Debt

A 7% general obligation bond matures in 1 year. A municipal dealer quoting the bond has just changed his quote from a 7.30 basis to a 7.35 basis. The approximate dollar change in price per $1,000 bond is: A. $.50 B. $5.00 C. $50.00 D. $500.00

The best answer is A. 100 basis points equals 1 point on a bond = 1% of $1,000 par = $10.00 in interest per year. Since this bond has only 1 year to maturity, a 100 basis point change in quote (1 point) will equal a $10.00 change in price. This quote is being changed by 5 basis points (from 7.30 basis to 7.35 basis), so the approximate price change on this 1 year bond 1/20th (5/100) of $10 is $.50.

A customer buys 10M of Allied Corporation 8% debentures, M '35, at 90 on Tuesday, October 8th. The interest payment dates are Feb. 1st and Aug. 1st. The trade settled on Thursday, October 10th. The amount of the next interest payment will be: A. $400 B. $444 C. $800 D. $888

The best answer is A. 10M stands for 10 - $1,000 bonds (M is Latin for $1,000) = $10,000 face amount of bonds. The bonds pay 8% interest annually. 8% of $10,000 is $800 annual interest. Since payments are made semi-annually, $400 is the amount of each payment. Note that the accrued interest paid from buyer to seller on settlement has no effect on the payments made by the issuer to the bondholder of record.

Wide swings in market interest rates would affect which of the following for holders of collateralized mortgage obligations? I Prepayment Rate II Interest Rate III Market Value IV Credit Rating A. I and III B. II and IV C. I, II, III D. I, II, III, IV

The best answer is A. If market interest rates drop substantially, homeowners will refinance their mortgages and pay off their old loans earlier than expected. Thus, the prepayment rate for CMO holders will increase. Furthermore, as interest rates drop, the value of the fixed income stream received from those mortgages increases, so the market value of the security will increase. Market interest rate movements have no effect on the stated interest rate paid by the security; and would not affect the credit rating of the issue.

In 2019, a customer buys 1 GE 8%, $1,000 par debenture, M '34, at 110. The interest payment dates are Jan 1st and Jul 1st. The yield to maturity on the bond is: A. 6.98% B. 7.58% C. 8.00% D. 8.24%

The best answer is A. The formula for yield to maturity for a premium bond is: $80 - ($100 premium / 15 years to maturity) ($1,100 + $1,000) / 2 = $80 - $6.67 $1,050 = $73.33 $1,050 = 6.98%

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.

A decreasing market rate of interest would lead to: A. higher bond prices and higher bond yields B. higher bond prices and lower bond yields C. lower bond prices and lower bond yields D. lower bond prices and higher bond yields

The best answer is B. A declining market rate of interest means that interest rates are dropping. If market interest rates drop, then bond prices will rise, and the yields on those bonds will fall.

The Government National Mortgage Association: A. buys conventional mortgages from financial institutions for repackaging as pass through certificates B. buys FHA and VA guaranteed mortgages from financial institutions for repackaging as pass through certificates C. gives its implied backing to the payment of interest and principal on mortgages purchased from financial institutions D. issues mortgages directly on U.S. Government subsidized housing

The best answer is B. Ginnie Mae buys FHA and VA guaranteed mortgages from banks and assembles them into pools. GNMA then sells undivided interests in these pools as pass-through certificates. The monthly mortgage payments are passed through to the certificate holders. GNMA guarantees the payment of interest and principal on the underlying mortgages and has the direct backing of the U.S. Government. The agencies that have an implied U.S. Government backing are Fannie Mae and Freddie Mac.

A customer in the 28% tax bracket is considering the purchase of a municipal bond yielding 11% or a corporate bond yielding 16%. Both bonds have similar maturities and credit ratings. Which statement is TRUE? A. The effective yield on the municipal bond is higher B. The effective yield on the corporate bond is higher C. Both effective yields are equivalent D. The coupon rates for each bond are necessary to determine the effective yield

The best answer is B. In order to compare the tax free municipal yield to the taxable corporate yield, the two must be equalized. 11% (100% - 28%) = 15.3% Since the corporate bond is yielding 16%, the corporate yield is higher.

When a municipal dealer gives a customer a "bond appraisal," he is disclosing: A. a firm price at which the bonds can be sold based on the market prices of similar securities B. a likely price at which the bonds can be sold based on the market prices of similar securities C. his inventory position of similar securities D. the last prices at which trades actually took place of similar bonds

The best answer is B. Municipal dealers are often asked for bond appraisals by customers who wish to sell bonds. Because there is no active trading market for municipal bonds, last trading price information is not available. To get an idea of the value of the bond, the dealer will get prices of similar bonds and then give an estimated price to the customer. This is a likely sale price - not a firm quote.

Municipal variable rate demand notes: I have a market value which will never go below par II have a market value which will never go above par III have a yield which will never fall below the stated rate IV have a yield which will never rise above the stated rate A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Municipal variable rate demand notes are issued by a municipality. The interest rate is reset to the market rate weekly; and at the reset date, the holder can "put" the bonds back to the issuer at par. Here, the minimum value of the bond is par - because of the put feature. Because the price of the bond cannot go below par, these bonds are not subject to market risk and the yield cannot go above the stated rate. However, if interest rates fall, the price can go above par (by a small amount) and the yield can fall below the stated rate until the next reset date.

A corporation has issued 7% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 8%. Which of the following are TRUE statements about the outstanding 7% issue? I The current yield will be higher than the nominal yield II The current yield will be lower than the nominal yield III The dollar price of the bond will be at a premium to par IV The dollar price of the bond will be at a discount to par A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The bond was issued with a coupon of 7%. Currently, the yield for a similar issue is 8%. Therefore, interest rates have risen subsequent to the issuance of the bond; or the credit quality of the bond has deteriorated. When interest rates rise, yields on bonds already trading must also rise. What causes this is a drop in the dollar price of the issue - the bond now trades at a discount.

A customer bought a $1,000 par convertible subordinated debenture at par, convertible into common at $31.25 per share. If the bond's market price increases by 20%, the conversion ratio will be: A. 31.25:1 B. 32.00:1 C. 37.50:1 D. 38.40:1

The best answer is B. The conversion price (and hence the conversion ratio) is fixed when the convertible security is issued and does not change. In this case, the bond is issued with a conversion price of $31.25, based upon converting each bond at par. $1,000 par / $31.25 conversion price = 32:1 conversion ratio. Thus, for every bond that is converted, the holder receives 32 shares.

A municipality would issue a GAN in anticipation of receiving: A. property tax collections B. proceeds from a long term bond sale C. federal transit funding D. federal highway funding

The best answer is C. A "GAN" is a municipal "Grant Anticipation Note." A GAN would be issued by a municipality to get immediate access to federal grant monies that are expected to be received months into the future. These grant monies typically are used to support mass transit programs, like buses and subways for cities. Note, in contrast, that a "RAN" - Revenue Anticipation Note - is paid from expected revenues to be received in the future, and that this source of funding is usually federal highway funds

An investor purchases a bond, which pays interest on January 1st and July 1st. The trade settles on May 1st. How many months of interest will the buyer receive from the issuer in the next interest payment? A. 1 month B. 3 months C. 6 months D. 12 months

The best answer is C. Issuers make fixed semi-annual interest payments to bondholders covering the preceding 6-month period. If the bond is traded in-between interest payment dates, the payment of accrued interest from buyer to seller ensures that each party gets the correct amount of interest. In this example, the buyer will receive the 6 month interest payment from the issuer; but will have paid 4 months of accrued interest to the seller on settlement. Thus, the buyer correctly only "earns" the net amount of 2 months of interest corresponding to the period that he or she held the bond.

A municipal "broker's broker" does which of the following? I Executes trades as agent for institutional clients II Executes trades as agent for other dealers III Trades for the firm's own account IV Obtains quotes from other dealers A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is C. Municipal broker's brokers act as agents handling large municipal orders, usually for institutions. These firms do not act as market makers and do not take inventory positions.

Net Direct Debt and Overlapping Debt equals: A. Debt per Capita B. Debt to Assessed Valuation C. Net Overall Debt D. Overlapping Debt

The best answer is C. Net Overall Debt of a municipality is used as the numerator in Debt Per Capita ratios and Debt to Assessed Value ratios. These ratios measure the relative size of the municipality's debt level. Net Overall Debt is: Net Direct Debt + Overlapping Debt.

The municipal bond counsel opines on all of the following EXCEPT: A. validity B. legality C. feasibility D. tax exempt status

The best answer is C. The bond counsel examines new municipal issues for legal or tax problems and renders an opinion on the validity, legality and tax exempt status of the issue. Bond counsels do not render economic opinions, which is the same as rendering an opinion on feasibility of an issue.

A corporation has issued 8% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 7%. Which are TRUE statements about the outstanding 8% issue? I The current yield will be higher than the nominal yield II The current yield will be lower than the nominal yield III The dollar price of the bond will be at a premium to par IV The dollar price of the bond will be at a discount to par A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. The bond was issued with a coupon of 8%. Currently, yield for a similar issue is 7%. Therefore, interest rates have fallen subsequent to the issuance of the bond; or the credit quality of the bond has improved. When interest rates fall, yields on bonds already trading must also fall. What causes this is a rise in the dollar price of the issue - the bond now trades at a premium.

The yield to maturity for a premium bond is: A. stated interest rate - annual capital loss / bond par value B. stated interest rate + annual capital gain / bond par value C. stated interest rate - annual capital loss / bond average value D. stated interest rate + annual capital gain / bond average value

The best answer is C. The formula for yield to maturity for a premium bond is:

A 10 year 7% municipal bond, quoted on a 5.00 basis, is priced at 104. A 10 year 6% municipal bond, quoted on a 5.00 basis, is priced at 101. What is the price of a 10 year, 6.30% municipal bond, quoted on a 5.00 basis? A. 100.60 B. 100.80 C. 101.90 D. 104.50

The best answer is C. This question is asking for the following: 7% Coupon 5.00 Basis 104 6.3% Coupon 5.00 Basis ? 6% Coupon 5.00 Basis 101 The difference in price between the 6% and 7% bonds is 3 points. The 6.30% bond is 30% of the way from 6% to 7%. 30% x 3 points = .90 point price increment from the 6% price. 101 + .90 = 101.90 price for the 6.30% bond.

