paid back at an earlier date, the price rises.

Which of the following statements describe Freddie Mac? I Freddie Mac buys conventional mortgages from financial institutions II Freddie Mac is an issuer of mortgage backed pass-through certificates III Freddie Mac is a corporation that is publicly traded IV Freddie Mac debt issues are directly guaranteed by the U.S. Government Incorrect answer A. You did not choose this answer. A I and II only Incorrect answer B. You did not choose this answer. B III and IV only Correct answer C. You chose this answer C I, II, III Incorrect answer D. You did not choose this answer. D I, II, III, IV

The best answer is C. Freddie Mac - Federal Home Loan Mortgage Corporation - buys conventional mortgages from financial institutions and packages them into pass through certificates. This agency has been partially sold off to the public as a corporation that was listed on the NYSE. Freddie is now bankrupt due to excessive purchases of bad "sub prime" mortgages and has been placed in government conservatorship. Its shares have been delisted from the NYSE and now trade OTC in the Pink OTC Markets. Freddie Mac buys conventional mortgages from financial institutions and packages them into pass through certificates. These pass through certificates are not guaranteed by the U.S. Government (unlike GNMA pass through certificates).

Which of the following agencies issuing mortgage backed pass through certificates is (are) restricted to purchasing conventional mortgages that are not VA or FHA insured? I Fannie Mae II Ginnie Mae III Freddie Mac Incorrect answer A. You did not choose this answer. A I only Incorrect answer B. You chose this answer. B II only Correct answer C. You did not choose this answer. C III only Incorrect answer D. You did not choose this answer. D I, II, III

The best answer is C. Freddie Mac - Federal Home Loan Mortgage Corporation - buys conventional mortgages from financial institutions and packages them into pass through certificates. This agency was partially sold off to the public as a corporation that was listed on the NYSE. Fannie Mae (Federal National Mortgage Association) buys FHA and VA insured mortgages from financial institutions and packages them into pass through certificates. This agency was sold off to the public as a corporation that was listed on the NYSE. Both Fannie and Freddie are now bankrupt due to excessive purchases of bad "sub prime" mortgages and have been placed in government conservatorship. Their shares have been delisted from the NYSE and now trade OTC in the Pink OTC Markets. Ginnie Mae (Government National Mortgage Association) performs the same function as Fannie Mae except that its pass through certificates are guaranteed by the U.S. Government. It remains an agency of the government and cannot be "sold off" as a public company as long as the government continues to guarantee its securities.

Which statements are TRUE when comparing Companion CMO tranches to "plain vanilla" CMO tranches? I Holders of Companion CMO tranches have lower prepayment riskII Holders of Companion CMO tranches have higher prepayment riskIII Holders of "plain vanilla" CMO tranches have lower prepayment riskIV Holders of "plain vanilla" CMO tranches have higher prepayment risk Incorrect answer A. You did not choose this answer. A I and III Incorrect answer B. You did not choose this answer. B I and IV Correct answer C. You chose this answer C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is C. Older CMOs are known as "plain vanilla" CMOs, because the repayment scheme is relatively simple - as payments are received from the underlying mortgages, interest is paid pro-rata to all tranches; but principal repayments are paid sequentially to the first, then second, then third tranche, etc. Thus, the earlier tranches are retired first. A newer version of a CMO has a more sophisticated scheme for allocating cash flows. Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a "Planned Amortization Class." Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments made earlier than that required to retire the PAC at its maturity are applied to the Companion class; while principal repayments made later than expected are applied to the PAC maturity before payments are made to the Companion class. Thus, the PAC class is given a more certain maturity date; while the Companion class has a higher level of prepayment risk if interest rates fall; and a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.

All of the following are true statements regarding both Treasury Bills and Treasury Receipts EXCEPT: A interest is paid at maturity . B the securities are sold at a discount C the maturity is 1 year or less . D payment of interest and principal on the underlying security is guaranteed by the U.S. Government

The best answer is C. T-Bills mature in 52 weeks or less, while Treasury Receipts are long term bonds stripped of coupons (long term zero coupon obligations). Both are guaranteed by the U.S. Government; interest is paid at maturity; and both trade at a discount until maturity. Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, the market for broker-created T-Receipts evaporated. However, you still must know the basics of these securities for the exam.

