Fundamentals of Debt Securities
The current yield on a municipal bond with a coupon rate of 4.50%, purchased at par and currently trading at $1,055, is: a. 4.15% b. 4.26% c. 4.46% d. 4.50%
b. 4.26% Explanation: The current yield is found by dividing the yearly interest payment of $45 by the market price of $1, 055. This equals 4.26%. The fact that the bond was purchased at par is not relevant.
An RR sees that a CMO is yielding 5.95% while the comparable Treasury is yielding 5.10%. This means that: a. The CMO is rated below investment-grade b. The yield pick-up on the CMO is 85 basis points c. The annual cash flow from the CMO is $85 greater than the Treasury d. The yield curve is inverted
b. The yield pick-up on the CMO is 85 basis points Explanation: If the yield on a CMO is 85 basis points higher (5.95 - 5.10) than a comparably maturing Treasury security, the CMO provides a yield pick-up or higher yield of 85 basis points.
A customer purchased a municipal bond with a 6.50% coupon rate that was priced at a 6.95 basis. If the bond is currently trading at $945, the current yield is: a. 6.95% b. 6.73% c. 6.88% d. 6.50%
c. 6.88% Explanation: The current yield is found by dividing the yearly interest payment of $65 by the market price of $945. This equals 6.88%. The fact that the bond was purchased at a 6.95 basis is not relevant.
A call premium is best described as the amount the: a. Investor pays above the par value b. Investor will receive if the bond is sold above the par value c. Issuer pays above 100 to retire bonds prior to maturity d. Bondholder receives at maturity
c. Issuer pays above 100 to retire bonds prior to maturity Explanation: A bond issue's indenture will usually require that, if an issuer calls bonds (redeems prior to maturity), it must pay the bondholder a premium (above par value). For example, a bond that matures in 30 years is callable at 103.5 in 10 years. The issuer must pay a premium of $35 per bond (103.5% of $1,000 is $1,035) above par to retire the bonds prior to maturity.
The purpose of a sinking fund is to redeem a corporation's: a. Common stock b. Warrants c. Rights d. Bonds
d. Bonds Explanation: A sinking fund is used by an issuer to set aside funds that will be used for the purpose of redeeming a corporation's bonds prior to or at maturity.
When a client buys a bond above par, the confirmations must indicate the: a. Rating b. Contraparty c. Lower of yield to call or yield to maturity d. Catastrophe call provisions
c. Lower of yield to call or yield to maturity Explanation: A bond's confirmation must disclose the lower of the yield to maturity or the yield to call. This is sometimes referred to as the yield to worst.
Municipal term bond quotes are based on: a. Yield to maturity b. Current yield c. Nominal yield d. Dollar price
d. Dollar price Explanation: Municipal term bonds (bond issues that have one maturity date) are quoted based on a dollar price. Term bonds are also known as dollar bonds. Municipal serial bonds (that have several maturity dates) are quoted on a yield-to-maturity basis.
Place the following ratings in the proper order from highest to lowest. I. A II. Aa III. Aaa IV. Baa
III, II, I, and IV Explanation: The highest Moody's rating is Aaa followed by Aa, A, and Baa.
When a bond is called, the bondholder receives the: a. Call price b. Call price plus accrued interest c. Market price d. Market price plus accrued interest
b. Call price plus accrued interest Explanation: The bondholder receives the call price (either at par or at a premium) plus accrued interest earned up to the call date.
If interest rates decline, which of the following securities will probably have the greatest increase in market value? a. Treasury bills b. Commercial paper c. Treasury bonds d. Treasury notes
c. Treasury bonds Explanation: When interest rates decline, the securities with the longest maturities will most likely have the greatest price increase.
From the issuer's perspective, when comparing term bonds and serial bonds, serial bonds have: a. Declining interest payments and declining principal amounts b. Increasing interest payments and increasing principal amounts c. Stable interest payments and stable principal amounts d. Stable interest payments and declining principal payments
a. Declining interest payments and declining principal amounts Explanation: Serial bonds have different maturity dates with lesser amounts of debt outstanding as time goes by. The bonds have declining interest payments and principal amounts. Term bonds, by comparison, mature at the same time and have stable interest payments with the principal paid on one maturity date.
A customer purchases a municipal bond with 25 years remaining to maturity. The bond has been prerefunded to its first call date. The issue is callable in 7 years at 108, declining to par in 14 years. It also has a sinking fund call provision that begins in 17 years at par. For confirmation purposes, the bond should be priced to the: a. First call date b. First par call c. Sinking fund date d. Final maturity date
a. First call date Explanation: When a bond is prerefunded, the only applicable date is the first call feature. Therefore, the bond must be priced to the first call date.