Which statements are always TRUE about Treasury Bonds? I Treasury Bonds are traded in 32nds II Treasury Bonds are quoted at a discount to par value III Treasury Bonds are issued in either bearer or registered form IV Treasury Bonds have minimum maturity of more than 10 years A. I and II only B. II and IV only C. I and IV only D. I, III and IV

The best answer is C. Treasury Notes have maturities of 10 years or less. Treasury Bonds have maturities that are greater than 10 years - currently they are issued with 30 year maturities. Both are quoted on a percentage of par basis in 32nds. All Treasury issues are available only in book entry form. There are no bearer or registered issues.

A yield quote change of 5 basis points on municipal bonds with a 6.25% nominal yield will result in the greatest dollar price change for bonds quoted at: A. 8.20% with 3 years to maturity B. 8.30% with 3 1/2 years to maturity C. 8.40% with 4 years to maturity D. 8.50% with 4 1/2 years to maturity

The best answer is D. All of the bonds listed are discount bonds. As a general rule, the deeper the discount, the more volatile the bond's price movements in response to market interest rate changes. Also, the longer the maturity, the more volatile the bond's price movements in response to market interest rate changes. The 6.25% bond quoted on an 8.50% yield with 4 1/2 years to maturity has both the longest maturity and deepest discount. This bond's price will move the farthest in response to market interest rate changes.

Municipal broker's brokers: I deal with the general public II do not deal with the general public III take inventory positions IV do not take inventory positions A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Municipal broker's brokers perform specialized trades for institutional investors on an agency basis only - they do not carry inventory positions nor do they deal with the general public.

Interest income from which municipal bond is LEAST likely to be included as a tax preference item under the Alternative Minimum Tax (AMT)? A. Airport revenue bond B. Convention center revenue bond C. Private utility revenue bond D. Water revenue bond

The best answer is D. Private purpose revenue bonds are taxable municipal bonds. They can either be subject to regular income tax, or If they are "qualified private purpose bonds," they are subject to AMT. Choices A, B and C are private uses. Choice D is an essential public use and the interest income would be federally tax-free.

A municipal bond dealer quotes 15 year 3% Revenue bonds at 97 3/4 - 99. The dealer's spread per $1,000 is: I $1.25 II $12.50 III 12.5 basis points IV 125 basis points A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. The spread is 1.25 points, which is 1 1/4% of $1,000 par, which equals $12.50. $12.50 is the same as 125 basis points, since each basis point equals $.10.

The nominal yield on a bond is: A. stated interest rate / bond par value B. stated interest rate / bond market value C. market interest rate / bond par value D. market interest rate / bond market value

The best answer is A. The nominal yield is the stated rate of interest on the bond, based on par value.

A CMO Z-tranche: A. receives payments prior to all other tranches B. receives payments after all other tranches C. receives payments on a pro-rata basis with other tranches D. does not receive payments

The best answer is B. A Z-tranch is a "Zero" tranche. It gets no payments until all prior tranches are retired. Then it is paid off at par. It acts like a long-term zero-coupon bond, so it is most susceptible to interest rate risk.

A municipal bond that has a put option is protected against depreciation due to: I rising interest rates II falling interest rates III rising demand for the issue IV falling demand for the issue A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. A bond with a put option allows the holder to put back the bond to the issuer at par value. Thus, this bond, once the put option is exercisable, is always worth at least par. Therefore, if interest rates rise or if market demand falls, this bond's price cannot fall below par (unlike traditional bonds).

Which of the following would NOT be considered when evaluating the credit risk of a municipal revenue bond? A. Coverage ratios B. Legislative actions C. Competing facilities D. Management experience

The best answer is B. Credit risk is the risk that a bond will default. To evaluate this risk for a revenue bond issue, one would examine coverage ratios; the effect of competing facilities; and the management of the facility. Legislative actions have no bearing on credit risk. Potential effects of adverse legislative actions would be evaluated as legislative risk.

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.

Which of the following debt securities may be issued by a corporation? I Mortgage Bonds II Collateral Trust Certificates III Revenue Bonds IV Income Bonds A. I and IV only B. II and III only C. I, II, IV D. I, II, III, IV

The best answer is C. Corporations do not issue revenue bonds - rather, these are a type of municipal bond. Corporations can issue mortgage bonds (backed by real property), collateral trust certificates (backed by a portfolio of marketable securities), and income or adjustment bonds (that obligate the issuer to pay only if there are sufficient earnings).

The interest income earned on which of the following municipal bonds would be included in the alternative minimum tax computation? A. School District Bond B. Turnpike Revenue Bond C. Industrial Revenue Bond D. Water District Revenue Bond

The best answer is C. The interest income derived from "non-essential use" private purpose revenue bonds is included in the alternative minimum tax computation. Industrial Revenue Bonds fall into this category. Public purpose bonds, such as G.O.'s, and public facility revenue issues are not subject to the alternative minimum tax (AMT).

Which of the following securities cannot be margined? A. Treasury bills B. Commercial paper C. Bankers' acceptances D. Structured products

The best answer is D. Because money market instruments are "safe," they can be margined - meaning that the brokerage firm can lend money against these securities held as collateral for the loan. Government securities, agency securities, investment grade money market instruments, investment grade corporate bonds and listed stocks are the marginable securities. As a general rule, structured products cannot be margined because they are not readily transferable.

This portfolio is diversified as to which of the following? I Issuer II Geography III Credit quality IV Maturity

The best answer is D. The issues have different credit ratings; different maturities; different issuers; and different issuer residencies; so the portfolio is diversified for all items.

A customer buys a $1,000 par reverse convertible note with a 1 year maturity and a 6% coupon rate. At the time of purchase, the reference stock is trading at $50 and the knock-in price is set at $40. If, at maturity, the reference stock is trading at $25, the customer will receive: A. $1,000 par B. 20 shares of the reference stock C. 25 shares of the reference stock D. 40 shares of the reference stock

he best answer is B. Reverse convertible notes were created for customers looking for enhanced yield in a low interest rate environment. Of course, any enhanced yield comes with higher risk. The note is linked to the price movements of an underlying stock (or very rarely, an underlying index). At maturity, the holder will receive par value, as long as the price of the reference stock is above the "knock-in" price (typically 70-80% of the initial reference price). On the other hand, if at maturity, the reference stock falls below the "knock-in" price, then the holder will receive the shares of stock. In this example, the share price has fallen from $50 to $25, which is below the "$40 knock-in" price. Thus, at maturity, the holder of the note will get the stock - not par value. The original conversion ratio was based on the reference price of $50. $1,000 par / $50 conversion reference price = 20 shares per note. Thus, at maturity, the customer gets 20 shares, currently worth $25 each = $500 worth of stock. This customer has lost $500, partially offset by any interest income received.

When comparing a CMO Planned Amortization Class (PAC) to a CMO Targeted Amortization Class (TAC), all of the following statements are true EXCEPT: A. Both PACs and TACs offer the same degree of protection against extension risk B. PACs differ from TACs in that TACs do not offer protection against a decrease in prepayment speeds C. PACs are similar to TACs in that both provide call protection against increasing prepayment speeds 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.

A municipal revenue bond trust indenture includes an "additional bonds test" covenant. This means that: A. an earnings test must be satisfied before additional bonds can be issued against the same revenue source B. additional bonds can only be issued if they have a subordinated lien on pledged revenues C. additional bonds can only be issued after the original issue is called or advance refunded D. additional bond issues having a lien on the same revenue source are prohibited

The best answer is A. An "additional bonds test" means that the issuer is prohibited from issuing new bonds against the revenues of a facility, unless the facility's revenues are sufficient. Typically, the debt service on the old bonds is added to that of the new bonds. The revenues of the facility must cover, by an adequate margin, the combined debt service before additional bonds can be sold.

When comparing an ETN to a structured product, which statement is TRUE? A. ETNs can be traded at any time while structured products cannot B. ETNs offer current income while structured products do not C. ETN income is taxable at higher rates than income from structured products D. ETNs are equity securities that are exchange listed

The best answer is A. An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. They are not an equity security - they are a debt instrument. ETNs are listed on an exchange and trade, so they have minimal liquidity risk. In comparison, a regular structured product is non-negotiable and, if redeemed prior to maturity, imposes an early-redemption penalty. ETNs make no interest or dividend payments. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to other structured debt products.

What constitutes a failed auction for an Auction Rate Security? I Lack of bids II Lack of offers III Clearing rate below bid rate IV Clearing rate above bid rate A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Auction Rate Securities are either preferred stock or bonds that have the dividend rate or interest rate reset at a weekly auction. In order to have a successful auction for anything, there must be bidders (buyers) for the securities offered. A lack of bids (or no bids) will result in no auction, making Choice I correct. The auction is conducted as a "Dutch Auction," where bids are accepted in minimum $25,000 increments to buy the amount of securities offered. The bids are accepted from the lowest interest rate on up to the highest interest rate, and bids are accepted until the total amount offered is sold. The highest interest rate bid that is accepted to complete the sale of the issue is called the "clearing rate" and the entire offering gets this interest rate for the next week. Note that there is usually a maximum interest rate set on bids (otherwise, the issuer could be forced to pay exorbitant interest rates if the only bids received were at excessively high interest rates). If the interest rate bids received are at or below the maximum rate, then the auction is carried out as a Dutch Auction. If the interest rate bids are above the maximum rate (this implies that the issuer's perceived credit quality has deteriorated or that market conditions are excessively volatile and buyers are demanding much higher interest rates), then the auction has "failed" and the sellers (holders) of the securities will carry the positions to the next week, during which they will receive the maximum interest rate on those securities. Then another auction will be attempted. Thus, the risk for the holder of an ARS is not that interest will not be earned; rather it is that the holder may be forced to continue to hold the security when that customer really wants to dispose of the position. This occurs when there is either a lack or bids; or the bids received are at interest rates that are higher than the maximum or clearing rate (which is the same as saying that the clearing rate is below the interest rate bid).

