Chapter 6
What are some of the reasons an A-rated bond would be dropped to a BBB rating?
There are a number of reasons that would lead to a drop in a bonds rating to BBB: operations are increasingly susceptible to swings in the business cycle long-term investment characteristics are less favourable the company is more susceptible to adverse trade conditions asset protection and safety are declining
How do CSBs differ from CPBs? a)CSBs have a fixed coupon, while CPBs have a variable coupon. b)CSBs are cashable at any time, while CPBs are cashable only once a year. c)CSBs are non-transferable, while CPBs have an active primary market. d)CSBs are offered for terms ranging from five to 20 years, while CPBs are offered for terms of five, 10, and 20 years only.
b)Unlike other bonds, Canada Savings Bonds can be purchased only between October and April of each year but can be cashed by the owner at any bank in Canada at any time. Canada Premium Bonds are very similar to CSBs but offer a higher interest rate when they are issued. They can be redeemed only once a year without penalty, on the anniversary of the date of issue and for 30 days thereafter.
Here's some additional information about the Manitoba bond: 10% 15 May 14 121.44 If you were interested in buying a $10,000 Manitoba bond, what would the purchase cost you (ignoring commissions and accrued interest)? a)$10,000 b)$11,000 c)$12,144 d)$13,358
c)A $10,000 bond would cost $12,144. The bond is currently priced at 121.44. A $10,000 investment in the bond would cost $12,144, calculated as $10,000 × 1.2144.
Which of the following corporate bonds is secured by physical property? a)Mortgage bond b)Preferred security c)Corporate note d)Collateral trust bond
a)A mortgage bond is secured by physical property. There is no fundamental difference between a mortgage and a mortgage bond except in form. Both are issued to allow the lender to secure property if the borrower fails to repay the loan.
Which feature will result in a greater proportion of a bond being retired early - a sinking fund or a purchase fund? a. A sinking fund because retirements are mandatory. b. A purchase fund because retirements are mandatory. c. A purchase fund because retirements are conditional and can be increased to take advantage of market situations. d. A sinking fund because retirements are conditional and can be increased to take advantage of market situations.
a)A sinking fund will result in a greater proportion of an issue being retired because a specified amount of the bond must be redeemed each year. With a purchase fund, redemptions will be made if the market price of the bond is at or below a specified price.
What is one reason an investor would buy a strip bond? a. The investor does not require cash until after the bond matures. b. The investor requires a steady stream of cash. c. Strips can be paid in installments over time. d. Strips are frequently lower quality with higher yields.
a)A strip bond is created when a dealer acquires a block of high-quality bonds and separates the interest coupons from the principal. Each part is sold separately with the principal part known as a strip bond. It is attractive to investors who do not need immediate cash flow and who do not want reinvestment risk or hassle. If the investor were to receive interest payments, they must be invested and there is the risk that the reinvestment rate will be lower than current rates.
Which of the following definitions are applicable to a bond with a Standard & Poor's rating of "A"? a. They are more susceptible to adverse trade or economic conditions relative to higher grade bonds. b. They are generally considered to be of superior in quality. c. The asset and earnings coverage may be modest or unstable. d. The quality of the assets and earnings has been constantly maintained or improved Save Answer
a)Bonds with an S&P "A" rating are considered to be good quality securities with favourable long-term investment characteristics. However, companies that issue these bonds tend to be more susceptible to adverse trade or economic conditions relative to bonds rated "AA" or "AAA".
Why are Government of Canada Real Return bonds attractive to investors? a. The interest payment and principal repayment are indexed to inflation. b. The principal repayment is indexed to inflation. c. Interest payments are indexed to inflation. d. Government of Canada bonds are the least risky of Canadian bonds.
a)Real Return bonds are attractive as a hedge against inflation. Both the interest payment and the principal repayment are calculated based on an inflation compensation calculation. Interest payments are determined as the real return multiplied by the bond value escalated for inflation. The maturity value is the original face value multiplied by the total amount of inflation since the issue date.
Interest rates have been declining dramatically over the last two years. Which of the following debt instruments would be most affected by this decline? a. Floating Rate Bonds. b. Strip Bonds. c. Canada Savings Bonds. d. Government of Canada Bonds.
a)The disadvantage of floating rate bonds is that when interest rates fall, the interest payable on them is adjusted downwards at six-month intervals, so their yield tends to fall faster than that of most bonds. A minimum rate on the bonds can provide some protection to this process, although the minimum rate is normally relatively low. CSBs and government bonds have fixed rates, while strip bonds do not pay interest.
