CFP Course 3 Module 2 - Practice
D
A) they offer a yield that is less than the yield on straight bonds with similar risk and maturities. B) they are normally not converted. C) because they are not callable, convertible bonds must be held until maturity. D) they lack the downside risk protection for investors.
A
ABC Corporation is a manufacturer of electronic devices used in the manufacturing of airplanes. Five years ago, the corporation floated a $100 million bond issue that would be used to finance improvements at its main manufacturing and distribution center. However, orders for its products have dropped dramatically due to demand being much lower than anticipated. The company believes it may miss paying the coupon payment on the bond issue in the upcoming fiscal year. The owners of the ABC Corporation bonds are facing which of the following types of risk? A. Default risk B. Reinvestment rate risk C. Market risk D. Regulation risk
C
According to the unbiased expectations theory of interest rates, A) an upward sloping yield curve indicates that investors require a yield premium to invest in long-term securities. B) yields are a function of the supply and demand of funds in each maturity segment of the market. C) the current long-term rate is the average of today's short-term rate and expected future short-term rates. D) investors require a higher yield on long-term bonds because they are riskier.
A
All of these statements correctly describe yield curves except A) a positive yield curve can signal an upcoming economic recession. B) a flat yield curve occurs when the economy is peaking and, therefore, no change in future interest rates is expected. C) an inverted yield curve occurs when the Federal Reserve has tightened credit in an overheating economy. D) a normal yield curve occurs during periods of economic expansion and generally predicts that market interest rates will rise in the future.
C (The answer is market price is less than the conversion value. An investor would consider converting a convertible bond into common stock if the bond's conversion value exceeds its market price.)
An investor would consider converting a convertible bond into common stock if the bond's A) yield to call is the same as a comparable municipal bond. B) duration exceeds 10 years. C) market price is less than the conversion value. D) yield to maturity is less than its conversion premium.
A
Ashley has a portfolio of bonds. She expects interest rates to increase significantly in the near future. Which of the following types of bond swaps is she likely to execute if she wants to take advantage of the expected change in interest rates? A. Rate anticipation swap B. Intermarket spread swap C. Pure yield pickup swap D. Substitution swap
B (The answer is $180. The downside risk of a convertible bond is the dollar or percentage decline from the current market price of the convertible bond to the investment value of the bond: $1,120 - $940 = $180)
Chuck Johnson owns a convertible bond that has a conversion price of $40 per share and a coupon of 5.5%. Interest is paid semiannually. The current market price of the stock is $41 per share. The investment value of the bond is $940, and the bond currently sells for a market price of $1,120. What is the downside risk of this bond? A) $95 B) $180 C) $120 D) $85
A
Darla, a U.S. citizen and resident of Georgia, owns a 5% coupon corporate bond, a 4% coupon State of Georgia municipal bond, and a 3% coupon U.S. Treasury note. Darla's marginal state income tax rate is 6% and federal tax rate is 24%. If Darla invested equal amounts in each of the three bonds, what is her after-tax rate of return on the portfolio? A) 3.26% B) 4.91% C) 2.86% D) 4.00%
D
Ellen Hyson purchased a BB rated convertible bond of TCD Corporation that has a 10% coupon and matures in nine years. Comparable debt (BB rated, nine years to maturity) yields 12%. The bonds are convertible at $32 per share of common stock, and the current market price of TCD common stock is $25. What is the conversion value of this bond? A) $800.00 B) $893.50 C) $916.25 D) $781.25
B (The answer is the principal value is adjusted for inflation every six months based on the CPI, and one-half of the stated coupon rate is paid semiannually on the inflation-adjusted principal value. TIPS coupon rate stays the same for the life of the security, but the interest payment changes based on the inflation-adjusted principal or par value.)
Identify which of these statements regarding Treasury Inflation-Protected Securities (TIPS) is CORRECT. A) TIPS are issued at 50% of the par value with the par value being adjusted every six months for inflation. B) The principal value is adjusted for inflation every six months based on the Consumer Price Index (CPI), and one-half of the stated coupon rate is paid semiannually on the inflation-adjusted principal value. C) The TIPS coupon rate is adjusted every 12 months based on changes in the Consumer Price Index (CPI). D) A semiannual inflation rate is combined with the stated coupon rate to determine the TIPS interest rate for the next six months
A
Identify which of these statements regarding revenue bonds is NOT correct. They are secured by a specific pledge or property. They are a type of full faith and credit bond. Their interest is tax-exempt at the federal level. They are analyzed by the project's ability to generate earnings. A) I and II B) II and IV C) III and IV D) I and III
D
If a bond is immunized against interest rate risk, a dollar decline in the bond's price, resulting from rising interest rates, will be approximately offset by a dollar increase in the A) bond issuer's common stock. B) price of comparable bonds in the market. C) bond's call price. D) income from coupons reinvested over the investment horizon.