A 6% bond is selling at a 6.25% basis. The bond will mature in 25 years and has 3 call dates. Which of the following bonds will give the investor the best return? a. The bond is called after 10 years at 103 b. The bond is called after 15 years at 102 c. The bond is called after 20 years at 101 d. The bond is held to maturity
a. The bond is called after 10 years at 103 Explanation: The bond is selling at a discount. The first call in 10 years at 103 will give the investor the best return. The investor receives the highest call price in the shortest number of years.
Which of the following securities has the LEAST amount of capital risk? a. Options b. Bonds c. Warrants d. Stocks
b. Bonds Explanation: Capital risk is the risk of an investor losing her principal, the amount of funds invested in a security. When compared to the other securities, bonds have the least amount of capital risk. At maturity, the investor would receive the principal amount of the bond, thus minimizing the capital risk.
When comparing long-term bonds and short-term bonds, all of the following statements are TRUE, EXCEPT: a. Long-term bonds generally have higher yields b. Fluctuations in the dollar price of long-term bonds are usually greater than for short-term bonds when the general level of interest rates change c. Long-term bonds generally provide greater liquidity than short-term bonds d. There is more purchasing power risk with long-term bonds when compared to short-term bonds
c. Long-term bonds generally provide greater liquidity than short-term bonds Explanation: When comparing long-term bonds and short-term bonds, all of the choices listed are true except long-term bonds generally provide greater liquidity than short-term bonds. Short-term bonds do not suffer from as large a price movement as long-term bonds when interest rates are changing. Long-term bonds are open to greater market risk, interest-rate risk, and purchasing-power risk. Both individual and institutional investors alike are more willing to accept a lower return (yield) in favor of more stable principal (less severe price swings).
If interest rates are expected to rise over a given period, a municipality that must raise money would probably issue securities with: a. Short-term maturities b. Intermediate-term maturities c. Long-term maturities d. Call provisions
c. Long-term maturities Explanation: By issuing securities with long-term maturities, the municipality can lock in the rate of interest it needs to pay on the bonds. Therefore, if interest rates are expected to rise over a given period, the municipality would not be subject to these changes. This would provide the municipality with the capital it needs, without borrowing again at higher rates of interest, as it would need to do if it issued shorter-term or intermediate-term securities.
A term bond has a mandatory sinking fund call feature. What method will be used to determine which specific bonds will be called? a. Investors with the largest position b. Investors with the largest coupon c. Investors with the longest maturity d. Random selection
d. Random selection Explanation: Random selection is the method used to call term bonds
A 4.65% New York City GO bond matures in 20 years. The bond is callable in 8 years at 103. Which of the following statements is TRUE? a. The investor has 3 years of call protection b. The issuer must pay investors an 8-point call premium to exercise the call privilege on the bonds c. The investor will receive less for the bond if it is called versus holding the bond to maturity d. The issuer may exercise the call provision anytime after the 8th year
d. The issuer may exercise the call provision anytime after the 8th year Explanation: The call premium of 3 points ($30 per bond) refers to the amount above par value which the issuer must pay the owner of the bond when the bond is called. Issuers usually call outstanding bonds when interest rates decline, and they are able to issue new bonds at lower rates of interest. The bond has 8 years of call protection. The issuer would need to make an outlay of cash to call back the bonds, but would save money because of the lower rate of interest the issuer would pay on the new bonds. A call provision is exercised by an issuer and not the bondholder.
When a municipal bond is to be advance-refunded (prerefunded), an escrow account is set up to insure that the money will be available. Securities are deposited in the escrow account. The securities that are deposited in the escrow account are: a. Revenue bonds b. General obligation bonds c. Federal agency bonds d. Treasury bonds
d. Treasury bonds Explanation: Only Treasury obligations are acceptable securities as escrow when a bond is advance-refunded.
Which of the following securities will probably have the greatest fluctuation in price when interest rates move up or down? a. Commercial paper b. Treasury bills c. Treasury notes d. Treasury bonds
d. Treasury bonds Explanation: Treasury bonds have the longest maturity of the choices listed and will have the greatest fluctuation in price. Since they have the longest maturity, they will be exposed to the risks of the marketplace for the longest period.
Which of the following Moody's ratings is the most speculative? a. Aa b. A c. Baa d. Ba
Explanation: Of the choices given, Ba is the most speculative. The highest Moody's rating is Aaa.
Interest rates had been very high. During the past three years rates have decreased dramatically, reaching historically normal level. The present yield curve would most likely be: I. Ascending II. Inverted III. Positive sloping IV. Negative sloping
I and III Explanation: If rates have declined for the past three years and reached a normal level, the present yield curve would most likely be ascending, which is also referred to as positive or upward sloping. This type of curve would have short-term rates lower than long-term rates, which is the way interest rates usually are. It is also referred to as a normal yield curve.