Which of the following securities can have a term to maturity of less than one year when issued? a)T-bills b)CSBs c)Government of Canada bonds d)CPBs
a)Treasury bills T-bills can have a term of less than one year. Treasury bills are short-term government obligations. These bills have original terms to maturity of approximately three months, six months or one year. Every two weeks, Treasury bills are sold at auction by the Minister of Finance through the Bank of Canada.
With both extendible and retractable bonds, the holder's decision to exercise the maturity option must be made during the time period called ______. a. The election period. b. The subscription period. c. The accrual period. d. None of the above.
a)With both extendible and retractable bonds, the holder's decision to exercise the maturity option must be made during the time period called the election period. This time period normally lasts for six months. In the case of an extendible bond, the election period normally occurs from one year to six months before the short maturity date. During this period, the bondholder must notify the appropriate trustee or agent of the debt issuer whether he wishes to extend the term of the bond or allow it to mature on the earlier date. If the holder takes no action, the bond automatically matures on the earlier date and interest payments cease. In the case of a retractable bond, the election period usually occurs from one year to six months before the earlier maturity date. If the retractable bondholder does not notify the appropriate trustee or agent of the debt issuer that they wish to exercise the retractable option during this period, the debt remains a longer term issue.
Which of the following statements regarding long-term debt is correct? i) Bonds are usually secured by real assets. ii) Subordinated debentures rank behind some other long term debt security. iii) A collateral trust bond is usually secured by financial assets. iv) Corporate notes rank ahead of all other fixed-interest securities of the borrower.
a)i) A bond is secured by physical assets in a trust deed written into the bond contract. If the bond goes into default, the trust deed provisions allow certain specified physical assets to be seized by the bondholders and sold to recover their investment. These physical assets could be a building, a railway car, or something more exotic. ii) Subordinated debentures are debentures which are junior to some other security issued by the company or some other indebtedness assumed by the company. The exact status of an issue of subordinated debentures may be ascertained from the prospectus. iii) A collateral trust bond is one which is secured, not by a pledge of real property as in a mortgage bond, but by a pledge of securities, or collateral. Collateral trust bonds are issued by such companies as holding companies, which do not own much in the way of fixed assets on which they can offer a mortgage, but do own securities of subsidiaries. This method of securing bonds with other securities is similar to the common practice of pledging securities with a bank to secure a personal loan. iv) A corporate note is an unsecured promise made by a borrower to pay interest and repay the funds borrowed at a specific date or dates. Corporate notes rank behind all other fixed-interest securities of the borrower.
Let's assume the Manitoba bond is currently rated AA by the S&P Bond Rating Service. The bond is subsequently downgraded to BBB status. What impact is this likely to have on the bond? a)The price of the bond will rise b)The price of the bond will fall c)The yield on the bond will fall d)The coupon on the bond will rise
b)A downgrading will likely lead to a lower price on the bond. The downgrading of a bond generally has a negative effect on its price. A BBB rating implies that the bond is considered riskier than an A-rated bond. Higher risk requires a higher yield, which leads to a lower price on the bond. Intuitively, investors will be willing to pay less for a bond that has had its investment grade reduced. To compensate for the lower investment grade, investors will demand a higher yield, or return, to hold the bonds.
ABC Inc. has just received a higher credit rating from Standard and Poor's. What impact will this have on its ability to raise funds? a. ABC will have to pay a higher coupon rate on its new bonds as investors know it is a successful company. b. ABC will be able to pay a lower coupon rate on its new bonds as it is seen as a more creditworthy company. c. ABC will have a harder time issuing equity as investors will expect a higher return. d. ABC will be able to pay its bonds off faster as they can lower the coupon rate on their existing bonds.
b)A high rating provides benefits, such as the ability to set lower coupon rates on issues of new securities.
A bond quoted as trading at 98, but with a $1,000 par value, would mean that: a. the bond is trading at par. b. the bond is trading at a discount. c. the bond is trading at a premium. d. an investor would pay $1,000 plus any accrued interest for each bond.
b)All bond prices are quoted based on an index with a base of 100. A bond trading at 100 is said to be trading at face value, or par. A bond trading below par, say at a price of 98, is said to be trading at a discount (the 98, based on the index of 100, indicates the bond is trading at 98% of par, or $980). A bond trading above par is said to be trading at a premium.
