Chapter 07 - Fixed-Income Securities

Which of the following is correct concerning bonds? A)A callable bond may be redeemed by the issuer within the terms of the indenture agreement. B)A putable bond may be redeemed by the issuer within the terms of the indenture agreement. C)A putable bond is likely to be redeemed when interest rates have declined since issuance. D)A callable bond is likely to be redeemed when interest rates have risen since issuance.

A)A callable bond may be redeemed by the issuer within the terms of the indenture agreement. Rationale A call feature gives the issuer the right to redeem the bond, which they are likely to do if rates have declined. A put feature gives the bondholder the right to redeem the bond, which they are likely to do if rates have risen

The issuing corporation has the option of retiring the bond, at a predetermined price, prior to the maturity date of the bond. What is this type of bond called? A)A callable bond. B)A convertible bond. C)A debenture bond. D)An retiring bond.

A)A callable bond. Rationale A callable bond can be retired by the issuing corporation.

Which of the following is true about I bonds? A)I bonds can be used to pay for qualified education expenses. B)I bonds pay interest monthly. C)I bonds are taxed the same as TIPS. D)I bonds are issued at a discount.

A)I bonds can be used to pay for qualified education expenses. Rationale They can be used to pay for qualified education expenses.

The primary difference between Treasury notes and bonds is: A)Maturity. B)Default risk. C)Liquidity. D)Taxability.

A)Maturity. Rationale Notes are up to 10 years, bonds up to 30 years. The default risk and taxability of notes and bonds are the same.

The price of a bond that a buyer would pay is equal to: A)The asked price plus accrued interest. B)The asked price less accrued interest. C)The bid price plus accrued interest. D)The bid price less accrued interest.

A)The asked price plus accrued interest. RationaleThe asked price plus accrued interest

A coupon bond pays interest semi-annually and has an ask price of 107%. If the last interest payment was made two months ago and the coupon rate is 9%, what will the full "dirty" price of the bond be? A)$1,070. B)$1,085. C)$1,100. D)$1,115.

B)$1,085. Rationale The full (dirty) price of the bond is the ask price plus accrued interest. The ask price is 107% x $1,000 par value = $1,070. The accrued interest is 2/6 months x $45 coupon amount = $15. The full price, then, is $1070 + $15 = $1,085.

Which of the following statements regarding collateralized mortgage obligations (CMOs) is correct? A)All tranches receive principal payments throughout the term. B)All tranches receive interest payments throughout the term. C)Tranches with shorter maturities are not subject to prepayment risk. D)Tranches with longer maturities are not subject to default risk.

B)All tranches receive interest payments throughout the term. Rationale While interest is paid to all tranches, principal is paid only to the first tranche until that tranche is retired, then is paid to the second tranche until it is retired, and so on. All tranches are subject to default risk and prepayment risk.

Convertible bonds typically have which of the following characteristics? A)Allow stockholders to convert their shares into bonds at a stated ratio. B)Allow bondholders to convert their bonds into shares at a stated ratio. C)Are more likely to be converted when a company's stock underperforms. D)Are likely to pay a higher yield than comparable non-convertible bonds.

B)Allow bondholders to convert their bonds into shares at a stated ratio. Rationale Convertible bonds allow bondholders the right to convert to stock, not the other way around. They are most likely to be converted when the stock performs well since the holder has the right to convert at a fixed value. Since this feature is valuable to bondholders, they are likely to provide a lower yield than a comparable non-convertible bond.

Which of the following is correct concerning T-bills? A)Non-competitive bids determine the yield at any given auction. B)Competitive bids determine the yield at any given auction. C)Non-competitive bidders are not guaranteed to have their orders filled up to the auction maximum. D)Competitive bidders are guaranteed to have their orders filled up to the auction maximum.

B)Competitive bids determine the yield at any given auction. Rationale Non-competitive bidders must accept the auction yield determined by the competitive bidders. Non-competitive bidders will have their orders filled up to the auction maximum, but that is not correct for the competitive bidders.

Which of the following are the 3 largest segments of the U.S. bond market? A)Municipal, corporate and Treasury B)Mortgage, corporate and Treasury C)Mortgage, corporate and Money Market D)Mortgage, Federal Agency and Treasury

B)Mortgage, corporate and Treasury Rationale Corporate, mortgage and Treasury are each in excess of 20% of the total bond market, while all other categories are under 10% each.