A corporation would choose to refinance its debt for which TWO of the following reasons? I. To reduce its overall interest costs II. To be able to borrow funds at a higher rate III. To be able to reduce the number of persons on the board of directors IV. To remove restrictive provisions from the indenture
I and IV Explanation: A corporation would most likely refinance its debt to reduce its overall interest cost. This is most likely to happen when interest rates have declined and/or the credit strength of the issuer increases. It may also refinance to remove a restrictive provision from a bond's indenture. This restriction may have been included when the issuer sold bonds and it was not easy for the issuer to borrow funds. Refinancing does not alter the number of persons on the board of directors.
Which TWO of the following statements are normally TRUE regarding the pricing of municipal bonds? I. Serial bonds are priced on a yield-to-maturity basis II. Serial bonds are priced on a dollar basis III. Term bonds are priced on a yield-to-maturity basis IV. Term bonds are priced on a dollar basis
I and IV Explanation: Normally, traders quote municipal bonds issued in a serial maturity on a yield basis, where the yield quoted is the lower of yield to call or yield to maturity. Term bonds are normally quoted using the dollar pricing (percentage of par) method and are sometimes referred to as dollar bonds. For example, a trader may quote a serial bond at a basis price of 5.35, which means a yield to maturity of 5.35%. A term bond would be quoted at a price of 98, which means that the bond is quoted at 98% of par value, or $980 ($1,000 par x 98%).
When comparing high-grade bonds to low-grade bonds, lower-grade bonds have which TWO of the following choices? I. Higher yields II. Lower yields III. Higher market prices IV. Lower market prices
I and IV Explanation: One of the basic principles of investing is the greater the risk, the greater the return, and the lower the risk, the lower the return. Since lower-grade bonds are riskier than higher-grade bonds, they will have higher yields and lower market prices.
New Issue $50,000,000 City of Denver, Colorado Pollution Control Bonds Par Value $1,000 Amount Rate Maturity Date Price $50,000 5 1/2% July 1, 2027 101 $60,000 6 1/2% July 1, 2028 101 Based on the above information, which of the following statements may be made about the bonds maturing in 2027? I. The yield to maturity will be greater than 5.50% II. The yearly interest payment is $55 per bond III. The amount of principal the investor will receive at maturity will be greater than $1,000 IV. An investor holding the bond until maturity will have a yield of less than 5.50%
II and IV Explanation: The bonds maturing on July 1, 2027 have a nominal yield of 5 1/2% and have been issued at 101, which is 101% of their par value of $1,000, or $1,010. The yearly interest payment is 5 1/2% of par, or $55. The bonds are offered at a premium and an investor paying $1,010,will receive $1,000 at maturity. A bond offered at a premium and held to maturity will have a yield of less than the coupon (nominal yield) of 5.50%.
Relative to a municipal bond purchased at a discount that is callable at par, place the following yields in the proper order from lowest to highest yield. I. Current yield II. Nominal yield III. Yield to maturity IV. Yield to call
II, I, III, IV Explanation: A bond trading at a discount, which is callable at par, has a nominal yield that is less than its yield to maturity. Current yield falls between the nominal yield and yield to maturity, and the yield to call is greater than the yield to maturity. A bond trading at a premium has a nominal yield, which is higher than the yield to maturity, with the current yield in between the other two yields. The yield to call is lower than the yield to maturity for a bond selling at a premium, which is callable at par.
Pennsylvania Power Company has announced that it will refund $800 million of its outstanding 6 1/4% bonds that were to mature in 2040. The bonds will be refunded at 106.75% of par value from the proceeds of an $800 million refunding issue. The refunding issue has a 4 1/2% coupon rate and matures in 2030. Bondholders who own 6 1/4% bonds maturing in 2040 will receive: a. $1,067.50 plus accrued interest b. The new 4 1/2% bonds being issued plus accrued interest c. $1,000 plus accrued interest d. The new 4 1/2% bonds being issued without accrued interest
a. $1,067.50 plus accrued interest Explanation: The company is refunding the bonds at 106.75% of its par value. The bondholders who own the 6 1/4% bonds will receive 106.75% of the $1,000 par value (106.75% x $1,000) for a total of $1,067.50 plus accrued interest.
Which of the following bonds results in the highest real interest rate? a. A bond yields 8% when inflation is at 3% b. A bond yields 12% when inflation is at 8% c. A bond yields 10% when inflation is at 7% d. A bond yields 6% when inflation is at 4%
a. A bond yields 8% when inflation is at 3% Explanation: The real interest rate, also called the real rate of return, refers to yields adjusted for inflation (yield minus inflation rate). Choice (a) provides the highest real interest rate (8% bond yield minus 3% inflation rate equals 5% real interest rate).
If a municipal bond has a basis of 6.35 and a coupon rate of 6.15%, the bond is selling at: a. A discount b. Par value c. A premium d. A price that cannot be determined from the information given
a. A discount Explanation: Municipal bonds may be quoted on a yield to maturity basis, which in this example is a 6.35 basis. This means the bond has a yield to maturity of 6.35%. If the nominal yield (coupon rate) is 6.15%, this means that the bond is selling at a discount, below the par value ($1,000). If the yield to maturity (6.35%) is greater than the nominal yield (6.15%), the bond is selling at a discount.
