Debt Securities Q's
If your customer has two bonds, and one has a coupon of 5.1% and the other has a coupon of 5.3%, what is the difference in annual interest payments between the bonds? A) $2 B) $10 C) $1 D) $20
Answer: A $1,000 × .053 = $53 $1,000 × .051 = $51 $53 − $51 = $2
Which of the following is a characteristic shared by debentures and equipment trust bonds? A) Both pay principal as it comes due. B) Both must pay interest annually. C) Both are a type of mortgage bond. D) Both are secured by assets of the corporation.
Answer: A Bonds must pay principal when due. Interest is generally paid semiannually. Debentures are unsecured and have no collateral backing the offering.
With regard to duration in bonds, which of the following statements are TRUE? I.The duration of a zero-coupon bond is shorter than its time to maturity. II.The duration of a zero-coupon bond is the same as its time to maturity. III.The duration of an interest-bearing bond is shorter than its time to maturity. IV.The duration of an interest-bearing bond is the same as its time to maturity. A) II and III. B) I and III. C) I and IV. D) II and IV.
Answer: A Duration is a measure of the length of time it takes a bond to repay its cost through internal cash flows (basically the semi-annual interest). A zero-coupon bond pays nothing until it matures, which makes its duration and maturity of the same length. Interest-bearing bonds have a cash flow prior to maturity, which makes their duration shorter than their time to maturity.
Duration would be considered in evaluating which of the following investments? A) Bonds B) Equities C) Growth funds D) Variable annuities
Answer: A Duration measures the time in years it takes for a bond or other debt instrument to repay its cost through internal cash flows (basically the interest).
Which of the following best describes book entry? A) The transfer of ownership is entered on the books of the issuer or the issuer's transfer agent. B) The transfer of ownership is entered on the books of the SRO. C) The transfer of ownership is entered on the books of the clearing agency. D) The transfer of ownership is entered only on the books of the buyer.
Answer: A For book-entry ownership, transfers of ownership are accounting functions in the records of the issuer or the issuer's transfer agent, since it is the issuer, not the SRO or the clearing agency, that must pay the interest and eventually the bond's principal.
The price of which of the following will fluctuate most with a change in interest rates? A) Long-term bonds. B) Common stock. C) Money-market instruments. D) Short-term bonds.
Answer: A Long-term debt prices fluctuate more than short-term debt prices as interest rates rise and fall.
A municipal bond has a coupon of 6.25% and at the present time, its yield to maturity is 6.75%. From this information, it can be determined that the municipal bond is trading: A) at a discount. B) flat. C) at par. D) at a premium.
Answer: A The YTM is greater than the nominal yield, or coupon yield. Therefore, the bond is trading at a discount.
The current yield of a 6% (<ANNUAL INTEREST PAYMENT) bond offered at 95 is: A) 6.3%. B) 63%. C) 5.7%. D) 6%.
Answer: A The current yield of 6.3% is computed by dividing the annual interest payment ($60) by the current market price ($950). A shortcut: only one logical answer is greater than 6%.
A customer purchases $50,000 worth of 10% corporate bonds at par. At the end of the day, the bonds close down a half point. The customer has a loss of: A) $250. B) $25. C) $2,500. D) $5,000
Answer: A The customer holds 50, $1,000 bonds. One bond point equals $10. Therefore, if each bond decreases by a half-point, the loss is $5 per bond; multiplied by 50 bonds, this equals $250.
An investor's portfolio includes an ABC 6% bond maturing in 2020 and 100 Shares of XYZ common stock. At market close, if the stock closed at $45.45 compared to yesterday's $44.95, and the bond moved from 95 to 95½ , the portfolio increased in value by: A) $55 B) $50 C) $100 D) $110
Answer: A The gain would be $5 for the bonds, (½ point for one bond is $5), and $50 for the stock, ($.50 × 100 shares) for a total of $55
An investor owns a 9% convertible bond issued by the XYZ Corporation, a subsidiary of the ABC Corporation. The bond is convertible at $25. This investor may convert the bond into A) 40 shares of common stock of the XYZ Corporation B) 4 shares of common stock of the ABC Corporation C) 4 shares of common stock of the XYZ Corporation D) 40 shares of common stock of the ABC Corporation
Answer: A To calculate the number of shares that a bond is convertible into, divide the bond's par value ($1,000) by the conversion price ($25). Because the bond was issued by the XYZ Corporation, this bond is convertible into 40 shares of XYZ Corporation's common stock.
A customer purchases a 4% corporate bond yielding 5%. A year before the bond matures, new corporate bonds are issued at 3%, and the customer sells the 4% bond. Which of the following statements regarding the bond are TRUE? I.The customer bought it at a discount. II.The customer bought it at a premium. III.The customer sold it at a premium. IV.The customer sold it at a discount. A) I and III. B) I and IV. C) II and III. D) II and IV.
Answer: A When the customer bought the bond, it was at a discount, since the YTM (5%) was higher than the nominal yield (4%). When he sold the bond, interest rates had declined to 3%, which was below his nominal yield. Therefore, since the bond has a higher coupon than current market rates, it would be sold at a premium.