Which type of government security holders to earn interest on the accumulated unpaid interest each year? a)Regular interest CSBs b)Compound interest CSBs c)T-bills d)Strip bonds
b)Compound interest on CSBs is calculated only on November 1st. Compound interest CSBs allow the holder to forgo receiving interest each year so that the unpaid interest can compound. The holder earns interest on the accumulated interest. The compound interest is calculated each November 1 and is accrued in equal monthly amounts over the next 12 months. At redemption, the holder receives the face value plus the total of the earned interest.
DDD Co. Inc. has an outstanding 12 year bond with a coupon of 8.75%. The financial press is quoting a yield of 6%. What does this imply with respect to the bond? a. Interest rates have gone up since the bond was first issued. b. Interest rates have gone down since the bond was first issued. c. The company must have defaulted on a payment if the yield has gone down. d. It implies nothing as yields naturally fall as time to maturity approaches.
b)Interest rates have fallen as the yield is now below the coupon rate.
If you purchased a Province of Manitoba bond (Manitoba 10% 15 May 14) in May 2010, how would the bond be categorized at the time of purchase? a)Money market bond b)Short-term bond c)Medium-term bond d)Long-term bond
b)This bond would be categorized as a short-term bond. The Province of Manitoba bond matures on May 15, 2011, thus the term to maturity is four years (short-term).
What type of security do municipalities generally use to raise funds? a)Municipal bonds b)Instalment debentures c)T-bills d)Savings bonds
b)Today, the instrument that most municipalities use to raise money from capital market is the instalment debenture or serial bond. Part of the bond matures each year of the term of the bond.
Which of the following describes one distinctive feature of strip bonds? a)The bond generates a capital gain if purchased at issue and held to maturity b)The bond pays regular interest based on the discounted purchase price and not on the full face value of the bond. c)The bondholder must annually report the interest income earned even though interest is not received until maturity. d)Strip bonds should be held outside a registered plan to take full advantage of the available tax deferral.
c)Bondholders of strip bonds must annually report the interest income earned even though interest is not received until maturity. A strip bond is created when a dealer acquires a block of high-quality bonds and separates the individual future-dated interest coupons from the rest of the bond. The dealer then sells each coupon as well as the residue separately at significant discounts to their face value. Holders of strip bonds receive no interest payments. Instead, the strips are purchased at a discount that provides a certain compound rate of return when they mature at par. The income is considered interest rather than a capital gain, which can cause a problem for investors because tax must be paid annually on the income even though the interest income on the bond is not received until the instrument matures. For this reason, it is often recommended that strip bonds be held in a tax-deferred plan such as an RRSP.
In November of the current year, Silpa has $10,000 to invest. She needs the full amount in 3 months time. Select a suitable investment for her. a. Canada Premium Bond (CPB). b. 5-year GIC. c. Canada Savings Bond (CSB). d. Corporate Bond.
c)CSBs can be cashed at any time. CPBs can only be cashed only on the anniversary date of the purchase. A 5-year GIC would lock her money in for 5 years. Corporate bonds are more volatile and less liquid. She may not be able to get her money back when she needs it.
What type of company would issue a collateral trust bond? a. A company which has already issued significant amounts of other types of bonds and debentures. b. A junior company with a low credit rating. c. A holding company that does not have fixed assets but owns securities of subsidiaries. d. A company that holds significant levels of rolling stock, e.g. locomotives and train cars.
c)Collateral trust bonds are issued by holding companies. These companies usually do not own many fixed assets. They own securities in subsidiaries that can be pledged to secure bonds.
If you have a five-year investment horizon and expect inflation to rise each year, what type of government-issued security would you consider a good choice? a)Regular marketable bonds b)CSBs c)Real return bonds d)T-bills
c)If inflation is expected to increase, real return bonds are a good choice since they offer the bondholder inflation protection. The nominal return on real return bonds is linked to the consumer price index (CPI). Both the semi-annual interest payments and the final redemption value of each bond are calculated by including an inflation compensation component.