A 30 year $1,000 par 4 3/4% Treasury Bond is quoted at 95-11 - 95-15. The note pays interest on Jan 1st and Jul 1st. A customer buys 1 bond at the ask price. What is the current yield, disregarding commissions? Incorrect answer A. You did not choose this answer. A 4.68% Incorrect answer B. You did not choose this answer. B 4.75% Correct answer C. You did not choose this answer. C 4.98% Incorrect answer D. You chose this answer. D 5.12%

The best answer is C. The bond is purchased at 95 and 15/32nds = 95.46875% of $1,000 = $954.6875. The formula for current yield is: $47.50 $954.6875 = 4.98%

Interest income received from a GNMA Pass-Through Certificate is: Incorrect answer A. You did not choose this answer. A taxed the same as for Treasury obligations Incorrect answer B. You chose this answer. B taxed the same as for Municipal obligations Correct answer C. You did not choose this answer. C taxed the same as for corporate obligations Incorrect answer D. You did not choose this answer. D exempt from all taxes

The best answer is C. Unlike Treasury obligations and regular agency debt, where interest income is subject to federal income tax, but is exempt from state and local tax, interest income from mortgage backed securities is subject to both federal and state income tax. This is the law because the interest payments made on the underlying mortgages are deductible to the homeowner making the mortgage payments at both the federal and state level, therefore the recipient of these payments should be taxed at both the federal and state level. Note that interest income from corporate bonds is also taxable at both the federal and state level, so interest income from mortgage backed pass through securities is taxed in the same manner.

A customer buys 5M of 6 1/4% Treasury Bonds at 100. How much interest income will the customer receive at each interest payment? Incorrect answer A. You did not choose this answer. A $31.25 Incorrect answer B. You chose this answer. B $62.50 Correct answer C. You did not choose this answer. C $156.25 Incorrect answer D. You did not choose this answer. D $312.50

The best answer is C. "5M" means that 5-$1,000 bonds are being purchased (M is Latin for $1,000). Annual interest on the bonds is 6.25% of $5,000 face amount equals $312.50. Since interest is paid twice per year, each payment will be for $156.25.

All of the following would be considered examples of derivative products EXCEPT: Incorrect answer A. You did not choose this answer. A PAC tranche Incorrect answer B. You did not choose this answer. B TAC tranche Correct answer C. You chose this answer C Treasury STRIP Incorrect answer D. You did not choose this answer. D Companion tranche

The best answer is C. A "derivative" product is one whose value is "derived" via a "formula" from an underlying investment. Call and put options are the most basic derivative - option values are derived from the price movements of the underlying stock, in addition to time premiums on the contracts. Collateralized mortgage obligation values are derived from the underlying mortgage backed pass-through certificates held in trust by recutting the cash flows and applying them to the CMO tranches. Again, these are derived via a formula. Treasury STRIPS are not a derivative, because the value of the coupons "stripped" from the Treasury bonds is a direct correlation to the interest payments received from the underlying U.S. Government securities.

All of the following statements are true about "plain vanilla" CMO tranches EXCEPT: Incorrect answer A. You did not choose this answer. A each tranche has a different maturity Incorrect answer B. You chose this answer. B each tranche has a different yield Correct answer C. You did not choose this answer. C each tranche has a different credit rating Incorrect answer D. You did not choose this answer. D each tranche has a different level ofinterest rate risk

The best answer is C. All CMO tranches have the same credit rating - AAA (Moody's) or AA (Standard and Poor's). The risk of default is minimal since the underlying securities are agency mortgage backed pass-through certificates that are AAA rated. Each tranche within a CMO has a different maturity and yield. Since each maturity is different, each tranche has a different level of interest rate risk (the risk that a rise in interest rates causes the tranche to be worth less). Interest rate risk is more severe for longer maturities than for shorter maturities.

Which of the following characteristics of Fannie Mae and Ginnie Mae pass-through certificates are the same? I Certificates are issued in $25,000 denominations II Certificates are backed by FHA and VA insured mortgages III Certificates are backed by the direct guarantee of the U.S. Government IV Certificate holders receive monthly payments of combined interest and principal A I and III only B II and IV only C I, II, IV . D I, II, III, IV

The best answer is C. Both Ginnie Mae and Fannie Mae pass-through certificates are issued in $25,000 denominations; are backed by VA and FHA insured mortgages; and pay monthly. However, only GNMA certificates have the direct guarantee of the U.S. Government. FNMA certificates are not directly backed by the U.S. Government.

Which statement is FALSE about CMBs? Incorrect answer A. You did not choose this answer. A CMBs are used to smooth out cash flow B CMBs are sold at a discount to par C CMBs are sold at a slightly lower yield than T-Bills D CMBs are direct obligations of the U.S. government

The best answer is C. CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. Because they are sold on an irregular basis, they sell at slightly higher yields than equivalent maturity T-Bills. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.