A
John is in the 35% federal marginal income tax bracket and resides in a state with a flat 3% state income tax rate. He has $25,000 to invest and wants to invest it all in a single bond issue. Which bond should John choose? A. Taxable corporate bond with a coupon rate of 9.5% B. Another state's municipal bond with a coupon rate of 5.5% C. His state's municipal bond with a coupon rate of 4.5% D. His county's municipal bond with a coupon rate of 5%
C (The answer is Series EE bonds may no longer be exchanged for Series HH bonds. Until September 2004 (when Series HH bonds were no longer issued by the Treasury), the exchange of EE bonds for HH bonds was a popular way of continuing the income tax deferral on the accrued interest portion of the EE bonds. Such changes are no longer possible.)
Sam holds a considerable amount of both Series EE and Series HH savings bonds. He is nearing retirement and likes the fact that his Series HH bonds pay interest semiannually and would like to exchange most of his Series EE bonds for Series HH bonds to increase his cash flow. Choose which of these statements regarding such an exchange is CORRECT. A) Only Sam's Series EE bonds issued prior to 2004 may be exchanged. B) Sam may exchange the bonds but will be subject to a three-month interest penalty. C) Series EE bonds may no longer be exchanged for Series HH bonds. D) Sam may exchange the bonds but must recognize the Series EE accrued interest at the time of exchange.
A
Select the CORRECT statements concerning preferred stock. I. Preferred stock is known as a hybrid security because it resembles both a fixed-income security and an equity instrument. II. Preferred stock has a maturity date and pays interest similar to a bond. III. A large portion of the preferred stock issued can be converted into corporate bonds. IV. A company's preferred stock may be cumulative where all unpaid dividends must be paid to the preferred shareholders before dividends can be paid to common shareholders. A) I and IV B) I and II C) II, III, and IV D) III and IV
A
Select which of these is NOT a primary risk associated with a coupon-paying bond. A) Debenture risk B) Purchasing power risk C) Interest rate risk D) Default risk
A
Select which of these statements regarding Treasury notes and Treasury bonds is CORRECT. I. Both Treasury notes' and bonds' interest payments are income tax free at the state and federal level. II. Treasury notes and bonds are considered default risk free. III. If held for more than one year, interest paid on Treasury bonds is eligible for long-term capital gain treatment. IV. Both Treasury notes and bonds are not traded in the secondary market. A) II only B) I, III, and IV C) III and IV D) I and II
B (The answer is Louisiana resident, 6% state income tax bracket, 35% federal income tax bracket. The municipal bond interest is generally exempt from federal income tax, but is subject to both state and local taxes unless the bond is purchased by a resident of the issuing state. While the Florida resident is taxed at the highest federal tax rate and pays no state income tax, the overall tax savings is greatest for the Louisiana resident whose combined state and federal tax bracket is 41%.)
The state of Louisiana has a new municipal five-year bond issue offering a 4% coupon rate. Which of these is the greatest tax benefit investors would receive from purchasing this bond? A) Mississippi resident, 6% state income tax bracket, 12% federal income tax bracket B) Louisiana resident, 6% state income tax bracket, 35% federal income tax bracket C) Florida resident, 0% state income tax bracket, 37% federal income tax bracket D) Georgia resident, 6% state income tax bracket, 24% federal income tax bracket
D
The yield curve theory that states current long-term interest rates contain an implicit prediction of future short-term interest rates is known as A) liquidity preference theory. B) market segmentation theory. C) preferred habitat theory. D) unbiased expectations theory.
A
Tim is considering investing in a portfolio of bonds. He wants all of his bonds to mature in 10 years so he can minimize interest rate risk. Which of the following bond strategies is most appropriate for meeting Tim's objectives? A. Bond bullet strategy B. Bond ladder strategy C. Bond barbell strategy D. Bond dumbbell strategy
D (The answer is 6.08%. The after-tax return is 8% × (1 − 0.24) = 6.08%.)
Tom owns a taxable investment that earns 8% interest annually. Tom pays taxes at a marginal rate of 24%. Calculate the after-tax rate of return that Tom will receive on this investment. A) 2.24% B) 6.30% C) 6.25% D) 6.08%
B
Which of the following are disadvantages of convertible bonds? I. A yield that is less than that of a regular bond with similar risk and maturity. II. The holder may be forced into conversion if the bond is callable. III. The bonds do not have to be retired if they are not converted. IV. They are doubly cursed in times of high interest rates and low stock prices. A. II only B. I, II, and IV C. I, II, and III D. I and IV
B
Which of the following statements is CORRECT? If an investor expects a decline in market interest rates, she should attempt to construct a portfolio of long maturity bonds with low coupon rates. If the investor expects an increase in market interest rates, he should attempt to construct a portfolio of short maturity bonds with high coupon rates. A) II only B) Both I and II C) I only D) Neither I nor II
A
Which of these describe similarities between preferred stock and long-term bonds? Both dividends and interest are tax-deductible expenses for the issuing corporations. Both generally pay a fixed periodic payment. Both preferred dividends and interest must be paid before common stock cash dividends are paid. A) II and III B) I and III C) I and II D) III only
B
Which one of these is CORRECT regarding preferred stock? A) Failure to pay preferred stock dividends results in bankruptcy. B) Preferred stock's value is based on prevailing interest rates. C) Preferred stock's dividends are tax deductible for corporations. D) Preferred stockholders have voting rights.