The 5.25% ABC convertible bond is convertible into 50 shares of common stock for each $1,000 of face value. Which of the following statements about the ABC convertible is true? a. If the common stock is currently trading at $20 a share, the ABC convertible is selling below its conversion value. b. If the common stock is trading at $25 a share, the ABC convertible acts like a straight debenture. c. If the common stock is currently trading at $22 a share, the ABC convertible will rise to a value of at least $1,100. d. If the common stock is trading at $20 a share, the premium on the ABC convertible will equal $52.50.
c)Market prices of convertible debentures are influenced by their investment value and by the price of the underlying common shares into which they can be converted. The conversion price of the ABC debenture is $20 a share. When the common shares of the issuing company trade well below the conversion price, the debenture acts like a straight debenture. When the common stock begins to trade above the conversion price, the value of the debenture begins to rise. When the ABC share price is $22, the value of the debenture rises to at least $1,100.
If you were to rank government borrowers from least risky to most risky, where would municipal securities likely rank? a)First b)Second c)Third d)Fourth
c)Municipalities rank third of public borrowers, following federal and provincial authorities; however, not all municipal credit ratings rank below those of each province. It is not unusual for debenture issues of some large metropolitan areas to be favoured by investors over the securities issued by one or more of the provinces.
You are interested in the following provincial bond: Manitoba 10% 15 May 14 When is interest paid on this bond? a)May 11 each year b)May 5 each year c)May 15 and November 15 each year d)May 11 and November 11 each year
c)This Province of Manitoba bond will pay interest on May 15 and November 15 each year. The majority of bonds pay interest on a semi-annual basis (or twice a year).
Encana Corporation, a Canadian company, issues a euro-denominated bond in the United States. How would you classify this type of bond? a)Canadian domestic bond b)Foreign bond c)Eurobond d)Currency bond
c)You would classify this bond as a Eurobond. Eurobonds are issued and sold outside a domestic market and are typically denominated in a currency other than that of the domestic market in which the bond is issued.
You are interested in purchasing a five-year corporate bond. If you believe that interest rates will trend higher over the period, what type of bond would you select? a)First mortgage bond b)T-bill c)Floating-rate security d)Strip bond
c)You would select a floating-rate security since it would automatically adjust to changing interest rates. They have proved popular because they offer investors protection during periods of very volatile interest rates. For example, when interest rates are rising, the interest paid on floating-rate debentures is adjusted upward at regular intervals of six months, which improves the price and yield of the debentures. The disadvantage of these bonds is that when interest rates fall, the interest payable on them is adjusted downward at six-month intervals, so their yield tends to fall faster than that of most bonds.
What limit does the Canada Deposit Insurance Corporation (CDIC) impose on its coverage of GICs? a. It does not cover amounts in excess of $25,000. b. It does not cover GICs with terms in excess of 10 years. c. It does not cover amounts in excess of $75,000. d. It does not cover terms in excess of 5 years.
d)CDIC does not cover GICs with terms in excess of 5 years. Score: 1/1
Natalie is concerned about the impact of inflation on her investments. She wishes to purchase an investment that shields her from the negative impact of rising prices. What security would you recommend to her? a. Canada Savings bond. b. 7-year GIC. c. Floating rate bond. d. Real return bond.
d)The Government of Canada also issues real return bonds (RRB). A RRB resembles a conventional bond because it pays interest throughout the life of the bond and repays the original principal amount on maturity. Unlike conventional bonds, however, the coupon payments and principal repayment are adjusted for inflation. RRBs have a fixed real coupon rate.
Which of the following types of government securities has an active secondary market? a)Compound interest Canada Saving Bonds b)Regular interest Canada Saving Bonds c)Canada Premium Bonds (CPBs) d)Government of Canada marketable bonds
d)The type of government securities that trade in the secondary market are Government of Canada bonds. These issues are called marketable bonds because, as well as having a specific maturity date and a specified interest rate, they are transferable, which means that they can be traded in the market. Instruments such as Canada Savings Bonds are not transferable and not marketable.
How would you classify a bond issued by a Crown corporation of the Province of Alberta? a)Direct bond b)T-bill c)Serial bond d)Guaranteed bond
d)You would classify a bond issued by a Crown corporation of Alberta as a guaranteed bond. Many provinces guarantee the bond issues of provincially appointed authorities and commissions. Provincial guarantees may also be extended to cover municipal loans and school board issues. In some instances, provinces extend a guarantee to industrial concerns, usually as an inducement to a corporation to locate (or remain) in that province.