When comparing CMOs to their underlying pass-through certificates, which of the following statements are TRUE? I CMOs receive a higher credit rating than the underlying mortgage backed pass-through certificate II CMOs receive the same credit rating as the underlying mortgage backed pass-through certificate III CMOs are subject to a lower degree of prepayment risk than the underlying pass-through certificate IV CMOs are subject to the same degree of prepayment risk as the underlying pass-through certificate Incorrect answer A. You did not choose this answer. A I and III Incorrect answer B. You chose this answer. B I and IV Correct answer C. You did not choose this answer. C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is C. CMOs receive the same credit rating (AAA or AA) as the underlying mortgage backed pass-through certificates held in trust. CMOs are subject to a lower degree of prepayment risk than the underlying pass-through certificates. During periods of falling interest rates, prepayments of mortgages in a pool are applied pro-rata to all holders of pass-through certificates. CMOs divide the cash flows into "tranches" of varying maturities; and apply prepayments sequentially to the tranches in order of maturity. Thus, prepayments are applied to earlier tranches first, so the actual date of repayment of the tranche is known with more certainty.

When comparing a PAC tranch to a TAC tranche: I TAC tranches have the same level of prepayment riskII TAC tranches have the same level of extension riskIII TAC tranches have a higher level of prepayment riskIV TAC tranches have a higher level of extension risk Incorrect answer A. You did not choose this answer. A I and II Incorrect answer B. You did not choose this answer. B III and IV Correct answer C. You did not choose this answer. C I and IV Incorrect answer D. You chose this answer. D II and III

The best answer is C. Companion classes are "split off" from the Planned Amortization Class (PAC) and act as buffers absorbing prepayment and extension risk prior to this risk being applied to the PAC tranche. The PAC, which is relieved of these risks, is given the most certain repayment date. The Companion, which absorbs these risks first, has the least certain repayment date. A Targeted Amortization Class (TAC) is like a PAC, but is only buffered for prepayment risk by the Companion; it is not buffered for extension risk. Thus, A TAC has the same level of prepayment risk as the PAC; but the TAC has a higher level of extension risk than the PAC.

Which CMO tranche will be offered at the lowest yield? Incorrect answer A. You did not choose this answer. A Plain vanilla Incorrect answer B. You did not choose this answer. B Targeted amortization class Correct answer C. You chose this answer C Planned amortization class Incorrect answer D. You did not choose this answer. D Companion

The best answer is C. Companion tranches are the "shock absorber" tranches, that absorb prepayment risk out of a TAC (Targeted Amortization Class) tranche; or both prepayment risk and extension risk out of a PAC (Planned Amortization Class) tranche. Because the companion absorbs both of these risks, it has the greatest risk and trades at the highest yield. Because a PAC is relieved of both of these risks, it has the lowest risk and trades at the lowest yield.

Which of the following statements are TRUE about the Government National Mortgage Association (GNMA)? I GNMA is a publicly traded corporation II GNMA is owned by the U.S. Government III GNMA pass through certificates are guaranteed by the U.S. Government IV GNMA pass through certificates are not guaranteed by the U.S. Government r. A I and III . B I and IV C II and III D II and IV

The best answer is C. GNMA performs the same function as Fannie Mae except that its pass through certificates are guaranteed by the U.S. Government; and it remains an agency of the government. It has not been "sold off" as a private company, like Fannie Mae, which, since it is bankrupt and is in government conservatorship, now trades OTC. For as long as the government continues to guarantee Ginnie Mae securities, it cannot be a publicly traded company.

Which statements are TRUE regarding Government National Mortgage Association pass-through certificates? I GNMA securities are insured by the FDICII Dealers typically quote GNMA securities at 50 basis points over equivalent maturity U.S. Government BondsIII Credit risk for GNMAs is the same as for equivalent maturity U.S. Government BondsIV Reinvestment risk for GNMAs is the same as for equivalent maturity U.S. Government Bonds Incorrect answer A. You did not choose this answer. A I and II only Incorrect answer B. You chose this answer. B III and IV only Correct answer C. You did not choose this answer. C II and III only Incorrect answer D. You did not choose this answer. D I, II, III, IV

The best answer is C. GNMA securities are not insured by the Federal Deposit Insurance Corporation (making Choice I incorrect) - they are guaranteed by the U.S. Government (making Choice III correct). Dealers typically quote agency securities, including Ginnie Maes, on a basis point differential to equivalent maturing U.S. Governments. A typical quote is 50 basis points above the yield on the same maturity U.S. Government issue. Please note, that dealers also quote agency securities on a percentage of par basis in 32nds, but this is not given as a choice in the question. Reinvestment risk is greater for Ginnie Maes than for U.S. Government bonds. Ginnie Mae holders receive monthly payments that must be continuously reinvested while T-Bond holders only receive payments every 6 months that must be reinvested. The greater the frequency of receipt of payments that must be reinvested, the greater the reinvestment risk.