All of the following statements are TRUE concerning a municipal bond issue having a serial maturity, EXCEPT: a. All of the bonds mature on one date in the future b. The bonds are priced on a yield-to-maturity basis c. The issue has a decreasing outstanding principal d. The issue has decreasing total interest payments
a. All of the bonds mature on one date in the future Explanation: Serial bonds mature in successive years and are priced on a yield-to-maturity basis. As a serial issue nears its final maturity, the outstanding principal and total interest payments decrease. Term bonds mature at one date in the future and are priced at a dollar price (percentage of par).
Various tranches of a long-term speculative bond issue are called by the issuer. The effect on the remaining outstanding bonds is likely to be: a. Improved quality b. Decreased quality c. Making them eligible for investment by banks d. Increased interest payments
a. Improved quality Explanation: When part of an issue of long-term speculative bonds is called, the effect on the remaining outstanding bonds will be an improvement in their quality. The issue will have less debt outstanding and there will be less interest charges to pay, which improves the quality of the issue.
A newly issued bond has a provision that it cannot be called for five years after the issue date. This call protection would be MOST valuable to a recent purchaser of the bond if: a. Interest rates are falling b. Interest rates are rising c. Interest rates are stable d. The yield curve slopes downward
a. Interest rates are falling Explanation: The call protection provision of five years would be most valuable to a recent purchaser of the bond if interest rates are falling. If interest rates fall, outstanding bond prices will rise. Issuers of bonds will call or retire bonds when interest rates decline, and will issue new bonds with lower rates of interest. Bonds are usually callable at a small premium above par value. If the bonds are not callable, the investor can realize the full benefit of an increase in the market price of the bonds.
ABC Corporation has issued two $1,000 par value bonds with the same coupon rate, one paying interest annually and the other paying interest semiannually. If both bonds are held to maturity in 10 years, the bond paying interest annually will have a total return that is: a. Less than the bond paying interest semiannually b. More than the bond paying interest semiannually c. The same as the bond paying interest semiannually d. Two times greater than the bond paying interest semiannually
a. Less than the bond paying interest semiannually Explanation: The bond paying interest annually will have a yield to maturity that is less than the bond paying interest semiannually. Yields to maturity assume a reinvestment and compounding of interest. The compounding of interest will be greater for the bond paying semiannual interest.
A corporation announced in an ad in The Wall Street Journal that it intends to call for the redemption of all its outstanding 7.25% callable bonds at 103 1/4 plus accrued interest. The market price of the bonds was 102 3/4 at the time of the announcement. Which of the following alternatives is MOST advantageous to an existing bondholder? a. Redeem the bonds b. Sell the bonds at the current market price c. Do nothing and hope for a takeover bid from another company d. Hold the bonds to maturity and continue to earn interest
a. Redeem the bonds Explanation: When bonds are called for redemption, the bondholder can only redeem the bonds at the callable price or otherwise sell them in the market. The bondholder cannot continue to hold the bonds in anticipation of a better offer or until maturity.
A customer buys a premium bond that is callable. Which of the following is LEAST beneficial for the customer? a. The bond is called at its par value in five years b. The bond is called at its par value in ten years c. The bond is called at its par value in fifteen years d. The bond is called at its par value in twenty years
a. The bond is called at its par value in five years Explanation: If the bonds are called in five years at par, the premium paid for the bond will be amortized over the shortest period. This results in the investor realizing a lower yield than if the bond were called after a longer period. It is important to note that rules require a firm to disclose to a customer the lowest possible yield that the customer can realize. On a premium bond (as in this example), the lowest yield will result from the bond being called at par in the shortest period.
An individual purchases $100,000 face value of a 6% municipal bond at a dollar price of 101 1/2. The bond's maturity is 7-1-27, but the issue has been called for redemption on the first call date of 7-1-15 @ par. The customer's confirmation should show the: a. Yield to call b. Yield to maturity c. Taxable equivalent yield d. After-tax yield
a. Yield to call Explanation: Since the bond has been called, the yield to the call must be shown because the maturity is no longer of importance. Taxable equivalent yield and after-tax yield are never shown since the investor's tax bracket and/or capital gains rate cannot be accurately predicted.
An investor owns $10,000 worth of XYZ Corporation convertible bonds that are callable at 102. The bonds are currently selling in the market at 103. If the corporation calls the bonds at the call price, the investor will receive: a. $10,000 b. $10,200 c. $10,300 d. $10,500
b. $10,200 Explanation: When bonds are called for redemption, the owner receives the call price. The call price is 102 for a total of $10,200 ($1,020 per bond x 10 bonds). If the investor were able to sell the bonds at the current price, she would receive $10,300 ($1,030 x 10 bonds). However, the question states that the bonds are called, which means the market price of the bond will gravitate to the call value of $10,200.