Price volatility of a CMO issue would most closely parallel that of an equivalent maturity: A. Treasury bond B. Mortgage backed pass-through certificate C. Treasury STRIP 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.

Which of the following can initiate repurchase agreements with government and agency securities as collateral? I Federal Home Loan Banks II Commercial banks III Federal Reserve Banks IV Government securities dealers A. II, III, IV B. I, II, III C. I, III, IV D. I, II, III, IV

The best answer is A. Government securities dealers, Commercial banks, and the Federal Reserve through its open market trading desk, all initiate repurchase agreements. Federal Home Loan Banks sell bonds to obtain funding. With the funds, it buys mortgages from Savings and Loans, making a secondary mortgage market and injecting fresh funds into the S&L's.

Which of the following statements are TRUE regarding a municipal bond issue that is advance refunded? I The security that backs the advance refunded bonds will change after the issue is refinanced II The security that backs the advance refunded bonds will not change after the issue is refinanced III The marketability of the advance refunded bonds will increase after the issue is refinanced IV The marketability of the advance refunded bonds will decrease after the issue is refinanced A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. In an advance refunding, the issuer floats a new bond issue and uses the proceeds to "retire" outstanding bonds that have not yet matured. These funds are deposited to an escrow account and are used to buy U.S. Government securities. The escrowed U.S. Government securities become the pledged revenue source backing the refunded bonds. These bonds no longer have claim to the original revenue source. Since there is a new source of backing for the bonds (and an extremely safe one!), the credit rating on the pre-refunded bonds increases, as does their marketability. The refunded bonds no longer have any claim to the original pledged revenues - and thus have been "defeased" - that is, removed as a liability of the issuer. (Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)

Jumbo Certificates of Deposit in amounts above $250,000 are guaranteed by the: I issuing bank II Federal Deposit Insurance Corporation III Securities Investor Protection Corporation A. I only B. II only C. I and II D. I and III

The best answer is A. Jumbo Certificates of Deposit are issued by banks in amounts larger than $100,000 (often, the minimum deposit is $1,000,000). Since FDIC insurance only covers deposits of up to $250,000, they are not FDIC insured for any amount that exceeds $250,000. They are backed solely by the guarantee of the issuing bank. SIPC does not cover bank deposits - it covers customer accounts at securities firms.

If an issuer defaults on a moral obligation bond, payment can only be made by: A. legislative apportionment B. judicial edict C. legal authorization D. municipal injunction

The best answer is A. Moral obligation bonds are backed by pledged revenues and also by a non-binding pledge to report any revenue deficiencies to the state legislature. The legislature is authorized to apportion the funds necessary to service the debt, but is under no obligation to do so.

Interest income from which of the following bonds is most likely to be considered a "tax preference item" in the Alternative Minimum Tax calculation? A. Airport revenue bond B. Hospital revenue bond C. Water revenue bond D. General obligation bond

The best answer is A. Municipal "Private Activity Bonds" are taxable - the interest income is subject to federal income tax. If the PAB is "qualified," then the interest income is not subject to regular income tax, but it is a tax preference item included in the AMT calculation (which typically only hits higher income taxpayers who take a lot of deductions). Qualified PABs include bonds where the proceeds go to finance the activities of a private entity, including airports, docks, residential rental projects that are privately owned, waste disposal projects, water and sewer facilities that are privately owned and enterprise zones. Note that if any of these activities were being done by public entities, the bonds would be tax-free.

Municipal dollar bonds are: I term bonds II serial bonds III quoted on a percentage of par basis IV quoted on a yield basis A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. Municipal dollar bonds are quoted on a percentage of par basis and are term bonds. Municipal serial bonds are quoted on a yield to maturity basis.

150 basis points are equal to: I $15.00 per $1,000 II $150.00 per $1,000 III 1.5% IV 15% A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. One basis point is .01% of interest. 100 basis points equals 1% of interest. 150 basis points equals 1.50%, which is the same as $15.00 per $1,000 face amount on a bond.

All of the following trade "and interest" EXCEPT: A. Treasury Bills B. Treasury Notes C. Treasury Bonds D. Corporate Bonds

The best answer is A. Original issue discount obligations trade "flat" - without accrued interest. Every day the issue is held, its value increases towards the redemption price of par. This increase in value is the interest income earned on the obligation. Obligations issued at par make periodic interest payments. They trade "and interest" - with accrued interest. These include Treasury Notes, Treasury Bonds, Corporate Bonds, and Municipal Bonds.

The obligor on a municipal bond issue is the: A. borrower of the bond proceeds B. lender of the bond proceeds C. guarantor of the payment of debt service on the bond issue D. fiduciary acting for the benefit of the bondholders

The best answer is A. The "obligor" on a bond issue is the party having the obligation to pay the debt service on the bonds. This is the "legal" name for the borrower or debtor.

Interest income from municipal bonds purchased by a resident of the issuing State is: A. exempt from Federal, State and Local tax B. exempt from Federal tax and subject to State and Local tax C. subject to Federal tax and exempt from State and Local tax D. subject to Federal, State and Local tax

The best answer is A. The interest income from municipal bonds is exempt from Federal income tax; but is subject to State and Local tax. However, if a bond is purchased by a State resident, then the State exempts that issue from taxation as well.

Which of the following are investment grade bonds? I A-rated II BBB-rated III BB-rated IV CCC-rated A. I and II only B. II and III only C. III and IV only D. I, II, III, IV

The best answer is A. The lowest investment grade is BBB. Any securities below this rating (BB or lower) are considered to be speculative - and are commonly known as "junk" issues.

XYZ Debentures Issue Date: 8-1-XX Payment Dates: J 1 & J 1 Maturity Date: 7-1-XX Some years after issuance, a customer buys 10 debentures in a regular way trade on Friday, October 14th. The customer will owe the seller: A. 107 days of accrued interest B. 108 days of accrued interest C. 109 days of accrued interest D. 110 days of accrued interest

The best answer is A. The purchase on Friday, October 14th will settle on Tuesday, October 18th - 2 business days after trade date. Accrued interest on corporate bonds is based on a 30 day month / 360 day year. And interest starts accruing from the morning of the last interest payment, up to, but not including, settlement. So, 30 days are due for July, 30 days for August, 30 days for September, and 17 days for October (up to but not including settlement) = 107 days total.

As stated in the flow of funds found in a revenue bond issue's trust indenture, before the revenues collected are applied to the operations and maintenance fund, revenues are placed in the: A. Revenue Fund B. Debt Service Reserve Fund C. Sinking Fund D. Reserve Maintenance Fund

The best answer is A. The trust indenture of a revenue bond issue includes a "flow of funds" - meaning how revenues will be applied by the issuer. As revenues are collected, they are first deposited to a revenue fund. The monies are then applied, in sequence, to the operation and maintenance account; sinking fund; debt service reserve fund; reserve maintenance fund; renewal and replacement fund; and finally to the surplus fund.

Which security is considered to have a "risk-free" rate of return? A. Treasury Bill B. Treasury Note C. Treasury Bond 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.

A 15 year 3 1/4% Treasury Bond is quoted at 100-12 - 100-16. The bond pays interest on Jan 1st and Jul 1st. A customer sells 5M of the bonds. Approximately how much will the customer receive, disregarding commissions and accrued interest? A. $5,006.00 B. $5,018.75 C. $5,025.00 D. $5,028.75

The best answer is B. "5M" means that the customer is selling $5,000 par value of the bonds (M is Latin for $1,000). The customer sells to the dealer at the bid price, which is 100 and 12/32nds = 100.375% of $5,000 par = $5,018.75.

Which of the following statements are TRUE regarding CMO "Planned Amortization Classes" (PAC tranches)? I PAC tranches reduce prepayment risk to holders of that tranche II PAC tranches increase prepayment risk to holders of that tranche III Principal repayments made earlier than expected are applied to the PAC prior to being applied to the Companion tranche IV Principal repayments made later than expected are applied to the PAC prior to being applied to the Companion tranche A. I and III B. I and IV C. II and III 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.

Sallie Mae debentures are backed by: A. the full faith and credit of the U.S. Government B. the full faith and credit of the Student Loan Marketing Association C. designated pooled mortgages 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.

Regarding the allocation of CMO cash flows, which statements are TRUE? I Interest received from the underlying securities is allocated pro-rata to all tranches II Interest received from the underlying securities is allocated sequentially by tranche maturity III Principal repayments received are allocated pro-rata to all tranches IV Principal repayments received are allocated sequentially by tranche maturity A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. A CMO backed by 30 year mortgages might be divided into 15-30 separate tranches. 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.

Which of the following bond issues would most likely have a mandatory sinking fund? I U.S. Government bond II General Obligation bond III Hospital Revenue bond IV Airport Revenue bond A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is B. A bond issue is likely to have a mandatory sinking fund provision if it is perceived to be somewhat risky causing potential purchasers to demand this additional safeguard. Treasury Bonds are backed by the full faith and credit of the U.S. Government, so these issues have no credit risk. State General Obligation bonds are backed by the unlimited taxing power of the State, and also are perceived to be of low risk. Hospital Revenue bonds and Airport Revenue bonds are backed solely by the facility's revenues and are considered to be somewhat risky. (If there is hospital overbuilding or patient stays are shortened, revenues can fall; if another airport is built nearby that takes away passengers, revenues can fall; etc.)

Special assessment bond issues are paid from: A. taxes levied upon all taxable property within the municipality, without limitation as to rate or amount B. taxes levied upon all taxable property within a particular locality, not to exceed the benefit derived from the improvement C. revenues pledged from the operation of a facility built with the proceeds of the issue D. excise taxes placed upon the sale of either alcohol, tobacco, or fuel

The best answer is B. A special assessment bond is one which is used to fund an improvement that benefits only a segment of the population; and only those people are charged taxes to pay for that improvement. Such taxes cannot exceed the value of the benefit received. This makes them totally different from general tax collections, such as ad valorem taxes, which have no such "tie-in".