A customer wishes to buy a security that provides monthly payments for his retirement. Which of the following is suitable? A Treasury Bonds B Income Bonds C GNMA Pass Through Certificates D Treasury Notes

The best answer is C. Ginnie Mae Pass Through Certificates "pass through" monthly mortgage payments to the certificate holders. Each payment is a combination of interest and principal from the underlying mortgage pool. Treasury Bonds and Notes pay interest semi-annually. Income bonds pay interest only if the corporate issuer has sufficient earnings.

Which statements are TRUE about prepayment experience on collateralized mortgage obligations? I When interest rates rise, prepayment rates riseII When interest rates rise, prepayment rates fallIII When interest rates fall, prepayment rates riseIV When interest rates fall, prepayment rates fall Incorrect answer A. You did not choose this answer. A I and III Incorrect answer B. You did not choose this answer. B I and IV Correct answer C. You chose this answer C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is C. Homeowners will prepay mortgages when interest rates fall, so they can refinance at more attractive lower current rates. They tend not to prepay mortgages when interest rates rise, since there is no benefit to a refinancing. The main reason for prepayments when interest rates have risen is that the homeowner has moved, and the house was sold.

The minimum denomination on a mortgage backed pass through certificate is: Incorrect answer A. You did not choose this answer. A $1,000 Incorrect answer B. You did not choose this answer. B $10,000 Correct answer C. You chose this answer C $25,000 Incorrect answer D. You did not choose this answer. D $100,000

The best answer is C. Mortgage backed pass through certificates are sold in minimum denominations of $25,000 (instead of the typical $1,000 for other bonds and $100 for Treasury issues). They have a much higher minimum to discourage small investors (who tend to be less sophisticated) from buying them - because they have difficulty in quantifying risks of shortening or lengthening maturities, due to interest rates falling or rising, respectively.

Sallie Mae makes a secondary market in: Incorrect answer A. You did not choose this answer. A FHA insured mortgages from banks Incorrect answer B. You did not choose this answer. B VA insured mortgages from banks Correct answer C. You chose this answer C student loans from state agencies Incorrect answer D. You did not choose this answer. D conventional mortgages

The best answer is C. Sallie Mae is the Student Loan Marketing Association. It buys student loans from state agencies and issues bonds to finance this activity.

Which of the following are TRUE statements about Treasury Bills? I T-Bills can be purchased directly at weekly auction II T-Bills trade at a discount from par III T-Bills have a maximum maturity of 2 years IV T-Bills are the most actively traded money market instrument Incorrect answer A. You did not choose this answer. A I and III only B II and IV only C I, II, IV D I, II, III, IV

The best answer is C. T-Bills have a maximum maturity of 1 year, not 2 years. They are sold at a discount from par; are the most widely traded money market instrument since the bulk of the government's financing is through T-Bills; and can be purchased directly at auction by anyone who tenders a non-competitive bid.

Which of the following statements are TRUE regarding the trading of government and agency bonds? I The securities are quoted by dealers in 1/8thsII The securities are quoted by dealers in 1/32ndsIII The trading market for governments and agencies is activeIV The trading market for governments and agencies is inactive Incorrect answer A. You did not choose this answer. A I and III Incorrect answer B. You did not choose this answer. B I and IV Correct answer C. You chose this answer C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is C. The government obligation trading market is the deepest and most active market in the world. Due to the great trading activity, dealers trade the securities at very narrow spreads, quoting them in 32nds (as opposed to corporate securities that are quoted in 1/8ths).

How is the interest income received from U.S. Government obligations taxed? . A Subject to both federal and state income tax . B Exempt from both federal and state income tax C Subject to federal income tax and exempt from state income tax D Exempt from federal income tax and subject to state income tax

The best answer is C. The interest income received from U.S. Government obligations is subject to federal income tax, but is exempt from state and local income taxes (one level of government cannot tax the other's obligations).