A bond purchased at $900 with a 5% coupon and a five-year maturity has a current yield of: A) 7.8%. B) 5.6%. C) 5%. D) 7.4%.
Answer: B Current yield is determined by dividing annual interest payment by the current market price of the bond ($50 / $900 = 5.6%). Years to maturity is not a factor in calculating current yield.
Market interest rates have been rising, which means that the price of bonds traded in the secondary market has: A) stayed the same. B) not changed because bond prices are not affected by interest rates. C) decreased. D) increased.
Answer: C When interest rates rise, bond prices fall.
Corporate bonds are considered safer than common stock issued by the same company because: A) if there is a shortage of cash, dividends are paid before interest. B) bonds place the issuer under an obligation but stock does not. C) bonds and similar fixed-rate securities are guaranteed by SIPC. D) the par value of bonds is generally higher than that of stock.
Answer: B A bond represents a legal obligation to repay principal and interest by the company. Common stock carries no such obligation, and is therefore considered riskier.
Which of the following must be paid before a corporation may pay arrearages on cumulative preferred stock dividends? I. Dividends on common stock. II.Loan payments. III. Straight preferred stock dividends. IV. Bond interest. A) II and III. B) II and IV. C) I and III. D) I and IV.
Answer: B Both loan payments and bond interest are senior to dividends on common or preferred stock.
An investor has secured bonds maturing in two weeks. He plans to purchase some unsecured bonds he has identified on the secondary market that have a 6% coupon rate. If interest rates decline before the investor can purchase the new bonds, he can expect the income he will receive from the new bonds to: A) pay no interest. B) remain at $60 per year. C) increase to more than $60 per year. D) decline to less than $60 per year.
Answer: B Fluctuations in interest rates will affect a bond's price, but will not affect the bond's payable interest. The percentage interest payable for use of money is stated on the face of a bond and is part of the bond indenture, a legal obligation on the part of the issuing company.
The difference between par and a lower market price on a bond is called the: A) premium. B) discount. C) reallowance. D) spread.
Answer: B The difference between a bond's par (or face) value and a market price lower than par is known as the bond's discount from par.
A bond offered at par has a coupon rate: A) greater than its yield to maturity. B) equal to its current yield. C) less than its current yield. D) less than its yield to maturity.
Answer: B When a bond is selling at par, its coupon or nominal rate, current yield, and yield to maturity are all the same.
When a company liquidates assets, in which order are claims satisfied, earlier to later? A) Common stockholders, preferred stockholders, secured bondholders, debentures. B) Secured bondholders, debentures, preferred stockholders, common stockholders. C) Secured bondholders, preferred stockholders, common stockholders, debentures. D) Debentures, secured bondholders, common stockholders, preferred stockholders.
Answer: B With this type of question, look for what you know should be first and last; it simplifies choosing the correct answer. Only one choice starts with secured bondholders and ends with common stockholders.
Which of the following factors is least important in rating a bond? A) Stability of the issuer's cash flows. B) Asset protection available to the issuer. C) Bond's coupon. D) Amount and composition of issuer's existing debt.
Answer: C A bond's coupon rate tends to be dictated by market factors and is not a factor in rating the bond
When a registered representative refers to a corporate bond using the term "guaranteed", it means that the bond is: A) required to maintain a self-liquidating sinking fund. B) guaranteed as to payment of principal and interest by the U.S. government. C) guaranteed as to payment of principal and interest by another corporation. D) insured by AMBAC.
Answer: C A guaranteed corporate bond is one guaranteed by another corporation that typically has a higher credit rating than the issuing corporation, and is in a control relationship with it.
If an investor purchases $50,000 face value of 5.10 bonds at par due in 2025 and holds them to maturity, which of the following statements is TRUE? A) The investor will receive $50,000 less 5.10 market discount at maturity. B) The investor will receive $50,000 plus 5.10 at maturity. C) The investor will receive $50,000 and the final interest payment at maturity. D) The investor will receive $50,000, the final two interest payments, and 5.10 market gain at maturity.
Answer: C At maturity, the investor will receive par ($50,000) plus the last semi-annual interest payment.
An investor would like to make a long-term investment in a debt security whose duration is equal to its maturity. Which of the following AAA rated bonds should his registered representative recommend? A) MNO zero-coupon bond maturing in eight months. B) DEF ten-year 8% bond maturing in eight months. C) XYZ zero-coupon bond maturing in five years. D) ABC 8% ten-year bond maturing in five years.
Answer: C Because they make no interim payments, zero-coupon bonds have duration equal to maturity. Of the choices offered, only XYZ is both long term (over one year to maturity) and zero-coupon.
Moody's bond ratings are based primarily on an issuer's: A) capitalization. B) trading volume. C) financial strength. D) marketability.
Answer: C Bond ratings are credit ratings for an issuer and measure the issuer's ability to repay principal and interest and, thus, its financial strength.