A new issue corporate bond has a dated date of September 1st. The bond is assigned by the issuer to the underwriter on August 31st. Accrued interest on the bond will be calculated based on how many days in a year? A. 359 B. 360 C. 364 D. 365

The best answer is B. Accrued interest on a corporate bond is calculated on a 30-day month / 360-day year basis. All of the other information in the question is irrelevant. Note that if the question asked about how many days of interest will be paid in the first interest payment, then the interest accrual starts on the dated date of September 1st (the date of legal issuance of the bonds) and ends when the first interest payment is made (which would be January 1st for most bond issues, since they use a "standard" January 1st and July 1st for the interest payment dates). In this case, the first interest payment would cover the months of September, October, November and December = 120 days.

Which statements are TRUE about ETNs? I ETNs are a structured product II ETNs are an investment company product III ETNs are suitable for investors seeking income IV ETNs are suitable for investors seeking long-term capital gains A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. ETNs make no interest or dividend payments, so they are not suitable for an investor seeking income. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to conventional debt instruments.

Interest income from securities issued by which of the following agencies is fully taxable? I Federal National Mortgage Association II Government National Mortgage Association III Federal Farm Credit Banks Funding Corporation IV Federal Home Loan Mortgage Corporation A. II only B. I, II, IV C. I, III, IV D. I, II, III, IV

The best answer is B. As a general rule, interest income from agency securities is subject to Federal tax and exempt from State and Local tax. However, the interest income from the pass-through certificates issued by the 3 housing agencies is fully taxable. These are: Federal National Mortgage Association ("Fannie Mae") Government National Mortgage Association ("Ginnie Mae") Federal Home Loan Mortgage Corporation ("Freddie Mac")

In order to recommend a structured product to a customer, all of the following statements are true EXCEPT: A. the member firm must perform a "reasonable basis" suitability determination evaluating the characteristics of the product to be recommended against competing products B. completion of the "reasonable basis" suitability determination means that the structured product can be recommended to all the firm's customers C. the member firm must perform a "customer specific" suitability determination prior to recommending a structured product to a customer D. the member must use its expertise to determine if the potential yield of the structured product is an appropriate rate of return in relation to the volatility of the reference asset

The best answer is B. Because of the complexity of structured products, which is typically a zero-coupon "synthetic bond" that gives a return tied to a market index such as the NASDAQ 100 Index or the Standard and Poor's 500 Index; and which has a maturity based on an embedded option; FINRA requires that the member firm perform a "reasonable basis" suitability determination to evaluate the product's potential rewards and risks (relative to other similar structured products offered by other firms). Once a "reasonable basis" suitability determination has been completed, then the member firm can offer the structured product only to its customers that are suitable for that investment. This is "customer specific" suitability. It cannot be recommended to all customers, since a specific suitability determination is required for each recommendation.

CMO investors are subject to which of the following risks? I Default risk II Credit risk III Prepayment risk IV Reinvestment risk A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is B. CMO investors have almost no default risk (the same thing as credit risk), since the underlying mortgages are usually implicitly backed by the U.S. Government. CMO tranch holders are subject to extension risk - the risk that the expected life of the tranch becomes much longer due to a rise in interest rates causing homeowners to keep their existing mortgages longer than expected. CMO tranch holders are subject to prepayment risk - the risk that the expected life of the tranch becomes much shorter due to a decline in interest rates causing homeowners to refinance and prepay their existing mortgages earlier than expected. The purchaser of a CMO tranch is subject to interest rate risk - if interest rates go higher, then the value of the tranch will decline. Finally, CMO tranch holders are subject to reinvestment risk, since monthly payments must be reinvested at the same interest rate to maintain the same rate of return on the investment. The only securities that do not have reinvestment risk are zero-coupon obligations.

All of the following statements are true about Eurodollar bonds EXCEPT: A. U.S. corporate issuers are not subject to foreign currency risk B. foreign corporate issuers are not subject to foreign currency risk C. trading is centered in the European market D. the bonds are issued in bearer form

The best answer is B. Eurodollar bonds are issued in bearer form outside the U.S. and trading is centered in London. Because the bonds are payable only in dollars, U.S. based issuers do not run any foreign currency risk. However, foreign issuers of Eurodollar bonds are subject to foreign currency risk. For example, if a British corporation issues Eurodollar bonds, and the British Pound declines in value relative to the dollar, then it will cost the British company more (in Pounds) to pay the debt service on the bonds.

Which of the following statements are TRUE about the taxation of interest on securities issued by the Federal Farm Credit Banks Funding Corporation? I Interest is exempt from state and local taxes II Interest is subject to state and local taxes III Interest is exempt from Federal tax IV Interest is subject to Federal tax A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. Federal Farm Credit Banks Funding Corporation does not issue pass-through certificates. Interest received gets the same tax treatment as Treasury issues. Interest on Federal Farm Credit issues is subject to federal income tax but exempt from state and local tax.

All of the following statements are true regarding GNMA "Pass Through" Certificates EXCEPT: A. the certificates are quoted on a percentage of par basis in 32nds B. the certificates are available in $1,000 minimum denominations C. certificates trade "and interest" 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.

Two 20-year corporate bonds are issued at par, with stated interest rates of 10%. One issue is puttable at par in 5 years, while the other is puttable at par in 10 years. If interest rates rise by 200 basis points shortly after issuance, which statement is TRUE? A. The bond puttable in 5 years will depreciate more than the bond puttable in 10 years B. The bond puttable in 10 years will depreciate more than the bond puttable in 5 years C. Both bonds will depreciate by equal amounts D. The rate of depreciation depends on the credit rating of the bonds

The best answer is B. If a bond is puttable at par in the near future, any price decline due to rising interest rates will be suppressed since the holder is able to put the bond back to the issuer sooner. Thus, the bond puttable in 10 years will depreciate more than the bond that is puttable in 5 years if interest rates rise.

A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive: A. $500 B. 103% of $500 C. $1,000 D. 103% of $1,000

The best answer is B. If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract.

Which of the following statements are TRUE regarding the effect of market interest rate movements on callable and puttable bond prices? I When interest rates fall, the call price tends to set a ceiling on the market price of the bond II When interest rates fall, the call price tends to set a floor on the market price of the bond III When interest rates rise, the put price tends to set a ceiling on the market price of the bond IV When interest rates rise, the put price tends to set a floor on the market price of the bond A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. If interest rates drop, it is more likely that an issuer will call its bonds. As interest rates drop, bond prices in the market will rise. The price will not rise by as much for a callable issue as that for a non-callable issue. The reason: why would someone pay a premium for an issue that is likely to be called off the market? The price for a puttable bond sets a floor under the market price of the bond during periods of rising interest rates. The price will never drop much below par once the option is exercisable, because if it did, customers would buy as many of the bonds as possible and "put" them to the issuer at par for a capital gain.

A customer purchases a convertible bond at 90, convertible into the common stock at $40. The common stock is currently trading at $36. The company declares a 25% stock dividend. The bond trust indenture includes an anti-dilution clause. After the ex date for the stock dividend, the conversion price for this bond issue will be: A. $30 B. $32 C. $36 D. $40

The best answer is B. If the company issues additional shares, each of the existing shares is worth "less" since the company's earnings are spread over a greater number of shares. Thus, the market price will adjust downward to reflect this. If a company issues 25% more shares (after the dividend, there will be 1.25 times the old number of shares), then the earnings and consequently the share price will drop by a factor of 1/1.25. The bondholder bought the issue based on a conversion price of $40. The market price of the stock is being diluted by the additional shares, reducing or eliminating the value of the bondholder's conversion feature. To protect the bondholder from this occurrence, trust indentures include an anti-dilution covenant. The conversion price of the stock is adjusted downwards by the same factor, so that the convertible bondholder experiences no loss from the issuance of the new shares. $40 1.25 = $32 per share

Current dealer offerings of corporate bonds can be found in: A. Bond Buyer B. Bloomberg C. Moody's D. Fitch's

The best answer is B. Quote providers such as Bloomberg and Reuters give dealer to dealer prices (the "wholesale" market) for corporate bonds daily. The Bond Buyer is the municipal new issue newspaper. Moody's and Fitch's rate bonds - they are not quote providers.

Which of the following terms describe a special tax bond issue? A. Self supporting B. Non-self supporting C. General obligation D. Moral obligation

The best answer is B. Special tax bonds are backed by taxes other than an ad valorem tax, such as liquor taxes, gasoline taxes, cigarette taxes or sales taxes. They are considered to be a non-self supporting debt since they are paid from tax collections. Self supporting debts are revenue bond issues that pay their own way from collected revenues. When ratings agencies such as Standard and Poor's look at the Debt Statement of a municipality to assign a credit rating, they will not deduct special tax bonds from Total Bonded Debt when calculating Net Direct Debt (All Bonded Debt Sold - Self Supporting Debt). They say that they treat Special Tax bonds as non-self supporting debt because, to be conservative, they consider ALL types of taxes paid by the population of a town to service its debt when calculating Net Bonded Debt.

What type of bond offers a "pure" interest rate? A. Zero coupon bond B. U.S. Government bond C. Municipal bond 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 agencies may issue securities EXCEPT: A. TVA B. FRB C. FHLMC 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.

The listing of current municipal bond offerings shows the following: Cook County School District Bond P/R @ 102 4.20 6/15/19 M'29 2.50 Which of the following statements are TRUE? I The bonds will be redeemed in 2019 II The bonds will be redeemed in 2029 III The redemption price is par IV The redemption price is 102 A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The School District bonds have a coupon of 4.20% and were scheduled to mature in 2029. However, the issuer has pre-refunded (P/R) the bonds by escrowing U.S. government securities to retire the bonds prior to maturity (at the call date of 6/15/19). At that time, the bondholder will receive 102 (call premium of 2 points). The bonds are currently being offered at a price to yield 2.50%, so they are trading at a premium (coupon is 4.20%). Remember, municipal issuers prerefund their debts when interest rates have fallen, similar to a homeowner refinancing a mortgage when interest rates have dropped. By prerefunding the debt, the issuer "retires" the debt prior to its maturity date because its debt service comes from escrowed government securities (and not tax collections in this case), freeing up the issuer to sell new bonds at lower current market rates.