A "riskless" security maturing in 52 weeks or less is a: Incorrect answer A. You did not choose this answer. A Money market instrument B Non-callable funded debt C Treasury bill D Treasury note

The best answer is C. The key word is "riskless." Treasury bills mature in 52 weeks or less and are issued by the U.S. Government, the safest issuer available.

The physical securities which are the underlying collateral for Treasury Receipts can be which of the following? I Treasury Bills II Treasury Notes III Treasury Bonds IV Series EE Bonds Incorrect answer A. You did not choose this answer. A I and II only B III and IV only C II and III only D I, II, III, IV

The best answer is C. The physical securities which are held in trust against the issuance of Treasury Receipts are either Treasury Notes or Treasury Bonds. Series EE bonds cannot be used because they are non-marketable. T-Bills cannot be used because their maturity is too short. Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, the market for broker-created T-Receipts evaporated. However, you still must know the basics of these securities for the exam.

A 70-year old customer who is looking for current income has inquired about purchasing a GNMA pass-through certificate because he has heard that it provides monthly payments. He wants to receive payments over a minimum 10-year investment time horizon. Which is the most important risk to discuss with this client? Incorrect answer A. You did not choose this answer. A Extended maturity risk Incorrect answer B. You did not choose this answer. B Default risk Correct answer C. You chose this answer C Prepayment risk Incorrect answer D. You did not choose this answer. D Interest rate risk

The best answer is C. This customer is looking for income over a 10-year time frame. If market interest rates fall, the mortgages backing the pass-through certificate will be prepaid, and the customer will be returned his principal much earlier than expected. When the customer goes to reinvest the principal, because interest rates have dropped, he will be earning a lower rate of return. Prepayment risk is a big concern with GNMA pass-through certificates and should be discussed with this client so he understands the risk.

A customer buys a $1,000 par Treasury Inflation Protection security with a 4% coupon and a 10 year maturity. If the inflation rate during the first year of the security's life is 5%, the: I coupon rate is adjusted to 9% II coupon rate remains at 4% III principal amount is adjusted to $1,050 IV principal amount remains at $1,000 A I and III B I and IV C II and III D II and IV

The best answer is C. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities.

Which of the following trade "flat" ? I Treasury BillsII Treasury STRIPSIII Treasury BondsIV Treasury Receipts Incorrect answer A. You did not choose this answer. A I and II only Incorrect answer B. You did not choose this answer. B III and IV only Correct answer C. You chose this answer C I, II, IV Incorrect answer D. You did not choose this answer. D I, II, III, IV

The best answer is C. Treasury Bills are short term original issue discount obligations, with the discount earned being the "interest." Treasury Receipts and Treasury STRIPS are essentially zero-coupon obligations. Because all of these obligations do not make periodic interest payments, they trade "flat" - that is, without accrued interest. Treasury Bonds pay interest semi-annually, so they trade with accrued interest.

Treasury Receipts: I pay interest semi-annually II pay interest at maturity III are essentially zero coupon T-Notes or T-Bonds IV are essentially zero coupon T-Bills . A I and III B I and IV C II and III D II and IV

The best answer is C. Treasury Receipts are "zero coupon" Treasury bonds or Treasury notes that pay interest earned at maturity. Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, the market for broker-created T-Receipts evaporated. However, you still must know the basics of these securities for the exam.

Which of the following statements are TRUE about CMOs in a period of rising interest rates? I CMO prices fall slower than similar maturity regular bond prices II CMO prices fall faster than similar maturity regular bond prices III The expected maturity of the CMO will lengthen due to a slower prepayment rate than expected IV The expected maturity of the CMO will lengthen due to a faster prepayment rate than expected Incorrect answer A. You did not choose this answer. A I and III Incorrect answer B. You did not choose this answer. B I and IV Correct answer C. You chose this answer C II and III Incorrect answer D. You did not choose this answer. D II and IV

The best answer is C. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the expected life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the expected maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster.

