Finals: Debt
A 15 year 3 1/2% Treasury Bond is quoted at 101-4 - 101-8. The bond pays interest on Jan 1st and Jul 1st. A customer sells 5M of the bonds. How much will the customer receive, disregarding commissions and accrued interest? A. $5,056.25 B. $5,070.00 C. $5,062.50 D. $5,090.00
The best answer is A. "5M" means that the customer is selling $5,000 par value of the bonds (M is Latin for $1,000). A customer will sell to the dealer at the bid price, which is 101 and 4/32nds = 101.125% of $5,000 par = $5,056.25.
Interest earned on corporate bonds is: A. subject to Federal tax and subject to State and Local tax B. subject to Federal tax and exempt from State and Local tax C. exempt from Federal tax and subject to State and Local tax D. exempt from Federal tax and exempt from State and Local tax
The best answer is A. Interest received from corporate bonds is taxable at the Federal, State and Local levels.
A customer wishes to invest in corporate bonds that offer minimum market risk. Which recommendation is appropriate? A. Bonds with short term maturities B. High yield bonds C. Guaranteed bonds with medium term maturities D. Bonds with long term maturities and high call premiums
The best answer is A. Market risk for a bondholder is the risk of rising interest rates forcing the price of a bond to drop. As interest rates rise, the price of a long term bond falls faster than that of a short term bond. To avoid market risk, a bondholder would want to invest in the shortest maturity possible.
A customer buys $100,000 face amount of municipal revenue bonds. The confirmation reads: 100M of PitterPatter Water Authority 10% Revenue Bonds. M - 1/01/17 @ 58 Flat with 7/1/15 and subsequent coupons attached Which of the following statements are TRUE? I The bonds are trading without accrued interest II The bonds are trading with accrued interest III The last interest payment was made on 1/1/15 IV The last interest payment was made on 7/1/15 A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. The bonds are trading "flat," therefore no interest payments are currently being made. Since the earliest coupon attached to the bond is 7/1/15, no payments subsequent to this date were made. Thus, the last interest payment was made on 1/1/15. After this date, interest payments ceased (the issuer defaulted) and those coupons are still attached to the bond. Also note that most bearer bonds have matured, but there are a few issues outstanding that mature in 2023.
Interest received from all of the following securities is exempt from state and local taxes EXCEPT: A. Fannie Mae Pass Through Certificates B. Treasury Notes C. Federal Farm Credit Funding Corporation Bonds D. Federal Home Loan Bank Bonds
The best answer is A. The interest income from direct issues of the U.S. Government and most agency obligations is subject to federal income tax but is exempt from state and local tax. An exception is the interest income received from mortgage backed pass through certificates (issued by GNMA, FNMA, FHLMC). This interest income is subject to both federal income tax and state and local tax. The logic behind this tax treatment is that the mortgage interest paid by the homeowners was fully deductible from both federal, state, and local taxes. When this interest is received by the certificate holder, both the federal and state government want to recapture this interest income and tax it.
All of the following statements are true regarding collateralized mortgage obligations EXCEPT: A. CMOs are issued by local government agencies B. CMOs are backed by agency pass-through securities held in trust C. CMOs have the highest investment grade credit ratings D. CMOs give the holder a limited form of call protection that is not present in regular pass-through obligations
The best answer is A. The last 3 statements are true. Collateralized mortgage obligations are backed by mortgage pass-through certificates that are held in trust. The underlying mortgage backed pass-through certificates are issued by agencies such as FNMA, GNMA and FHLMC, all of whom have an "AAA" (Moody's or Fitch's) or "AA" (Standard and Poor's) credit rating. The CMO takes on the credit rating of the underlying collateral. CMOs take the payment flow from the underlying pass-through certificates and allocate them to so-called "tranches." 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. Thus, the earlier tranches are retired first. The CMO purchaser buys a specific tranche. Because of the sequencing of principal repayments from the underlying mortgages, the holder has a more definite maturity date on the issue, as compared to actually buying a mortgage backed pass-through certificate. This is true because prepayments on pass-through certificates are allocated pro-rata. During periods of falling rates, all certificate holders receive their share of those repayments pro-rata. The holder of a specific tranche of a CMO will only receive prepayments after all earlier tranche holders are repaid. Thus, CMOs give holders a form of "call protection" not available in regular pass-through certificates. CMOs are not issued by government agencies; the agency issues the underlying pass-through certificates. CMOs are packaged and issued by broker-dealers.