A customer buys bonds with a $50,000 par value at 85 1/2. The bonds are callable at 110. If the customer holds the bonds to maturity, he will receive: a. $42,750 b. $50,000 c. $55,000 d. $85,500
b. $50,000 Explanation: At maturity, the holder of the bonds will receive the par value, which in this example is $50,000. The call price and market value are not relevant.
Wilsons Chemicals bonds have a nominal yield of 6.6%. They closed the previous day at 91 7/8. An owner of 10 bonds will receive a yearly interest payment of: a. $66 b. $660 c. $91.88 d. $918.75
b. $660 Explanation: A nominal yield of 6.6% for a corporate bond with a $1,000 par value equals $66 in interest payments. If an investor owns 10 bonds, he will receive an annual interest payment of $660.
Which of the following securities have the most interest-rate risk? a. 2X short-term bond leveraged ETFs b. 2X long-term bond leveraged ETFs c. Long-term bond leveraged ETFs d. Short-term bond leveraged ETFs
b. 2X long-term bond leveraged ETFs Explanation: An essential bond concept is that long-term bonds have a higher degree of interest-rate risk than short-term bonds. A leveraged ETF seeks to deliver a multiple of the performance of an index or other benchmark. Therefore, a 2X long-term bond leveraged ETF will have the highest degree of interest-rate risk of the answer choices.
Which of the following features is NOT a benefit of a laddered portfolio of bonds? a. A higher average yield b. Elimination of interest-rate risk c. Improved liquidity d. Lower reinvestment risk
b. Elimination of interest-rate risk Explanation: A laddered portfolio is created by investing in the same type of bonds with different maturity dates. This approach reduces, but does not eliminate, interest-rate risk. Some of the benefits of laddering include a higher average yield since there is a mix of both short-term and long-term bonds, improved liquidity since bonds will be maturing on a regular basis, lower reinvestment risk since proceeds will be reinvested each year rather than only reinvesting when all of the bonds mature.
A municipal bond issue with an inverted yield scale has: a. Lower yields on the shorter maturities than on the longer maturities b. Higher yields on the shorter maturities than on the longer maturities c. The same yields on all maturities d. Prices higher on the shorter maturities than on the longer maturities
b. Higher yields on the shorter maturities than on the longer maturities Explanation: A municipal bond issue with an inverted yield scale will have higher yields on the shorter maturities and lower yields on the longer maturities.
A customer buys a 6 3/4% municipal bond at 101 3/4. The yield to maturity on the bond is: a. 6 3/4% b. Less than 6 3/4% c. More than 6 3/4% d. Par plus 1 3/4%
b. Less than 6 3/4% Explanation: The customer bought the bond at 101 3/4, which is at a premium over the $1,000 par value of the bond. If she holds the bond to maturity, her yield will be less than 6 3/4%, since a bond bought at a premium will have a yield to maturity that is less than the coupon rate.
If the Federal Reserve Board increases the discount rate, you would expect: a. Short-term bonds to decrease more in price than long-term bonds b. Long-term bonds to decrease more in price than short-term bonds c. That there would be no effect on either long-term or short-term bond prices d. Long-term bonds would increase more in price than short-term bonds
b. Long-term bonds to decrease more in price than short-term bonds Explanation: If the FRB increases the discount rate, the general level of interest rates increases. The prices of long-term bonds decreases more in price than the price of short-term bonds.
All of the following statements are TRUE regarding yield curves, EXCEPT: a. In an ascending curve, short-term rates are lower than long-term rates b. They are fixed and may only be changed by the Federal Reserve Board c. In a descending curve, short-term rates are greater than long-term rates d. In a flat yield curve, both short-term and long-term rates are equal
b. They are fixed and may only be changed by the Federal Reserve Board Explanation: Yield curves are ascending (upward sloping from the shorter to longer maturities) when money is easy. When this occurs, short-term rates are lower than long-term rates. A descending yield curve, which is indicative of a tight money situation, shows short-term rates higher than long-term rates. A flat yield curve indicates that short-term and long-term rates are approximately the same. FRB policies may influence yield curves, but they are not fixed and are influenced by a variety of factors.
During periods of tight money, when the yield curve becomes inverted, the highest yield would probably be found in: a. Two-year Treasury notes b. Three-month Treasury bills c. Five-year Treasury notes d. Thirty-year Treasury bonds
b. Three-month Treasury bills Explanation: When interest rates have increased due to a tight monetary policy, the yield curve may become inverted, causing short-term rates to be higher than long-term rates. Three-month Treasury bills, having the shortest maturity, would have the highest yield. If the premise of the question was an easy money policy and a normal yield curve, the correct answer would be choice (d).
An investor sells ten 5% bonds and buys another 10 bonds with a 5 1/4% coupon rate. The investor's yearly cash flow from the bonds will have increased by: a. $1.25 per bond b. $1.50 per bond c. $2.50 per bond d. $5.00 per bond
c. $2.50 per bond Explanation: The investor's yearly return will have increased by $2.50 per bond. The increase is 1/4% (5% to 5 1/4%), which is 1/4 of 1% of the par value of $1,000, or $2.50.