The yield to maturity on a bond is: A)Lower than the coupon rate when the bond sells at a discount, and equal to the coupon rate when the bond sells at a premium. B)The discount rate that will establish the present value of the payments equal to the current bond price. C)Based on the assumption that payments received are reinvested at the coupon rate of return. D)Always equal to the coupon rate when the bond sells at a discount.

B)The discount rate that will establish the present value of the payments equal to the current bond price. Rationale Essentially the IRR. The rate that will equalize the negative and positive cash flows in present value terms.

Which of the following is not correct about TIPS? A)TIPS are issued directly from the U.S. Treasury. B)The interest rate for TIPS changes based on inflation. C)TIPS can be purchased on a competitive or noncompetitive basis. D)With deflation, the interest payments will decrease for TIPS.

B)The interest rate for TIPS changes based on inflation. Rationale TIPS are issued by the U.S. Treasury on both a competitive and noncompetitive basis. The interest rate does not change. Instead, the principal amount changes based on inflation or deflation.

A convertible bond has a par value of $1,000, but its current market price is $750. The current price of the issuing company's stock is $17 and the conversion ratio is 30 shares. The bond's conversion premium is closest to: A)$44.12. B)$25.00. C)$240.00. D)$490.00.

C)$240.00. Rationale The bond is convertible into 30 shares, which is worth $510 at $17 per share. The bond is trading at $750. Thus, the conversion premium equals the difference or $240.$750 - [30 x $17 = $510] = $240.

Which of the following best describes the clean price of a corporate bond quoted at 98.03? A)$98.03. B)$98.09. C)$980.30. D)$980.94.

C)$980.30. Rationale Corporate bonds are quoted as a percentage of par value ($1000).

Which of the following types of municipal bonds has the highest credit risk? A)A general obligation bond. B)An insured general obligation bond. C)A revenue bond. D)An insured revenue bond.

C)A revenue bond. Rationale A revenue bond depends on the revenue from the dedicated project and is more risky than a general obligation bond.

Which of the following is a disadvantage of bonds for the issuing corporation? A)Interest paid by the issuing corporation on bonds is a deductible expense for the corporation for federal income tax purposes. B)Bonds (debt) can increase the return on equity through favorable leverage. C)Bonds typically require payment of both periodic interest and maturity value. D)Bonds impact shareholder control.

C)Bonds typically require payment of both periodic interest and maturity value. Rationale The disadvantage is the requirement to pay interest and principal. Options a and b are advantages and option d is false.

In a low interest rate environment, which of the following bonds are most likely to be called? A)Zero-coupon bonds. B)Coupon bonds selling at a discount. C)Coupon bonds selling at a premium. D)Floating rate bonds.

C)Coupon bonds selling at a premium. Rationale Bonds sell at a premium when prevailing interest rates are lower than the rate on the existing bonds. Since new rates are lower, the issuing corporation will find it desirable to call the existing bonds and issue new bonds at the lower rates. The interest rate on floating rate bonds will adjust periodically to changes in prevailing interest rates.

Commercial paper is most likely issued by: A)The Federal Reserve bank. B)Commercial banks. C)Large, well-known companies. D)A securities exchange.

C)Large, well-known companies. Rationale Large companies with excellent credit issue commercial paper.

Which of the following is not included in money market funds? A)Repurchase agreements. B)Eurodollars. C)Real estate investment trusts. D)Money market mutual funds.

C)Real estate investment trusts. Rationale Real estate investment trusts are not short-term investments and are not included in money market funds.

Which of the following best describes the difference between a serial bond and a bond with a sinking fund? A)Serial bonds require the company to periodically set aside funds into a trust to redeem the bonds at maturity. B)Sinking fund bonds require the company to periodically redeem a portion of the bond prior to maturity. C)Serial bonds require the company to periodically redeem a portion of the bond prior to maturity. D)Serial bonds that pay a coupon are not subject to OID, while sinking fund bonds that pay a coupon are subject to OID.

C)Serial bonds require the company to periodically redeem a portion of the bond prior to maturity. Rationale Coupon paying bonds are not subject to OID regardless if they are sinking or serial.

A Treasury bond has an ask price of 107.04 and a bid price of 107.00. What is the dollar price a buyer expects to pay? A)$1,070.00. B)$1,070.40. C)$1,071.13. D)$1,071.25.