Which of the following statements regarding a corporate bond quoted as QRS Zr 20 is TRUE? A) The bond pays $200 interest annually. B) The interest payable is tax free. C) The bond pays no interest until maturity. D) The bond pays $20 interest annually.
Answer: C QRS Zr 20 represents a zero-coupon bond issued by the QRS Company maturing in 2020. Zero-coupon bonds are bought at a discount and mature at face value. If a bond is held to maturity, the difference between the purchase price and the maturity price is considered interest, though it is taxed on a yearly basis.
An investor's portfolio includes ten bonds and 200 shares of common stock. If both positions increase by one point, what is the appreciation? A) $210. B) $220. C) $300. D) $100.
Answer: C The gain would be $100 for the bonds (one point for one bond is $10 × 10 bonds) and $200 for the common stock (one point is $1 × 200 shares). The total portfolio gain is $300.
All of the following statements regarding bonds registered as to principal only are true EXCEPT: A) coupons are attached. B) the registered owner may sell the bonds before maturity. C) such bonds can be purchased today in the secondary market. D) interest payments are sent directly to the owner twice a year.
Answer: D A bond registered as to principal only has a certificate registered in the owner's name and has bearer coupons attached to the bond certificate. Only the person to whom the bond is registered may sell the securities. Interest is not sent directly to the owner but is paid only if the interest coupons are presented to the bond's paying agent.
An electric company issued mortgage senior lien bonds, with an 8-7/8 coupon, priced at 96. Each bond pays annual interest of: A) $85. B) $85.51. C) $96.35. D) $88.75.
Answer: D A coupon of 8-7/8 represents an annual interest payment of 8-7/8% of $1,000, or $88.75. Because the interest rate always applies to par, which is $1,000, the issue price does not have an effect.
Which of the following is a characteristic of bearer bonds? A) They come in registered form. B) They have interest coupons in a separate envelope. C) They pay interest quarterly. D) They have interest coupons attached to the bond certificate.
Answer: D Bearer bonds, which are not registered to a specific holder, must have the interest coupons attached to the bonds.
What would happen to the market value of existing bonds during an inflationary period coupled with rising interest rates? A) The price of the bonds would increase. B) The price of the bonds would stay the same. C) The nominal yield of the bonds would increase. D) The price of the bonds would decrease.
Answer: D Bond prices fall when interest rates rise because bond prices have an inverse relationship with interest rates.
Bondholders are paid interest A) after the preferred stockholders receive their dividends, but before the common stockholders are paid. B) after the common stockholders are paid, but before the preferred stockholders are paid. C) at any time determined by the board of directors. D) before both the preferred and the common stockholders are paid dividends.
Answer: D Dividends are paid to both preferred and common stockholders only after interest has been paid on all of the corporation's outstanding debts and debt securities.
The current yield on a bond with a coupon rate of 7.5% currently selling at 105 is approximately: A) 7.6%. B) 7.5%. C) 9%. D) 7.1%.
Answer: D Each $1,000 7.5% bond pays $75 of interest annually. Current yield equals the annual interest divided by the current price of $1,050. Since the bond is at a premium, the current yield must be below the nominal yield, and only one answer fits.
All of the following statements about a bond selling above par value are true EXCEPT: A) the yield to maturity is lower than the nominal yield. B) the current yield is higher than the yield to maturity. C) the nominal yield always stays the same. D) the nominal yield is lower than the current yield.
Answer: D Nominal (i.e., coupon) yield is fixed and stays the same with all bonds. A bond selling above par is selling at a premium, so the yield to maturity is lower than the current yield, which, in turn, is lower than the nominal yield.
A 7% bond is quoted with a yield-to-maturity of 4.5%. The next time interest is paid, an investor who owns $1,000 face amount of the bonds will receive A) $22.50 B) $45 C) $70 D) $35
Answer: D The bond is a 7% bond. When the yield-to maturity is less than the coupon of 7%, which indicates the bond is selling at a premium (but has no bearing on the amount of interest paid). The total amount paid each year on 1 bond is $70. The amount of semi-annual interest is $35.
If your customer holds ten KLP 6% bonds, how much money will he receive in total at the debenture's maturity? A) $10,000. B) $10,200. C) $10,600. D) $10,300.
Answer: D The holder of 10 bonds will receive $10,000 in principal at maturity. Each bond pays 6% annual interest, or $60. Thus, ten bonds pay a total of $600 per year in two semiannual payments of $300. At maturity, the bondholder will receive the $10,000 face amount plus the final semiannual payment ($10,000 + $300 = $10,300).
Which of the following statements regarding corporate zero-coupon bonds are TRUE? I.Interest is paid semiannually. II.The discount is in lieu of periodic interest payments. III.The discount is taxed annually as phantom income. IV.The discount is not taxed until maturity. A) I and III. B) I and IV. C) II and IV. D) II and III.
Answer: D The investor in a corporate zero-coupon bond receives the return in the form of growth of the principal amount over the bond's life. The bond is purchased at a deep discount and redeemed at par at maturity. The discount from par represents the interest that will be earned at the maturity date. However, the discount is accreted annually and the investor pays income taxes yearly on the imputed interest.