A customer purchases 10 M Dade Co. Florida 7.50% G.O. bonds at a 9.50 basis. How much interest will she collect each year? a. $75 b. $95 c. $750 d. $950
c. $750 Explanation: 10 M equal's $10,000 par value of bonds (the symbol M refers to thousands). The coupon rate is 7.50%. Therefore, the annual interest is $750 ($10,000 x 7.50%).
Napa Tools 7 1/4% bonds due in 2038 are listed in a financial publication as having closed the previous day at 81 7/8. The closing price of Napa Tools bonds is: a. $714.00 b. $725.00 c. $818.75 d. $817.80
c. $818.75 Explanation: Corporate bonds may be quoted in fractions as a percentage of par value. The closing price of 81 7/8 is equal to 81 7/8% of the $1,000 par value. When converted to a decimal, it equals .81875 of $1,000. Therefore, the correct answer is $818.75.
If a municipal bond has a basis of 4.35 and a coupon rate of 4.95%, the bond is selling at: a. A discount b. Par value c. A premium d. A price that cannot be determined from the information given
c. A premium Explanation: Municipal bonds may be quoted on a yield to maturity basis, which in this example is a 4.35 basis. This means the bond has a yield to maturity of 4.35%. If the nominal yield (coupon rate) is 4.95%, this means that the bond is selling at a premium, above the par value ($1,000). If the yield to maturity (4.35%) is less than the nominal yield (4.95%), the bond is selling at a premium.
The State of North Carolina is offering $100,000,000 of general obligation bonds with serial maturities. The bonds maturing in 2029 have an interest rate of 5 1/2% and a yield to maturity of 5.60%. This means the bonds are being offered: a. At par b. At a premium c. At a discount d. To yield 5 1/2%
c. At a discount Explanation: Since the bonds have a yield to maturity of 5.60% (that is greater than the 5 1/2% coupon rate), the bonds are being offered at less than their face (par) value. These bonds were, therefore, issued at a discount.
A client with $1,000,000 to invest is interested in acquiring $100,000 of bonds that mature each year over the next 10 years. This approach is referred to as: a. Dollar cost averaging b. Asset allocation c. Laddering the portfolio d. A barbell strategy
c. Laddering the portfolio Explanation: The approach is referred to as the laddering of a portfolio. When the earliest bonds mature, the proceeds are then reinvested at the long side (i.e., longest maturity) of the ladder. This investor reinvests the proceeds of the bonds that mature in year one into bonds that mature in 10 years. The purpose of this strategy is to reduce the impact that changes in interest rates will have on the portfolio. Investors that utilize a barbell strategy will buy bonds at the two ends (long and short maturities) of the yield curve. This strategy seeks to capture the high-coupon interest from the long-term bonds while also retaining the ability to reinvest quickly when the short-term bonds mature. Therefore, if the investor anticipates that there will be a shift in interest rates, only a portion of the portfolio will need to be adjusted.
An announcement in The Wall Street Journal states that New York State plans an advance refunding of its 7 1/2% Dormitory Bonds through the issuance of a special $50,000,000 bond issue. This means that: a. Existing bondholders will receive a new bond with a lower rate of interest b. Existing bondholders will receive a new bond with a higher rate of interest c. Proceeds from the sale of a new bond issue will be put in an escrow account to retire the existing bond issue d. The Dormitory bonds will be convertible into Treasury bonds
c. Proceeds from the sale of a new bond issue will be put in an escrow account to retire the existing bond issue Explanation: Advance refunding means that proceeds from the sale of the new bond issue will be put in an escrow account to retire the existing bond issue. If a municipality wants to engage in advance refunding, as is the case in this example, the municipality will sell the new issue with the proceeds of the sale going into an escrow account containing U.S. government securities. The U.S. government securities would be purchased with a maturity date that coincides with the issue's call date. This allows the refunded issue to be retired using the proceeds from the matured government securities.
In a discussion with a client, a registered representative refers to a bond yield that has been reduced by the inflation rate. This yield is known as the: a. After-tax yield b. Discount rate c. Real interest rate d. LIBOR
c. Real interest rate Explanation: The real interest rate is the yield of a security reduced by the inflation rate. While it represents earnings remaining once inflation is taken into account, the real interest rate does not factor in the tax consequences. The discount rate is the rate of interest that the Federal Reserve charges member banks for loans. LIBOR (the London Interbank Offered Rate) is the rate of interest that banks in London charge each other for short-term loans.