D)$1,071.25. Rationale4 / 32 = 0.125 + 107 = 107.125107.125% x $1,000 par value = $1,071.25

Elmira is single and in the 37% federal and 4% state tax brackets, and she is subject to the federal 3.8% Net Investment Income Tax. She is considering the purchase of a municipal bond, issued in her state of residence, with a YTM of 7%. What is Elmira's tax equivalent yield on the bond? A)7.29%. B)11.11%. C)11.86%. D)12.68%.

D)12.68%. Rationale The tax equivalent yield is calculated using the formula: [municipal rate/(1-tax bracket)]. Municipal bond interest is not subject to tax at the federal level, and not subject to tax at the state level if the bondholder is a resident of the state in which the issuing municipality is located. Elmira lives in the state in which the issuing municipality is located, so she will save a total of 37% + 3.8% + 4% = 44.8% in taxes by purchasing the municipal bond. The tax equivalent yield is: [7/(1-.448) = 12.68%)

Which of the following is correct concerning CDs? A)CDs and Jumbo CDs are used only by small investors since larger investors can earn a higher yield. B)Jumbo CDs are non-negotiable. C)Jumbo CDs are not eligible for FDIC insurance. D)All CDs issued by federally insured banks are eligible for FDIC coverage up to the coverage limit.

D)All CDs issued by federally insured banks are eligible for FDIC coverage up to the coverage limit. Rationale All CDs issued by federally insured banks are eligible for FDIC coverage up to $250,000. Jumbo CDs are purchased by larger investors for much the same reason that smaller investors purchase regular CDs. Only Jumbo CDs are negotiable

Which of the following is not correct concerning Bankers Acceptances? A)Bankers Acceptances have similar tax treatment to Jumbo CDs. B)Bankers Acceptances are subject to capital gains tax since they are negotiable. C)Bankers Acceptances are typically used in connection with foreign commerce. D)Bankers Acceptances are typically issued by banks on behalf of smaller companies that have weaker credit on their own.

D)Bankers Acceptances are typically issued by banks on behalf of smaller companies that have weaker credit on their own. Rationale Bankers Acceptances, used to facilitate foreign trade, are typically issued by banks on behalf of companies that have strong credit on their own because the bank is unwilling to take on the credit risk of companies without a strong credit rating. Since Bankers Acceptances are negotiable, they are subject to capital gains tax, like Jumbo CDs.

Thirty-year Treasury bonds are not subject to which of the following risks? A)Purchasing power risk. B)Interest rate risk. C)Reinvestment rate risk. D)Default risk.

D)Default risk. Rationale Treasury bonds are subject to all of the above except default risk since they are issued by the U.S. government, which has never missed a payment.

Which of the following statements is false? A)Every bond has a maturity value. B)Every bond has a maturity date. C)Every bond has a YTM. D)Every bond has coupon payments.

D)Every bond has coupon payments. Rationale Not all bonds are coupon bonds.

Money market securities are least likely to: A)Be readily marketable. B)Have low volatility. C)Be highly liquid. D)Have long maturities.

D)Have long maturities. Rationale Money market securities are marketable because they trade in highly liquid markets and have low volatility. They have short term matures of less than one year.

Which of the following statements is true regarding U.S. Government Agency bonds? A)GNMA bonds have low default risk. B)Mortgage backed securities have low prepayment risk. C)Interest income and capital gains are exempt from state and local taxes. D)Interest income and principal payments from the GNMA bonds are made monthly.

D)Interest income and principal payments from the GNMA bonds are made monthly. Rationale GNMA bonds have no default risk. Prepayment risk is a significant concern for MBS. CMOs allow an investor to mitigate prepayment risk, not MBS. All forms of income are taxable at the local, state and federal level.

Which of the following statements is not correct? A)Yields on bankers acceptances are typically higher than commercial paper since there is additional risk. B)Negotiable CDs are deposits of $100,000 or more and are tradeable in the secondary market. C)Commercial paper is not considered default risk free. D)Repurchase agreements typically have maturities equal to that of commercial paper.

D)Repurchase agreements typically have maturities equal to that of commercial paper. Rationale Choice a, b and c are correct. T-bills are default risk free, while commercial paper has some, although minor, default risk. Repurchase agreements typically have a maturity of only a few days, while commercial paper often has maturities of six months to 270 days