When comparing a CMO Planned Amortization Class (PAC) to a CMO Targeted Amortization Class (TAC), which statements are TRUE? I PACs are similar to TACs in that both provide call protection against increasing prepayment speeds II PACs differ from TACs in that TACs do not offer protection against a decrease in prepayment speeds III PAC holders have a degree of protection against extension risk that is not provided to TAC holders IV TAC pricing will be more volatile compared to PAC pricing during periods of rising interest rates Incorrect answer A. You did not choose this answer. A I only Incorrect answer B. You did not choose this answer. B II and III only Incorrect answer C. You chose this answer. C I, II, III Correct answer D. You did not choose this answer. D I, II, III, IV

The best answer is D. A Targeted Amortization Class (TAC) is a variant of a PAC. A PAC offers protection against both prepayment risk (prepayments go to the Companion class first) and extension risk (later than expected payments are applied to the PAC before payments are made to the Companion class). A TAC bond protects against prepayment risk; but does not offer the same degree of protection against extension risk. A TAC bond is designed to pay a "target" amount of principal each month. If prepayments increase, they are made to the Companion class first. However, if prepayment rates slow, the TAC absorbs the available cash flow, and goes in arrears for the balance. Thus, average life of the TAC is extended until the arrears is paid. Therefore, both PACs and TACs provide "call protection" against prepayments during period of falling interest rates. TACs do not offer the same degree of protection against "extension risk" as do PACs during periods of rising interest rates - hence their prices will be more volatile during such periods.

Which of the following statements are TRUE about CMOs? I CMO issues have a serial structure II CMO issues are rated AAA III CMO issues are more accessible to individual investors than regular pass-through certificates IV CMO issues have a lower level of market risk than regular pass-through certificates Incorrect answer A. You did not choose this answer. A I and II only Incorrect answer B. You did not choose this answer. B III and IV only Incorrect answer C. You chose this answer. C I, II, III Correct answer D. You did not choose this answer. D I, II, III, IV

The best answer is D. All of the statements are true about CMOs. CMOs have a lower level of market risk (risk of price volatility due to movements in market interest rates) than do mortgage backed pass-through certificates. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower. CMOs have a serial structure since they are divided into 15 - 30 maturities known as tranches; CMOs are rated AAA; and CMOs are more accessible to individual investors since they have $1,000 minimum denominations as compared to $25,000 for pass-through certificates.

CDO tranches: I have underlying mortgage collateral that is backed by Fannie Mae, Freddie Mac or Ginne Mae II have underlying mortgage collateral that is backed only by the credit quality of those mortgages III are all rated AAA IV are rated based on the credit quality of the underlying mortgages Incorrect answer A. You did not choose this answer. A I and III Incorrect answer B. You did not choose this answer. B I and IV Incorrect answer C. You did not choose this answer. C II and III Correct answer D. You chose this answer D II and IV

The best answer is D. CDOs - Collateralized Debt Obligations - are structured products that invest in CMO tranches (and they can also invest in other debt obligations that provide cash flows). They are used to create tranches with different risk/return characteristics - so a CDO will have higher risk tranches holding lower quality collateral and lower risk tranches holding higher quality collateral. The housing bubble that ended badly in 2008 with a market crash was fueled by massive issuance of sub-prime mortgages to unqualified home buyers, that were then packaged into CDOs and sold to unwitting institutional investors who relied on the credit rating assigned by S&P or Moodys. These credit ratings agencies really did not understand the complex structure of CDOs and how risky their collateral was (sub-prime mortgage loans that were often "no documentation liar loans"). The CDO market collapsed with the housing crash in 2008-2009 and has still not recovered (as of 2020).

All of the following statements are true about CMOs EXCEPT: Incorrect answer A. You did not choose this answer. A CMO issues have aserialstructure Incorrect answer B. You chose this answer. B CMO issues are rated AAA Incorrect answer C. You did not choose this answer. C CMO issues are more accessible to individual investors than regular pass-through certificates Correct answer D. You did not choose this answer. D CMO issues have the samemarket riskas regular pass-through certificates

The best answer is D. CMOs have a lower level of market risk (risk of price volatility due to movements in market interest rates) than do mortgage backed pass-through certificates. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise. When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster. When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower. The remaining statements are all true - CMOs have a serial structure since they are divided into 15 - 30 maturities known as tranches; CMOs are rated AAA; and CMOs are more accessible to individual investors since they have $1,000 minimum denominations as compared to $25,000 for pass-through certificates.

Trades of all of the following securities settle in Fed Funds EXCEPT: Incorrect answer A. You did not choose this answer. A U.S. Government bonds Incorrect answer B. You did not choose this answer. B U.S. Agency bonds Incorrect answer C. You did not choose this answer. C GNMA Pass-Through certificates Correct answer D. You chose this answer D General Obligation bonds

The best answer is D. Corporate and municipal bond trades settle in clearing house funds. These are funds payable at a registered clearing house in three business days. These trades are settled through NSCC - the National Securities Clearing Corporation. U.S. Government and agency bond trades settle in Federal Funds, which are good funds the business day of the funds transfer (next business day for regular way settlement of government securities). Ginnie Mae Pass-Through certificates are U.S. Government guaranteed, so trades settle in Fed Funds. These trades are settled through GSCC - the Government Securities Clearing Corporation. .