What type of risk do zero-coupon bonds eliminate? a. Credit risk b. Purchasing power risk c. Reinvestment risk d. Market risk
c. Reinvestment risk Explanation: Zero-coupon bonds are issued at a discount and do not pay semiannual interest. Therefore, there are no interest payments to reinvest, eliminating reinvestment risk. When investing in fixed-income investments, one of the uncertainties is whether interest rates will allow an investor to realize the total return that was calculated at the time of the investment (yield to maturity). Zero-coupon bonds do not have reinvestment risk, but they do have extreme interest-rate risk because the bonds' duration will equal the years to maturity.
Which of the following issues will most likely have a mandatory sinking fund? a. Serial issues b. Balloon issues c. Term issues d. Convertible issues
c. Term issues Explanation: A term issue is one in which all the bonds mature in one specific year. To accumulate monies to help retire the bonds, the issuer will deposit monies (above the amount to pay interest) in a sinking fund. These monies will generally be used to retire some of the bonds prior to maturity. A serial issue is one in which a portion of the bond issue is paid off each year, versus all being paid in one specific year as with a term bond issue.
A customer bought an 8% debenture at a 7.20 basis. If the bonds are currently trading 15 basis points higher: a. The customer's yield to maturity has increased to 7.35% b. The bond's coupon has increased to 8.15% c. The bond's market price has decreased d. The investment has not been affected
c. The bond's market price has decreased Explanation: When the customer bought the bond, he established a yield to maturity of 7.20%. A 7.20 basis is used to quote a bond that is offered at a price equivalent to a YTM of 7.20%. This will remain the same over the life of his investment. The coupon rate was established when the bonds were issued and will never change. However, when yields in the market increase, the market price of outstanding bonds decreases. The bond is now trading at a price equivalent to a YTM of 7.35%.
XYZ Corporation has issued $50 million 7% bonds at a premium. The bonds have a current yield of 6% and a yield to maturity of 5%. An investor purchasing $1,000,000 face value of bonds at the offering will receive a yearly income of: a. $35,000 b. $50,000 c. $60,000 d. $70,000
d. $70,000 Explanation: An owner of the bonds will receive 7% of the par value yearly regardless of the cost. In this example, the investor purchased $1,000,000 face value of bonds and will, therefore, receive $70,000 (7% of $1,000,000 = $70,000) in yearly income.
An investor purchases a zero-coupon municipal bond maturing in 15 years that is callable in five years at 102. If the bond is called, the investor will receive: a. Par value b. 102% of the par value c. 102% of the original cost d. 102% of the compound accreted value
d. 102% of the compound accreted value Explanation: The investor would receive 102% of the compound accreted value since the security is a zero-coupon bond or original issue discount (OID) bond. The compound accreted value is equal to the original value of the bond plus the annual accretion as of the call date. If the bond was not an OID bond and was called, the investor would receive 102% of par or $1,020.
Four municipal bonds maturing in 2039 are all selling at a 7.00 basis. Which of the following bonds is most likely to be refunded? a. 5 1/2% callable in 2024 @ 103 b. 6 1/2% callable in 2023 @ 100 c. 7% callable in 2024 @ 103 d. 7 1/2% callable in 2023 @ 100
d. 7 1/2% callable in 2023 @ 100 Explanation: The most common reason for a municipality to refund an outstanding issue is to save interest costs. If a municipality can borrow money at a lower rate than the outstanding issue, it can use this money to refund the outstanding issue and thus save interest cost. The bonds are selling at a 7.00% yield. The municipality can then expect to borrow new monies at a 7.00% interest rate. The municipality can only save money by refunding an issue with a higher interest rate, 7 1/2% (choice d).
A municipal bond with a 6% coupon is priced at a 7.20 basis. If the bond's yield to maturity increases by 40 basis points, the yield to maturity is: a. 5.60% b. 6.40% c. 6.80% d. 7.60%
d. 7.60% Explanation: The term priced at a 7.20 basis refers to a serial bond that is priced to yield 7.20 or a YTM of 7.20%. If the bond's basis increased by 40 basis points, the new yield to maturity is 7.60%. The 6% coupon rate is relevant if the question asked about whether the bond was trading at a discount or a premium. Since the YTM is greater than 6%, the bond is trading at a discount.
An investor who is in his late 80s wants tax-free income and the ability to provide funds for his children after his death. Which of the following choices should an RR recommend? a. An asset allocation mutual fund b. A portfolio of long-term municipal bonds c. A laddered corporate bond portfolio d. A laddered municipal bond portfolio
d. A laddered municipal bond portfolio Explanation: Through municipal bond purchases, investors receive tax-free income. A laddered portfolio is one that invests in the same type of bonds with different maturity dates. When the first bond matures, the proceeds are then reinvested in the long side (i.e., longest maturity) of the ladder. By laddering the portfolio, investors will have greater access to money if the need arises. For instance, if short-term funds are needed (e.g., a person wants to provide funds for his children), the investor may use the amount that is maturing rather than being forced to sell the longer term bonds in the secondary market.