The conversion ratio of these convertible debentures is set at issuance at 200:1. The trust indenture for the debentures includes an "anti-dilutive" covenant. The company wants to issue 50,000 additional common shares. The conversion price after the issuance of the additional common shares will be: A. $1.25 B. $4.00 C. $5.00 D. $12.50

The best answer is B. The conversion price of the convertible bonds set at issuance was $5 per share ($1,000 par / 200 conversion ratio). If the company issues more common shares, the market value of outstanding shares will fall. For example, assume that the common stock price is trading at $5. The bond and the common are at parity. If the company issues 25% more shares (as it does in this example - there is $1,000,000 of common at $5 par or 200,000 shares outstanding, and the company wishes to issue 50,000 more shares, or 25% more), the adjusted conversion price of the stock after issuance will be $5 / 1.25 = $4 per share. If the conversion price were not adjusted, the convertible security, which was "at the money," goes "out the money." To protect convertible security holders, an anti-dilutive covenant is included in the trust indenture. The conversion price is adjusted for these dilutive effects. The new conversion price will be $5 original conversion price / 1.25 = $4.

The current yield on a bond is: A. stated interest rate / bond par value B. stated interest rate / bond market value C. market interest rate / bond par value D. market interest rate / bond market value

The best answer is B. The current yield is the stated rate of interest on the bond, based on current market value.

The effective Fed Funds Rate is the: A. rate charged by the largest members of the Federal Reserve System B. averaged rate of member banks throughout the United States C. highest rate charged by member banks, calculated on Wednesdays D. lowest rate charged by member banks, calculated on Wednesdays

The best answer is B. The effective Federal Funds Rate is the average daily rate charged by member banks for overnight loans of reserves.

As interest rates rise, which of the following statements are TRUE? I Bonds trading at large discounts fall faster in price than bonds trading at small discounts. II Bonds trading at small discounts fall faster in price than bonds trading at large discounts. III Bonds trading at large premiums fall faster in price than bonds trading at small premiums. IV Bonds trading at small premiums fall faster in price than bonds trading at large premiums. A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. The general rule is the lower the price of the bond, the faster that bond's price will move as market interest rates change. Deep discount bonds have a lower price than small discount bonds, hence their prices move faster. Small premium bonds have a lower price than large premium bonds, hence their prices move faster as well.

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.

The nominal yield of a bond will: I increase as bond prices fall II decrease as bond prices rise III remain unchanged as bond prices fall IV remain unchanged as bond prices rise A. I and II B. III and IV C. I and IV D. II and III

The best answer is B. The nominal yield is the stated rate of interest as a percentage of par value. It does not change as bond prices move. However, the current yield and yield to maturity will be affected by changes in bond prices.

The ratio of pledged revenues to debt service requirements would be used to analyze which of the following municipal issues? A. School District Bonds B. Hospital Revenue Bonds C. Special Tax Bonds D. General Obligation Bonds

The best answer is B. The ratio of pledged revenues to debt service requirements applies to revenue bonds. Pledged revenues are those pledged to pay debt service and any other requirements set in the bond contract. The bondholder has a lien on these revenues. The higher this ratio, the safer a revenue bond, since there is a greater ratio of revenues to cover debt service. School district bonds are G.O. issues, paid by unlimited ad valorem taxing power; applicable ratio tests would be debt per capita (How much debt is each citizen of the town responsible for?); debt to assessed valuation (How much debt is there outstanding against the real properties that are assessed taxes to pay for the interest expense on that debt?); and the collection ratio (Of the taxes assessed by the municipality, what percentage is actually collected?)

The most commonly used measure to evaluate the ability of a revenue bond issuer to pay interest and repay principal is the ratio of: A. Gross Revenues / Debt Service B. Net Revenues / Debt Service C. Overall Net Debt / Population D. Overall Net Debt / Assessed Value

The best answer is B. The ratio used to analyze revenue bonds is the Debt Service Coverage Ratio. It is the ratio of Pledged Revenues to Debt Service cost. Almost all revenue bonds have a net revenue pledge, where "net revenues" are pledged to the bondholders (net revenues are gross revenues minus operation and maintenance costs). Thus, the most commonly used ratio to analyze revenue bonds is the ratio of Net Revenues / Debt Service.

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.

For bonds trading at a premium, rank the yield measures from lowest to highest? A. Nominal; Current; Yield to Maturity; Yield to Call B. Yield to Call; Yield to Maturity; Current; Nominal C. Current; Nominal; Yield to Call; Yield to Maturity D. Yield to Maturity; Current; Yield to Call; Nominal

The best answer is B. When bonds are trading at a premium, the yield to call will be the lowest measure since the annual return is reduced by the annual amortized portion of the premium that will be "lost" over the life of the bond to the call date. The next highest yield will be the yield to maturity, since the premium will be lost over a longer "life" than if the bond is called early. Current yield will be higher than yield to maturity, since it does not include the annual premium loss. Stated yield will be the highest since it is the return based on par value.

Yield quotes for collateralized mortgage obligations are based upon: A. average life of the tranche B. expected life of the tranche C. 15 year standard life D. actual maturity of the underlying mortgages

The best answer is B. Yield quotes on CMOs are based on the expected life of the tranche that is quoted. Do not confuse this with the "average life" of the mortgages in the pool that backs the CMO. This pool, with say an average life of 12 years, is "chopped-up" into many different tranches, each with a given "expected life." For example, there may be 10 tranches in the pool, with the first tranche having an expected life of 1-2 years, the second tranche having an expected life of 3-5 years, the third tranche having an expected life of 5-7 years, etc.

A basis quote for a $5,000 municipal bond with one year left to maturity has just been dropped by 20 basis points. The bond's change in price will be: A. $1 increase B. $1 decrease C. $10 increase D. $10 decrease

The best answer is C. A basis point is .01% of par. 20 basis points equals .20% of par. .20% = .002 x $5,000 par = $10. If interest rates drop by 20 basis points, this bond with 1 year to maturity should increase in value by $10. Also note that this type of question can only be asked for a bond with 1 year to maturity. If there are many years to maturity, then discounted cash flow calculations are required, which are not tested.

Which statement is TRUE about floating rate tranches? A. When interest rates rise, the price of the tranche rises B. When interest rates rise, the price of the tranche falls C. When interest rates rise, the interest rate on the tranche rises D. When interest rates rise, the interest rate on the tranche falls

The best answer is C. 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.

In a municipal bond contract, a "covenant of defeasance" would be invoked if: I interest rates have risen subsequent to bond issuance II interest rates have dropped subsequent to bond issuance III call premiums on the issue are low IV call premiums on the issue are high A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A municipal "covenant of defeasance" allows the issuer to "advance refund" or "pre-refund" the bond issue under the terms specified in the bond contract. When a bond is advance refunded, the issuer places Treasury securities in escrow that will mature when the outstanding bonds mature, so this becomes the bond issue's backing, freeing up the issuer to sell new bonds at lower current market rates. An issue is "pre-refunded" if the bond is callable, and Treasury securities are placed in escrow with a maturity that matches the call date. An issuer will take advantage of the defeasance covenant if interest rates have dropped and the issue is not currently callable. If the issue was callable, instead of pre-refunding the issue, the issuer would just call in the bonds and issue new ones at the lower current interest rate. An issuer will be more likely to call bonds with low call premiums (lower cost to the issuer to call in the issue) than those with high call premiums (higher cost to the issuer to call in the issue). (Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)

A municipal variable rate demand note is: I a short term issue II a long term issue III issued at short-term interest rates IV issued at long-term interest rates A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A municipal variable rate demand note is a long-term municipal security because it has no stated maturity, but it is issued at short-term (lower) interest rates, because the holder has the right to "put" the bond to the issuer at par at each interest payment date. The interest rate is reset, usually weekly at the interest payment date, to an indexed rate for the next week. Thus, the interest rate will vary. With any variable rate note, the interest rate varies as market rates move; therefore the market price remains at, or very close to, par. Thus, these instruments have almost no market risk.

A municipality would defease its debt with all of the following EXCEPT: A. U.S. Government securities B. U.S. Government agency securities C. AAA Municipal securities D. Bank certificates of deposit

The best answer is C. A municipality will defease its debt with securities of the highest credit rating, that provide the highest interest income to the municipality (since this interest income will be used to pay the interest expenses on the municipality's outstanding bonds that have been defeased). Acceptable securities to the bondholders are U.S. Governments, Agencies, and sometimes (rarely) bank certificates of deposit. AAA municipals would not be used because their yield is lower than governments (since the interest is exempt from Federal income tax, while the others are taxable). (Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)

Nominal quotes for municipal bonds are: A. a firm price at which a transaction would take place B. a likely price at which a transaction would take place C. an indication of a price given for informational purposes only D. prohibited to be disseminated to municipal market participants

The best answer is C. A nominal quote is an approximation of a market price for a bond, given for informational purposes only. The dealer giving such a quote is under no obligation to trade at that price; or even near to that price.

A nominal quotation given by a municipal dealer represents a(n): A. firm bid or offer B. likely bid or offer C. approximate market value, with no bid or offer D. bid or offer limited to round lots of 100 bonds

The best answer is C. A nominal quote is really no quote - it is simply an approximate price. The dealer is not obligated to trade at this quote and must identify it as a nominal quote.

The income source backing a special tax bond issue could be: I Cigarette taxes II Sales taxes III Ad valorem taxes IV Business taxes A. I only B. II only C. I, II, IV D. I, II, III, IV

The best answer is C. Ad valorem taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales, business or income taxes).

Which characteristic is NOT common to both Treasury STRIPS and Treasury Notes? 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 C. All T-Notes and T-STRIPS have a minimum $100 par value; are quoted in 32nds; and are directly backed by the U.S. Government. T-Notes pay interest semi-annually. Treasury STRIPS are notes or bonds "stripped" of coupons, meaning all that is left is the principal repayment portion of the note or bond (sometimes called the "corpus" or body). STRIPS are zero coupon original issue discount obligations that do not have a stated interest rate. The accretion of the discount over the note's or bond's life represents the interest earned, which is paid at maturity.