Regarding auction rate securities, a failed auction will result if the: I total par amount of sell orders received by the auction agent exceeds the total par amount of bids II total par amount of buy orders received by the auction agent exceeds the total par amount of offers III bid rates are lower than the Clearing Rate set for the auction IV bid rates are higher than the Clearing Rate set for the auction A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. 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).
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.
Customer "A" buys a Credit Default Swap (CDS) from Customer "B," with the reference loan being one made to Customer "C." If Customer "C" continues to pay interest and principal on a timely basis, then: A. Customer A benefits B. Customer B benefits C. Customer C benefits D. any benefit to a specific party is based on the terms of the contract
The best answer is B. In a Credit Default Swap (CDS), the buyer pays a premium to the seller, where the seller agrees that if the reference loan defaults, the seller will pay the face amount of the loan to the buyer. The buyer pays an annual "insurance-like" premium for this. If the loan does not default, the seller wins - collecting the premiums without having to make a payout. If the loan does default, the buyer wins - since the seller must pay the buyer the face amount of the loan in cash.
A customer buys 10 PDQ Corporation 10% debentures, M '35, at 93 on Friday, June 12th in a regular way trade. The interest payment dates are March 1st and September 1st. The trade settles on: A. Monday, June 15th B. Tuesday, June 16th C. Wednesday, June 17th D. Friday, June 19th
The best answer is B. Regular way trades of corporate bonds and stocks settle 2 business days after trade date (effective September 5, 2017).
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
The 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.
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%.
Treasury Bonds are issued by the U.S. Government in: I bearer form II book entry form III minimum denominations of $100 IV minimum denominations of $10,000 A. I and III B. I and IV C. II and III D. II and IV
The best answer is C. The U.S. Government issues Treasury Bonds (and Treasury Bills and Notes) in book entry form, in minimum denominations of $100.
Regarding the flow of funds set forth in a municipal bond contract, collected monies would FIRST be deposited to the: A. Operations and Maintenance Fund B. Debt Service Reserve Fund C. Revenue Fund D. Reserve Maintenance Fund
The best answer is C. 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 deposited to a revenue fund, also called a general collection account. 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 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 municipal bond dealer buys 100M of 30 year non-callable 9% General Obligation bonds at par less 1 point. After holding the bonds in inventory for a week, the dealer reoffers the bonds on an 8.90 basis. The dealer's approximate profit or loss per bond on this transaction is: A. loss of $12 B. loss of $21 C. gain of $12 D. gain of $21
The best answer is D. The dealer purchases these bonds at par less 1 point, so the bonds were purchased at 99. Since these 9% coupon bonds were reoffered on an 8.90 basis, they must have been reoffered at a premium price. Since these are long term bonds (30 years), we can approximate the reoffering price by dividing 9% (nominal yield) by the 8.90 reoffering yield. 9/8.90 = 1.011. Thus, the bonds were reoffered at an approximate price of 1.011% of par (note, this only works for long term maturities - not short term maturities). The bonds were reoffered at a price that is .021% higher than the cost to the dealer (.99 cost versus 1.011 reoffer price). .021% x $100,000 face amount = $21 gain on the transaction. (Note that "100M" of bonds is $100,000 face amount, where M = $1,000. )
The feasibility study prepared in connection with a new municipal revenue bond offering is performed by the: A. issuer B. underwriter C. bond counsel D. independent consultant
The best answer is D. The feasibility study in a revenue bond offering is a projection of building costs; expected revenues; and expenses. The net result should show that the revenues anticipated from the project are sufficient to pay for both operation and maintenance of the facility and interest expense on the bonds issued to finance the construction, as well as cover the repayment of the bonds. This study is performed by an independent consulting firm.