If a municipal bond has a basis of 4.33 and a coupon rate of 5.77%, the bond is selling at: a. A price that cannot be determined from the information given b. Par value c. A discount d. A premium
d. A premium Explanation: Municipal bonds may be quoted on a yield to maturity basis, which in this example is a 4.33 basis. This means the bond has a yield to maturity of 4.33%. If the nominal yield (coupon rate) is 5.77%, this means that the bond is selling at a premium, above the par value ($1,000). If the yield to maturity (4.33%) is less than the nominal yield (5.77%), the bond is selling at a premium.
Pennsylvania Power Company has announced that it will refund $800 million of its outstanding 6 1/4% bonds that were to mature in 2040. The bonds will be refunded at 106.75% of par value using the proceeds of an $800 million refunding issue. The refunding issue has a 4 1/2% coupon rate and matures in 2030. The refunding will reduce all of the following items, EXCEPT the: a. Interest cost to the issuer b. Company's maturity schedule c. Company's annual debt service obligation d. Amount of outstanding debt
d. Amount of outstanding debt Explanation: Pennsylvania Power has reduced the interest charges (from 6 1/4% to 4 1/2%) by advancing the repayment of its existing debt. The company is paying off the 6 1/4% bonds, due in 2040, with the issuance of another bond. It is also improving its debt service by reducing the interest rate from 6 1/4% to 4 1/2%, thereby reducing its fixed charges each year. However, the amount of debt outstanding will remain the same at $800 million.
Investors who are seeking income may invest in all of the following securities, EXCEPT: a. Special tax bonds b. Lease rental bonds c. Moral obligation bonds d. Capital appreciation bonds
d. Capital appreciation bonds Explanation: A capital appreciation bond (CAB) has a similar structure to a zero-coupon bond. CABs do not pay periodic interest and are NOT suitable for investors who seek income.
Which of the following interest-rate environments makes call protection MOST valuable to a purchaser of bonds? a. Increasing interest rates b. Stable interest rates c. Volatile interest rates d. Decreasing interest rates
d. Decreasing interest rates Explanation: Call protection would be most valuable to a purchaser of bonds when interest rates decline. If interest rates fall, existing bond prices rise. A municipality or any issuer would likely call bonds when interest rates decline so it can issue new bonds with lower rates of interest. Although bonds may be callable at a small premium above par value, if the bonds are not callable, the investor may realize the full benefit of an increase in the market price of the bonds.
An investor is expecting a sharp decline in interest rates in the near future. To capitalize on this situation, the investor should buy: a. Premium bonds with short maturities b. Premium bonds with long maturities c. Discount bonds with short maturities d. Discount bonds with long maturities
d. Discount bonds with long maturities Explanation: Long-term bond prices are more volatile than short-term bond prices. Discount bond prices are more volatile than premium bond prices. If the investor expects interest rates (yields) to decline, she is anticipating rising bond prices. The bonds that will rise (fluctuate) the most are long-term, discount bonds.
A tombstone ad states that the McGee Oil Company is offering $200,000,000 of 8 1/2% bonds due July 1, 2038 at 99 1/2% of par value. The yield to maturity on the bonds is: a. 8% b. Less than 8 1/2% c. 8 1/2% d. Greater than 8 1/2%
d. Greater than 8 1/2% Explanation: The 8 1/2% bonds are being offered at a discount at 99 1/2% of their $1,000 par value. An investor who purchased the bonds at the offering (at $995) and held the bonds to maturity will receive the par value of $1,000. The investor will, therefore, have a yield to maturity that is greater than the coupon rate (nominal yield) of 8 1/2%.
The proceeds of the sale of a municipal bond issue are invested in U.S. government securities that are sufficient to cover interest, principal, and call premiums on an outstanding bond issue. The outstanding bonds are called: a. Structured notes b. Double-barreled bonds c. Guaranteed bonds d. Prerefunded bonds
d. Prerefunded bonds Explanation: The outstanding bonds are called prerefunded or advance-refunded bonds. The new issue is called a refunding issue. This is usually done when the issuer can borrow funds at lower rates, thereby reducing its interest costs.
Which of the following risk factors is the MOST important for purchasers of long-term, high-grade bonds? a. The ability to pay interest when due b. The ability to pay principal upon maturity c. Limited marketability d. Purchasing power risk
d. Purchasing power risk Explanation: Long-term, high-grade bonds are relatively safe investments, but do have purchasing-power risk. Because the amount of interest income is fixed, the purchasing power of the interest income may decline over the long term because of inflation. A rise in inflation reduces the amount of goods and services that can be purchased with the fixed amount of dollars.
Which of the following companies would probably be MOST leveraged? a. Software b. Biotech c. Consumer electronics d. Utilities
d. Utilities Explanation: A leveraged company has a large amount of outstanding debt (bonds) and would be the most leveraged. Of the choices given, utilities are the heaviest users of debt and have the greatest amount of interest charges (fixed charges). The percentage of debt in a utility company's capitalization is usually greater than that of the other companies listed.