A municipal revenue bond trust indenture includes an "additional bonds test" covenant. This prohibits the issuer from doing all the following EXCEPT: A. issuing parity bonds unless the facility's revenues are sufficient to pay for existing and proposed debt B. issuing senior lien bonds unless the facility's revenues are sufficient to pay for existing and proposed debt C. issuing junior lien bonds unless the facility's revenues are sufficient to pay for existing and proposed debt D. issuing bonds with the same lien on pledged revenues unless the facility's revenues are sufficient to pay for existing and proposed debt

The best answer is C. An "additional bonds test" means that the issuer is prohibited from issuing new bonds against the revenues of a facility that have the same lien ("parity lien") against pledged revenues, unless the facility's revenues are sufficient. There is no prohibition on selling bonds that have a junior claim (meaning they are paid after) the existing bonds. In all bond issues, there is a prohibition on selling debt that has a senior claim to that of the existing bondholders. To perform an additional bonds test, typically, the debt service on the old bonds is added to that of the new bonds. The revenues of the facility must cover, by an adequate margin, the combined debt service before additional bonds can be sold.

When comparing a Variable Rate Demand Obligation (VRDO) to an Auction Rate Security (ARS), which statement is FALSE? A. Both are long-term bonds that have interest rates reset weekly or monthly B. Both are issued by corporations and municipalities C. Both can be put back to the issuer at par at the reset date D. Both have minimal market risk

The best answer is C. Both variable rate demand obligations (VRDOs) and auction rate securities (ARSs) are long-term bonds that have the interest rate reset weekly or monthly, giving the issuer the advantage of lower short-term interest rates on a long-term bond issue. The interest rate on a VRDO is typically set to a market index and the issue can be put back to the issuer at the reset date. With an ARS, the interest rate is reset by Dutch auction, and the owner can only sell at the auction to another buyer - there is no embedded put option. Both have minimal market risk, since the interest rate is reset weekly - so the price stays at, or close to, par. However, ARSs have proven to have marketability risk - in February 2008, the credit markets started to freeze and buyers did not turn up at the Dutch Auctions. The holders of ARSs found themselves with securities that were unmarketable, so these have marketability risk.

Principal repayments on a CMO are made: A. all at once at maturity date of the tranche purchased B. in constant dollar amounts every month C. in varying dollar amounts every month D. according to the amortization schedule of the underlying mortgages

The best answer is C. CMOs are Collateralized Mortgage Obligations. Each CMO tranche has an expected maturity, but the actual repayments are based on the rate of principal repayments that come in from the underlying mortgages - and this rate can vary. If interest rates start dropping, homeowners refinance and prepay their mortgages, and these prepayments are passed-through to pay off the tranches. On the other hand, if market interest rates rise, homeowners stay in their existing homes longer than expected and the rate of expected principal repayments slows, extending the maturity of the tranches. Thus, the rate of principal repayments varies, depending on market interest rate movements.

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 A. I and III B. I and IV C. II and III 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.

A calamity call covenant would be activated for which of the following reasons? I Earthquake damage has incapacitated a facility II Flooding has inundated a facility III Fire has incinerated a facility IV Obsolescence has caused the mothballing of a facility A. II and III only B. I and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Catastrophes are "sudden" occurrences, such as flooding, hurricanes, fires, earthquakes, etc. Damage from all of these could activate a calamity call covenant. Obsolescence does not factor into this definition.

When comparing a PAC tranch to a TAC tranche: I TAC tranches have the same level of prepayment risk II TAC tranches have the same level of extension risk III TAC tranches have a higher level of prepayment risk IV TAC tranches have a higher level of extension risk A. I and II B. III and IV C. I and IV 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.

Construction Loan Notes are repaid from: A. rents received from the housing project built with the proceeds of the offering B. rent subsidies received from the U.S. Government C. monies received from a permanent take-out financing D. monies received from the issuance of the Construction Loan Note

The best answer is C. Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing).

Which of the following statements are true regarding Construction Loan Notes ("CLNs")? I The use of CLNs allows the municipal issuer to reduce its interest cost when constructing a new facility II The maturity of CLNs is generally 2 - 3 years III Accrued interest on CLNs is computed on an actual day month / actual day year basis IV When the facility is completed, the permanent financing is added to the outstanding balance ("basis") of the CLNs A. I only B. II and III only C. I, II, III D. I, II, III, IV

The best answer is C. Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing). CLNs allow an issuer to reduce its interest cost, since the interest rate that must be paid on short term notes is lower than that for long term bond issues. CLNs typically have a maturity of 2 to 3 years, to coincide with the projected construction period of the building. Accrued interest on all municipal short term notes is computed in a manner similar to other money market instruments - an actual day month / actual day year basis. Please note that this is not true for long term municipal bonds, which accrue interest on a 30 day month / 360 day year. Finally, the last statement is false. When the long term financing is completed, the proceeds are used to retire the CLNs. The proceeds of the long term bond issue are not added to the original debt outstanding.

General obligation bond analysis would consider which of the following? I Protective covenants in the trust indenture II Trend of assessed valuation of property III Ratio of overall debt per capita IV Record of tax collections A. I and III only B. II and IV only C. II, III, IV D. I, II, III, IV

The best answer is C. G.O. bonds are typically issued without a trust indenture - revenue bonds have trust indentures. The specific protections of an indenture are not needed since the municipality's taxing power is unconditionally pledged to pay off the bonds. Trust indentures are found in revenue bond issues, where only the revenues are pledged to pay off the debt, and purchasers of the bonds demand additional protections that are spelled out in the trust indenture, such as rate, insurance, and maintenance covenants. To assess whether taxes are likely to be sufficient to pay off the debt, G.O. bond analysis includes evaluation of the tax collection record; trend of assessed valuation of property in the area; and debt to population ratios.

Which risk is NOT applicable to Ginnie Mae Pass Through Certificates? A. Purchasing power risk B. Risk of early prepayment of mortgages if interest rates fall C. Risk of default if homeowners do not make their mortgage payments D. Risk of loss of principal if interest rates rise

The best answer is C. Ginnie Maes are guaranteed by the U.S. Government so there is no risk of default. Ginnie Mae is authorized to raid the U.S. Treasury to make up any payment shortfalls, if required. The holder of a certificate is subject to potential loss of principal if interest rates rise, and to loss of interest income if mortgages are prepaid early (these prepayments are passed on to the certificate holders).

If Treasury bill yields are rising at auction, this indicates that: I interest rates are falling II interest rates are rising III Treasury bill prices are falling IV Treasury bill prices are rising A. I and III B. I and IV C. II and III D. II and IV

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

In a repurchase agreement, the initiating government securities dealer: I buys securities from another dealer II sells securities to another dealer III agrees to buy back the securities at a later date IV agrees to sell the securities at a later date A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. In a repurchase agreement, the initiating government securities dealer "sells" securities to another dealer to obtain cash, with an agreement to buy them back at a later date.

Which of the following are TRUE statements regarding revenue bonds? I Yields for revenue bond issues are generally higher than yields for comparable G.O. issues II Revenue bonds are only suitable for investors willing to assume a high level of risk III The bonds may be double barreled with backing by ad valorem taxes IV Issuance of the bonds is dependent on earnings requirements A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

The best answer is C. In order to issue revenue bonds, a feasibility study must be prepared and it must show adequate net revenues ("earnings") to service the debt before the bonds can be floated. A revenue bond can be double barreled to improve its safety by additionally backing the issue with the ad valorem taxing power of the issuer. Yields on revenue bonds are higher than that of comparable G.O. bonds because of generally higher risk. Revenue bonds are suitable for investors willing to take on low, medium or high risk. To evaluate credit risk on these issues, look at Moody's or Standard and Poor's ratings.

Which of the following statements are TRUE about Eurodollar bonds? I Issuers include the United States Government II Issuers do not include the United States Government III The bonds are only issued outside the United States IV The bonds are only issued within the United States A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Issuers of Eurodollar bonds include U.S. corporations, U.S. local and state governments, foreign corporations, sovereign governments, and supranational agencies. The U.S. Government does not issue Eurodollar bonds. Eurodollar bonds are only issued outside the U.S. and are purchased by foreigners. The bonds are not registered for sale in the U.S. The bonds are not subject to withholding taxes and are issued in bearer form.

Short sale transactions are typical for which of the following? I Listed options II Common stock III Municipal bonds IV Treasury bonds A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is C. Municipal bonds are generally not sold short because the trading market in each maturity is very thin, making short covering difficult, if not impossible. Short selling (the sale of borrowed securities, with the purchase and replacement of the borrowed securities occurring later) is a strategy that allows the investor to profit in a falling market. Short selling can only be performed with actively traded securities (since ultimately the borrowed securities that were sold must be repurchased and replaced). Common stocks, listed options, and U.S. Government securities are all actively traded; and short selling of these securities is common.

Which of the following securities will trade without accrued interest (trade "flat")? I Treasury Bills II Banker's Acceptances III Treasury Receipts IV Negotiable Certificates of Deposit A. I and III only B. II and IV only C. I, II, III D. I, II, III, IV

The best answer is C. Negotiable CDs that mature in 1 year or less are issued at par and mature with accrued interest. Those issued for longer periods pay interest semi-annually and trade with accrued interest. The other choices are all original issue discount obligations, which trade flat.

Which of the following municipal issues would be exempt from taxation of interest by the Federal Government? I San Francisco, California - Convention Center Revenue Bond II Miami, Florida - Sewer and Water Revenue Bond III Nassau County, New York - Pollution Control Bond IV Des Moines, Iowa - Baseball Stadium Revenue Bond A. I only B. I and IV C. II and III D. I, II, III, IV

The best answer is C. Non-essential use, private purpose municipal issues are subject to Federal Income tax, via the Alternative Minimum Tax computation (AMT). The building of a convention center constitutes such a use, as does the building of a baseball stadium. Sewers, water, pollution control, and schools are all essential public uses and these issues qualify for the Federal Income Tax exemption on interest.