All of the following statements are true about the Federal National Mortgage Association Pass-Through Certificates EXCEPT: . A FNMA is a publicly traded company B interest payments are subject to state and local tax C certificates are issued in minimum units of $25,000 D the credit rating is considered the highest of any agency security

The best answer is D. FNMA is a publicly traded company. Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets. Unlike GNMA, whose securities are directly U.S. Government guaranteed; FNMA only carries an "implicit" U.S. Government backing, so its credit rating is lower than that of GNMA. Interest received by the holder of a mortgage backed pass through security is fully taxable by both federal, state, and local government. Certificates are issued in minimum $25,000 denominations. For most investors this is too much money to invest, so they buy shares of a mutual fund that invests in these instruments instead.

Series EE bonds: I are negotiable II are non-negotiable III pay interest semi-annually IV pay interest at redemption A I and III B I and IV C II and III D II and IV

The best answer is D. Series EE bonds are "savings bonds" issued by the U.S. Government with a minimum purchase amount of $25 (or more). The interest rate is set at the date of issuance. Interest is "earned" monthly and credited to the principal amount every 6 months. The bonds have no stated maturity - the holder can redeem at any time, however interest is only credited to the bonds for 30 years. Savings bonds do not trade - they are issued by the Treasury and are redeemed with the Treasury (a bank can act as agent for the Treasury issuing and redeeming Series EE bonds). No physical certificates are issued - the bonds are issued in electronic form.

Series EE bonds: I are issued at a discount to face II are issued at face value III pay interest semi-annually IV pay interest at redemption A I and III B I and IV C II and III D II and IV

The best answer is D. Series EE bonds are "savings bonds" issued by the U.S. Government with a minimum purchase amount of $25 (or more). This is the face value of the bond, and any interest earned is added to the bond's value. The interest rate is set at the date of issuance. Interest is "earned" monthly and credited to the principal amount every 6 months. The bonds have no stated maturity - the holder can redeem at any time, however interest is only credited to the bonds for 30 years. Savings bonds do not trade - they are issued by the Treasury and are redeemed with the Treasury (a bank can act as agent for the Treasury issuing and redeeming Series EE bonds). No physical certificates are issued - the bonds are issued in electronic form.

A 5 year $1,000 par 3 1/2% Treasury Note is quoted at 98-4 - 98-9. The note pays interest on Jan 1st and Jul 1st. A customer buys 1 note at the ask price. What is the current yield, disregarding commissions? Incorrect answer A. You did not choose this answer. A 3.26% Incorrect answer B. You did not choose this answer. B 3.36% Incorrect answer C. You did not choose this answer. C 3.46% Correct answer D. You chose this answer D 3.56%

The best answer is D. The bond is purchased at 98 and 9/32nds = 98.28125% of $1,000 = $982.8125. The formula for current yield is: $35 $982.8125 = 3.56%

Which of the following statements are TRUE about Treasury Receipts? I The underlying securities are backed by the full faith and credit of the U.S. Government II The interest coupons are sold off separately from the principal portion of the obligation III The securities are purchased at a discount IV The securities mature at par A I and II only B III and IV only C I, II, IV D I, II, III, IV

The best answer is D. Treasury Receipts are zero coupon Treasury obligations (which are directly backed by the full faith and credit of the U.S. Government) created by broker/dealers who buy Treasury Bonds or Treasury Notes and strip them of their coupons, keeping the corpus of the bond only. The bonds are put into a trust, and "units" of the trust are sold to investors. Treasury Receipts are purchased at a discount and mature at par. The discount earned over the life of the bond is the "interest income." Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, this market evaporated. However, you still must know the basics of these securities for the exam.

A customer who lives in the state of New York who buys GNMA Pass-Through Certificate: Incorrect answer A. You chose this answer. A must include the interest income received on his federal tax return, but not his state tax return Incorrect answer B. You did not choose this answer. B does not include the interest income on his federal tax return, but must include it on his state tax return Incorrect answer C. You did not choose this answer. C excludes the interest income from both his federal tax return and his state tax return Correct answer D. You did not choose this answer. D must include the interest income receive on both his federal tax return and his state tax return

The best answer is D. Unlike Treasury obligations and regular agency debt, where interest income is subject to federal income tax, but is exempt from state and local tax, interest income from mortgage backed securities is subject to both federal and state income tax. This is the law because the interest payments made on the underlying mortgages are deductible to the homeowner making the mortgage payments at both the federal and state level, therefore the recipient of these payments should be taxed at both the federal and state level.

All of the following statements regarding collateralized mortgage obligations are true EXCEPT: Incorrect answer A. You did not choose this answer. A varying maturities are available to meet a wide variety of investor needs Incorrect answer B. You did not choose this answer. B in some issues, investors may choose between PAC and TACtranches, aside from regular tranches Incorrect answer C. You did not choose this answer. C differing tranches will be offered at differing yields Correct answer D. You chose this answer D each tranche has the same level of market risk

The best answer is D. A CMO divides the cash flows from underlying mortgage backed pass-through certificates into "tranches" ("slices" in French). Each tranche, in effect, represents a differing expected maturity, hence each tranche has a different level of market risk. Since each tranche represents a differing maturity, the yield on each will differ. New CMOs have special classes of tranches called PAC (Planned Amortization Class) and TAC (Targeted Amortization Class) tranches. These tranches are given a greater certainty of repayment at the projected date, by allocating earlier than expected repayments to so-called "companion" tranches, before prepayments are applied to these tranches.

Which statements are TRUE regarding Z-tranches? I Interest is paid before all other tranchesII Interest is paid after all other tranchesIII Principal is paid before all other tranchesIV Principal is paid after all other tranches Incorrect answer A. You did not choose this answer. A I and III Incorrect answer B. You did not choose this answer. B I and IV Incorrect answer C. You did not choose this answer. C II and III Correct answer D. You chose this answer D II and IV

The best answer is D. A Z-tranch is a "zero" tranche that receives no payments, either interest or principal, until all other tranches before it are paid off. It acts like a long-term zero coupon bond.

Treasury Receipts pay interest: . A quarterly B semi annually C annually D at maturity

The best answer is D. Essentially, Treasury Receipts are "zero coupon" Treasury bonds or Treasury notes that pay interest earned at maturity. Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, the market for broker-created T-Receipts evaporated. However, you still must know the basics of these securities for the exam.

All of the following statements are true about PAC tranches EXCEPT: Incorrect answer A. You did not choose this answer. A If prepayment rates slow down, the PAC tranche will receive its sinking fund payment prior to its companion tranches Incorrect answer B. You did not choose this answer. B If prepayment rates rise, the PAC tranche will receive its sinking fund payment after its companion tranches Incorrect answer C. You did not choose this answer. C PAC tranche holders have lowerprepayment riskthan companion tranche holders Correct answer D. You chose this answer D PAC tranche holders have higher extension risk than companion tranche holders

The best answer is D. Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a "Planned Amortization Class." Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments that are made earlier than the PAC maturity are made to the Companion classes before being applied to the PAC (this would occur if interest rates drop); while principal repayments made later than anticipated are applied to the PAC maturity before payments are made to the Companion class (this would occur if interest rates rise). Thus, the PAC class is given a more certain maturity date and hence lower prepayment risk; while the Companion classes have a higher level of prepayment risk if interest rates drop; and they have a higher level of so-called "extension risk" - the risk that the maturity may be longer than expected, if interest rates rise.

Which investment gives the LEAST protection against purchasing power risk? A 6 month Treasury Bill B 10 year Treasury Note C 10 year Treasury "TIPS" D 10 year Treasury "STRIPS"

The best answer is D. Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. Treasury STRIPS are zero-coupon Treasury obligations - these have the highest level of purchasing power risk. In contrast, 6 month Treasury bills have a low level of purchasing power risk. Since they will mature at par in the near future, their value cannot fall very far below this if interest rates rise.

Which of the following statements about Treasury STRIPS are TRUE? I Treasury STRIPS are suitable investments for individuals seeking a high level of safety II The interest income is accreted and taxed annually III At maturity, there is no capital gain IV The investor's interest rate is locked in at purchase, eliminating any reinvestment risk A I and III only B II and IV only C I, III, IV D I, II, III, IV

The best answer is D. Treasury STRIPS are government bonds that are "stripped" of coupons. They do not provide current income, but they do provide a high level of safety as the underlying securities are direct obligations of the U.S. Government. The discount on the bonds must be accredit annually, with the annual accretion amount being taxable as interest income. As the bond is accreted, its cost basis is adjusted upwards so that at maturity, the bond has an adjusted cost basis of par. Therefore, no taxable capital gain is realized at maturity. This is a zero coupon obligation with a "locked in" rate of return over the life of the bond (thus, it is not subject to reinvestment risk).