Which bond portfolio with a 20-year life would be expected to give the highest long-term return? A. Portfolio #1 with an expected rate of return of 6% and a default risk of 5% over the portfolio life B. Portfolio #2 with an expected rate of return of 8% and a default risk of 10% over the portfolio life C. Portfolio #3 with an expected rate of return of 10% and a default risk of 20% over the portfolio life D. Portfolio #4 with an expected rate of return of 12% and a default risk of 40% over the portfolio life

The best answer is C. The "default risk" represents the loss of return that is likely due to making higher risk investments. If Portfolio #1 has an expected annual rate of return of 6% over 20 years; but there is the probability that 5% of those bonds will default, so the net return will be 95% of 6% = 5.7%. If Portfolio #2 has an expected annual rate of return of 8% over 20 years; but there is the probability that 10% of those bonds will default, so the net return will be 90% of 8% = 7.2%. If Portfolio #3 has an expected annual rate of return of 10% over 20 years; but there is the probability that 20% of those bonds will default, so the net return will be 80% of 10% = 8.0%. If Portfolio #4 has an expected annual rate of return of 12% over 20 years; but there is the probability that 40% of those bonds will default, so the net return will be 60% of 12% = 7.2%.

A city has a total assessed value of property of $1,700,000,000 and a tax rate of 10 mills. For the year, the city collects $14,000,000 of taxes. The city's collection ratio is: A. $14,000,000 / $1,700,000,000 B. $1,700,000,000 / $14,000,000 C. $14,000,000 / $17,000,000 D. $17,000,000 / $14,000,000

The best answer is C. The "mill" rate is the tax rate in the city. 1 "mill" = 1/1,000 = .001. = $1 per $1,000 of assessed value. Since the city has a tax rate of 10 mills, the tax is $10 per $1,000 of assessed value. The total assessed value of $1,700,000,000 means that taxes assessed equal $10 x 1,700,000 = $17,000,000. Since the city only collected $14,000,000 of the assessed taxes, its collection ratio is $14,000,000 / $17,000,000 = 82%

Which of the following issue agency securities? I FNMA II FHLMC III FRB IV FHLB A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is C. The Federal Reserve Bank does not issue bonds. Fannie Mae (FNMA) and Freddie Mac (FHLMC) issue mortgage-backed pass through certificates. The Federal Home Loan Banks (FHLB) issues short term and long term bonds.

Which of the following measures would be evaluated when analyzing a General Obligation Bond? I Debt to assessed valuation ratio II Debt per capita ratio III Tax collection ratio IV Debt service coverage ratio A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is C. The debt service coverage ratio is used for revenue bond analysis - not G.O. bond analysis. The debt service coverage ratio is Net Revenues From the Facility / Debt Service Requirements. G.O. bonds are paid off from property tax collections, not collected revenues. Therefore, the relevant measures for G.O. bond analysis are Debt / Assessed Valuation of Property; Debt / Population; and Taxes Collected / Taxes Assessed.

A municipal dealer quotes a 2 year, 6% term revenue bond at 99. The yield to maturity is: A. 5.92% B. 6.00% C. 6.53% D. 6.85%

The best answer is C. The formula for yield to maturity is: This bond has a coupon rate of 6% = 6% of $1,000 par = $60 of annual income. The bond is purchased at 99% of $1,000 par = $990; and will mature at $1,000 in 2 years, Thus, the $10 capital gain is earned over 2 years for an annual gain of $10 / 2 = $5 per year. The bond is purchased at $990 and matures at $1,000, for an average value of $990 + $1,000 / 2 = $995. The YTM is: $60 + $5 = 6.53% $995

A customer has a discretionary account at a brokerage firm. The customer calls the registered representative handling the account and states "Buy $50,000 of investment grade corporate bonds" with at least 5 years to maturity and a minimum 8% yield. To comply with the customer's instructions, the registered representative must choose bonds that are rated, at a minimum: A. Aaa B. A C. Baa D. B

The best answer is C. The investment grades published by Moody's are: Aaa Highest Investment Grade Aa Upper Medium Investment Grade A Lower Medium Investment Grade Baa Lowest Investment Grade Any bond with a rating below Baa is considered to be speculative. To comply with the customer's requirement that the bonds be investment grade, a Baa rated bond is the lowest that could be purchased.

When analyzing municipal general obligation bonds of different issuers, it is difficult to use the ratio of Overall Debt / Assessed Valuation because: A. the ratio does not consider a municipality's ability to collect the taxes levied on all real property B. municipalities differ in their method of computing overall debt C. municipalities differ in their method of computing assessed value of properties D. the ratio does not consider the management capabilities of municipal government

The best answer is C. The ratio of Overall Debt to Assessed Value of Property is a more difficult measure to use when comparing municipal issuers for safety because municipalities have differing methods of computing assessed values of properties, and such assessments tend to be quite subjective. The computation of Overall Debt is consistent across municipalities, so this is not a problem. The other choices do not address the characteristics of the components of the ratio.

Which of the following trade "flat" ? I Treasury Bills II Treasury STRIPS III Treasury Bonds IV Treasury Receipts A. I and II only B. III and IV only C. I, II, IV 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.

Which of the following are money market instruments? I Tax Anticipation Notes II Certificates of Deposit III Treasury Bonds IV Commercial Paper A. I and III only B. II and IV only C. I, II, IV D. I, II, III, IV

The best answer is C. Treasury Bonds are issued in 10 to 30 year maturities, hence they are not a money market instrument (until they have a remaining life of 1 year or less). A money market instrument is issued with a maturity of 1 year or less. Tax Anticipation Notes, Certificates of Deposit, and Commercial Paper are all money market instruments.

Which of the following are required to calculate the yield to maturity of a bond? I Maturity Date II Coupon III Purchase Price IV Redemption Price (Par) A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. The coupon rate x par value gives the annual interest. The annual capital gain or loss is the difference between the purchase price and the redemption price divided by the number of years to maturity. Therefore, all of the items listed are required to calculate the YTM of a bond. questi

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 A. I and II only B. III and IV only C. I, II, III 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.

Which of the following are TRUE statements about the trading of bonds and their prices? I Bonds trading at a premium are more likely to be called than bonds trading at a discount II A bond trading at a discount can indicate that the issuer's rating has deteriorated III Discount bonds will appreciate more rapidly as interest rates fall than will similar premium bonds IV A bond trading at a discount can indicate that interest rates have risen A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is D. All of the statements are true regarding bonds. If a bond issued at par is trading at a discount, it can indicate that the issuer's rating has deteriorated or that market interest rates have risen. As interest rates fall, discount bonds will appreciate at a faster rate than will premium bonds. The change in value of the bond's price is a result of an increased "present value" of the remaining interest payments to be received. This increase in the "value" of the remaining interest payments is a larger percentage of a discount bond's price than of a premium bond's price. Thus, as interest rates drop, discount bonds rise faster than premium bonds. Similarly, as interest rates rise, discount bond prices fall faster than premium bond prices. If the bond is trading at a discount and is then called, then the issuer will have to pay par for the bonds. Why not, instead of paying par, purchase the bonds at the current market price? It would be better to pay the discount than the full market value. Furthermore, a bond trading at a discount indicates that market interest rates have risen - why would an issuer call in such an issue, when it has a bargain interest rate? The only bonds that are likely to be called are those trading at premiums - meaning that market interest rates have fallen. The issuer can call in the premium bonds at a price close to par, and refund at lower current market interest rates.

An ETN does NOT have which risk? A. Market risk B. Credit risk C. Marketability risk D. Reinvestment risk

The best answer is D. An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. Thus, if the bank's credit rating is lowered, the value of the ETN will fall as well - so it has credit risk. ETNs are listed on an exchange and trade, so they have minimal marketability risk. ETNs have market risk - if market prices fall, their value will fall in the market. Finally, ETNs make no interest or dividend payments - so they do not have reinvestment risk. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. ETNs are "Exchange Traded Notes." They are an equity index linked structured product, that is listed and trades on an exchange. Because they trade, the liquidity risk aspect of structured products is eliminated. What is not eliminated, however, is credit risk. These products are only as good as the guarantee of the issuing bank. These products typically have a 7 year maturity and a lot can go wrong in 7 years. If the issuing bank is downgraded, then it would be expected that investor interest in the ETN would fall. This should make the issue less marketable and also should cause the price to fall.

Under FINRA rules, if a member firm wishes to offer a structured product to its customers, all of the following statements are true EXCEPT the member: A. has an obligation to perform a reasonable basis suitability determination before recommending the product to any of its customers B. must use its expertise to determine if the potential yield of the structured product is an appropriate rate of return in relation to the volatility of the reference asset C. must determine that its recommendation to purchase a structured product is suitable for that particular investor D. must determine that an investment in the reference asset is suitable for that particular investor

The best answer is D. Because of the complexity of structured products, which is typically a zero-coupon "synthetic bond" that gives a return tied to a market index such as the NASDAQ 100 Index or the Standard and Poor's 500 Index; and which has a maturity based on an embedded option; FINRA requires that the member firm perform a "reasonable basis" suitability determination to evaluate the product's potential rewards and risks (relative to other similar structured products offered by other firms). Once a "reasonable basis" suitability determination has been completed, then the member firm can offer the structured product only to its customers that are suitable for that investment. This is "customer specific" suitability. There is no requirement to determine whether an investment in the reference asset (say a NASDAQ 100 Exchange Traded Fund) is suitable for the investor.

If a member firm wishes to offer structured products to its customers, which of the following procedures are required? I The member must perform a reasonable basis suitability determination before the product can be recommended to some of the member's customers II The member must perform a customer specific suitability analysis in order to make a recommendation of a structured product to an individual customer III The member must have procedures to determine that the account is eligible to purchase structured products and generally must have the account approved for options trading A. I only B. I and II only C. II and III only D. I, II, III

The best answer is D. Consider this to be a learning question. Structured products are securities based on, or derived from, a basket of securities, an index, or other securities, commodities or currencies. There are many types of structured products, but generally they consist of a "bond" portion, which pays interest based on the performance of a well known index such as the S&P 500 Index. In addition, they have a derivative component (an embedded option) that allows the holder to sell the security back to the issuer (at par) at maturity. These are often marketed as debt instruments, but that is not really the case. Structured products are created by many different brokerage firms and each firm's version is somewhat different. Because of the complexity of these products, FINRA requires that the member firm perform a "reasonable basis" suitability determination to evaluate the product's potential rewards and risks (relative to other similar structured products offered by other firms). Once a reasonable basis suitability determination has been completed, then the member firm can offer the structured product only to its customers that are suitable for that investment. This is "customer specific" suitability. Because of the embedded option in the product, FINRA strongly encourages member firms to use the same suitability and approval standards as it uses for options accounts when recommending structured products.

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.

Which of the following statements are TRUE regarding a 5% municipal bond purchased at par that has a put option at par? I The yield on the bond can fall below 5% II The put would be exercised if interest rates rise III The holder can receive 100% of par for the bond if he or she exercises the put option IV The investor can exercise the put at his or her discretion A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV

The best answer is D. If a bond has a put option at par, the holder can always exercise the put and "put" the bond back to the issuer, receiving 100% of par for that bond. Thus, as market interest rates rise, this bond's price will not fall, because it must always be worth par. Thus, such a bond is not susceptible to market risk. The yield on such a bond with a 5% coupon rate cannot rise above this level, because the price will not fall below par. However, the yield can drop below this level, because if interest rates fall, the bond's price will go to a premium and the put option would be worthless.

A repurchase agreement is effected between two U.S. Government securities dealers. The interest charged under the agreement is the: A. coupon rate of the underlying U.S. Government securities, paid directly from the issuer to the securities' original buyer B. coupon rate of the underlying U.S. Government securities, paid directly from the issuer to the securities' original seller C. "repo" rate, paid by the buyer of the securities to the seller D. "repo" rate, paid by the seller of the securities to the buyer

The best answer is D. In a repurchase agreement between 2 government dealers, a government securities dealer "sells" securities to another dealer, with an agreement to buy them back at a later date. The selling dealer obtains cash, and for this, agrees to pay interest to the buying dealer. The interest rate charged is known as the "repo" rate - the repurchase agreement interest rate. The rate fluctuates with, and parallels, the Federal Funds rate.

A customer buys 10M of Allied Corporation 8% debentures, M '28, at 90 on Wednesday, May 29th. The interest payment dates are Mar. 1st and Sept. 1st. The trade settled on Friday, June 1st. The customer will receive how many months of interest in the next payment? A. 3 B. 4 C. 5 D. 6

The best answer is D. Issuers make fixed semi-annual interest payments to bondholders covering the preceding 6-month period. If the bond is traded in between interest payment dates, the payment of accrued interest from buyer to seller ensures that each party gets the correct amount of interest.

Which statements are TRUE about private CMOs? I The CMO is backed by mortgage backed securities issued by Ginnie Mae, Fannie Mae or Freddie Mac II The CMO is backed by mortgage backed securities created by a bank-issuer III The CMO is rated AAA IV The CMO is rated dependent on the credit quality of the mortgages underlying mortgage backed pass through securities held in trust A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Private CMOs (Collateralized Mortgage Obligations) are also called "private label" CMOs. Instead of being backed by mortgages guaranteed by Fannie, Freddie or Ginnie, they are backed by "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). Bank issuers make non-conforming mortgages that cannot be sold to Fannie, Freddie or Ginnie and rather than hold them as investments, they can pool them into mortgage backed securities which are then placed into trust and sold as private label CMOs. Whereas CMOs backed 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? I STRIPS II TIPS III Treasury Bonds IV Treasury Bills A. I and III B. I and IV C. II and III D. II and IV

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. "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. Money market instruments, such as T-Bills, do not have purchasing power risk, because they mature within 1 year and the funds can be reinvested at higher interest rates caused by inflation. Thus, the securities that have the lowest purchasing power risk are short term money market instruments and TIPS.

Dealer offerings of corporate bonds found in Bloomberg are: I retail quotes II wholesale quotes III new issue offerings sold under a prospectus IV secondary market offerings A. I and III B. I and IV C. II and III D. II and IV

The best answer is D. Quote providers such as Bloomberg and Reuters give dealer to dealer prices (the "wholesale" market) for corporate bonds daily. These are bonds that are trading in the secondary market.

Which of the following issue Eurodollar bonds? I U.S. Corporations II Foreign Corporations III U.S. State Governments IV Foreign Governments A. I, II, III B. I, II, IV C. I, III, IV D. I, II, III, IV

The best answer is D. The U.S. Government does not issue Eurodollar bonds. U.S. corporations and foreign subsidiaries of U.S. corporations issue Eurodollar bonds to gain access to lower cost foreign capital markets. Foreign governments and international agencies issue the bonds to broaden the available market for their bonds beyond the country of issuance (since they are dollar denominated). Also, U.S. State and local governments have issued Eurodollar bonds to broaden their investor base (New York City bonds are popular in Europe!)

A corporation has issued 10%, $1,000 par convertible debentures, convertible at $31.25. The common stock is currently trading at $35. If the bond and the common are trading at parity, a customer purchasing 5M of the bonds will pay: A. $3,500 B. $4,800 C. $5,000 D. $5,600

The best answer is D. The bonds are convertible at $31.25, based on $1,000 par value. Therefore each bond converts into 32 shares ($1,000 par / $31.25 conversion price). If the common is trading at $35, the bond must be trading at 32 times this to be at parity. $35 x 32 = $1,120 parity price of one bond. The parity price of "5M" ($5,000 face amount, "M" is Latin for $1,000) is $1,120 x 5 = $5,600.

A municipal bond dealer buys 100M of 30 year non-callable 9% General Obligation bonds at par less 1 1/2 points. After holding the bonds in inventory for a week, the dealer reoffers the bonds on a 9.10 basis. The dealer's approximate profit or loss on this transaction is: A. loss of $150 B. loss of $400 C. gain of $150 D. gain of $400

The best answer is D. The dealer purchases these bonds at par less 1 1/2 points, so the bonds were purchased at 98.5. Since these 9% coupon bonds were reoffered on a 9.10 basis, they must have been reoffered at a discount price. Since these are long term bonds (30 years), we can approximate the reoffering price by dividing 9% (nominal yield) by the 9.10 reoffering yield. 9/9.10 = .989. Thus, the bonds were reoffered at an approximate price of .989% of par (note, this only works for long term maturities - not short term maturities). The bonds were reoffered at a price that is .004% higher than the cost to the dealer (.985 cost versus .989 reoffer price). .004% x $100,000 face amount = $400 gain on the transaction. Note that "100M" of bonds is $100,000 face amount, where M = $1,000.

A $1,000 par Treasury Note is quoted at 100-2 - 100-7. The spread is: A. 5 basis points B. $.015625 per $1,000 C. $.15625 per $1,000 D. $1.5625 per $1,000

The best answer is D. The spread between the bid and ask is 5/32nds. Remember, government and agency securities are quoted in 32nds (with the exception of T-Bills, quoted on a yield basis). 5/32nds = .15625% of $1,000 par = $1.5625.

Which of the following statements are TRUE about Treasury Receipts? I Interest is paid semi-annually II Tax on interest earned is deferred until maturity III Interest and principal are paid at maturity IV Tax on interest earned is due annually A. I and II B. I and IV C. II and III D. III and IV

The best answer is D. Treasury Receipts are U.S. Government bonds which have been stripped of coupons. In essence, they are original issue discount Government obligations. As with any OID, the discount must be accreted annually, and the accretion amount is taxable as interest earned for that year. However, no monies are received from the issuer until maturity, when the security is redeemed at par. At this point, the owner receives the face amount but has no tax consequences (since the discount was taxed over the life of the bond).

Which of the following statements are TRUE about Treasury Receipts? I The interest income from Treasury Receipts is subject to Federal income tax each year II The investor "locks in" a rate of return that is free from reinvestment risk if the Treasury Receipt is held to maturity III The underlying Treasury Bonds are held by a trustee for the beneficial owners IV The Receipts are issued by broker-dealers, who maintain a secondary market in these securities A. I and II only B. III and IV only C. I, III, IV D. I, II, III, IV

The best answer is D. Treasury Receipts represent an undivided interest in a portfolio of U.S. Government securities held by a trustee. The portfolio is assembled by a broker-dealer, who sells "receipts" representing ownership of the interest. Each receipt is, essentially, a zero-coupon obligation, that is purchased at a discount, and which is redeemable at par at a pre-set date. Thus, there is no reinvestment risk, since semi-annual interest payments are not received. The implicit rate of return is locked-in when the security is purchased, and the customer will earn that rate of return if the security is held to maturity. The annual accretion amount is taxable, since the underlying securities are U.S. Governments. At maturity, the receipt will have an adjusted cost basis of par, and will be redeemed at par, for no capital gain or loss. There are no new T-Receipt issues coming to market. Once the Treasury started issuing STRIPS in 1986, there was no need for the "middleman" anymore. However, T-Receipts still trade until they all mature.

Which of the following statements are TRUE about Treasury Receipts? I The investor "locks in" a rate of return that is free from reinvestment risk if the Receipt is held to maturity II The underlying bonds are held by a trustee for the beneficial owners III The interest income on the Receipts is subject to Federal income tax annually IV The Receipts are issued by broker-dealers, who maintain a secondary market in these securities A. III and IV only B. I, II, III C. I, II, IV D. I, II, III, IV

The best answer is D. Treasury Receipts represent an undivided interest in a portfolio of U.S. Government securities held by a trustee. The portfolio is assembled by a broker-dealer, who sells "receipts" representing ownership of the interest. Each receipt is, essentially, a zero-coupon obligation, that is purchased at a discount, and which is redeemable at par at a pre-set date. Thus, there is no reinvestment risk, since semi-annual interest payments are not received. The implicit rate of return is locked-in when the security is purchased, and the customer will earn that rate of return if the security is held to maturity. The annual accretion amount is taxable, since the underlying securities are U.S. Governments. At maturity, the receipt will have an adjusted cost basis of par, and will be redeemed at par, for no capital gain or loss. There are no new T-Receipt issues coming to market. Once the Treasury started issuing STRIPS in 1986, there was no need for the "middleman" anymore. However, T-Receipts still trade until they all mature.