SERIES 7 -Debt
A customer buys 5M of 3 1/4% Treasury Bonds at 99-31. The current yield of the Treasury Bond is: A. 3.25% B. 3.50% C. 3.75% D. 4.00%
The best answer is A. The customer buys the bonds at 99 and 31/32s = 99.96875% of $1,000 = $999.6875 (the fact that $5,000 face amount of bonds were purchased is irrelevant, since the formula is a percentage). The formula for current yield is: annual income/market price = current yield $32.50 (per $1,000 face amount)/ $999.6875 (per $1,000 face amount) = 3.25% Since this price $999.6875 is so close to par, you get essentially the same yield.
A "qualified" legal opinion on a revenue bond is one which: A. states that the pledged revenues are subject to prior liens B. is given by a qualified bond counsel C. states that no liens have been found against pledged revenues D. states that the bond counsel is qualified in the state to render an opinion
The best answer is A. A qualified legal opinion is one where the bond counsel has found a legal or tax "problem," and the counsel details the "qualification" in the opinion. For a revenue bond issue, a reason for a qualified opinion is that the bond counsel has found other legal claims (liens) on the revenues that have been pledged to the bondholders.
Customer "A" buys a Credit Default Swap (CDS) from Customer "B," with the reference loan being one made to Customer "C." If Customer "C" defaults, 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 A. 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.
Which risk is unique to investing internationally in less-developed countries? A. Political risk B. Market risk C. Marketability risk D. Default risk
The best answer is A. Political risk is the risk of investing internationally in countries that have weak political systems. Thus, the bondholder has very little in the way of legal protection. Political risk is an issue for consideration when making investments in 3rd World countries. Any investment in a fixed rate bond has market risk. Marketability risk depends on how deep and liquid the market is for the bonds purchased. And all bonds have some potential level of default risk.
Under a municipal revenue bond rate covenant, rates must be set to cover all of the following EXCEPT: A. deposits to the reserve maintenance fund B. debt service C. maintenance of the facility D. operation of the facility
The best answer is A. Revenue bond rate covenants usually require that rates be set at a level sufficient to cover operation and maintenance of the facility, as well as debt service costs. There is no requirement to cover "optional" sinking fund deposits or reserve fund deposits.
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).
A municipal quote which is used to get an indication of a likely price at which a dealer will buy bonds is known as a: A. firm quote B. workable quote C. subject quote D. nominal quote
The best answer is B. A municipal "workable quote" is used to get an indication of a likely price at which a dealer will buy specified bonds. The municipal trading market is very thin, so quotes are not readily available for all bonds.
Securities subject to reinvestment risk are those that: I make periodic payments to investors II do not make periodic payments to investors III are held for short time horizons IV are held for long time horizons A. I and III B. I and IV C. II and III D. II and IV
The best answer is B. Reinvestment risk occurs when an investor is holding fixed income securities over a long time horizon during a time period when interest rates have been declining. As payments are received from these investments, they must be reinvested to maintain the overall rate of return on that portfolio - and if interest rates have been dropping, these payments are reinvested at lower and lower interest rates, lowering the overall rate of return on the portfolio.
All of the following agencies provide financing for residential housing EXCEPT: A. Fannie Mae B. Sallie Mae C. Ginnie Mae D. Freddie Mac
The best answer is B. Sallie Mae is the Student Loan Marketing Association. It buys student loans from state agencies and issues bonds to finance this activity. Fannie Mae, Ginnie Mae, and Freddie Mac all buy mortgages from banks (Fannie and Ginnie Mae buy FHA and VA insured mortgages; Freddie Mac buys conventional mortgages) and packages them into pools for sale to the public as pass through certificates.
The conversion price of a convertible debenture is set at issuance at $40 per share. The common stock is now trading at $42 while the bond is trading at 110. In order for the common stock to be trading at parity to the current market price of the bond, the stock price would be: A. $40 B. $44 C. $46 D. $48
The best answer is B. Since the bond is now trading at 110 ($1,100 per bond) and each bond is convertible into 25 common shares, the parity price of the common is $1,100 / 25 = $44. Since the common is currently trading at 42, it is below parity and it does not make sense to convert. It only makes sense to convert if the common is trading above parity.
A security which gives the holder an undivided interest in a pool of mortgages is known as a(n): A. equity real estate investment trust B. pass through certificate C. first mortgage bond D. mortgage real estate investment trust
The best answer is B. The question defines a pass through certificate - an undivided interest in a pool of mortgages, where the mortgage payments are passed through to the certificate holders. Real Estate Investment Trusts (REITs) are investment companies similar to closed end funds. In such an investment, one owns a trust unit; however the unit does not represent a undivided ownership interest in the underlying real estate or mortgages. Mortgage bonds are issued by corporations pledging real estate as collateral.
A bank qualified municipal issue is one where: A. 0% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted B. 20% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted C. 80% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted D. 100% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted
The best answer is C. A "bank qualified" municipal issue is an issue of $10,000,000 or less that has been designated by the issuer as a "bank qualified issue." To be bank qualified, it must be a public purpose (not private purpose issue). Any bank that buys the issue receives a tax benefit that is not available on all other municipal investments. The bank can deduct 80% of the interest expense it incurs on deposits used to fund the purchase of the bonds, while the interest income from the municipal issue is not taxable to the bank.
All of the following corporate bonds are secured EXCEPT: A. equipment trust certificates B. second mortgage bonds C. sinking fund debentures D. collateral trust certificates
The best answer is C. A secured bondholder has a lien on a specific asset of the company - such as equipment (an equipment trust certificate), real property (a mortgage bond) or securities given as collateral (a collateral trust certificate). A debenture is a promise to pay without any liens on corporate assets.
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.
MBIA insures municipal bonds for the: A. loss of interest only from the time of default B. loss of principal only from the time of default C. loss of both interest and principal from the time of default D. fair market value of the securities at the time of default
The best answer is C. MBIA (Municipal Bond Insurance Association Corporation) insures municipal bonds for loss due to default by the issuer. Both the payment of interest on a timely basis and the repayment of principal (par value at maturity) are insured.
CMO investors are subject to all of the following risks EXCEPT: A. Interest rate risk B. Prepayment risk C. Extended maturity risk D. Default risk
The best answer is D. CMO investors have almost no default risk, since the underlying mortgages are usually implicitly backed by the U.S. Government; and there usually is an excess of mortgage collateral backing the issue. 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. 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. Conversely, 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.
Term corporate bonds are quoted on a: A. yield to maturity basis B. current yield basis C. nominal yield basis D. percentage of par basis
The best answer is D. Corporate bonds are usually term bonds - all bonds of an issue having the same interest rate and maturity. Term bonds are quoted on a percentage of par basis in 1/8ths, which is the same as a "dollar" quote.
Which of the following would be used to evaluate a general obligation bond issue? I The trend of assessed property valuation II The collection ratio of the issuer III The debt ratios of the issuer IV The mill rate trend of the issuer A. I and IV only B. II and III only C. I and III only D. I, II, III, IV
The best answer is D. In order to evaluate a general obligation bond issue, all of the factors listed would be evaluated. One would look for a trend of increasing assessed property valuation; a consistently high collection ratio - meaning that most of the taxes assessed are actually being collected; a low ratio of debt to assessed valuation and low ratio of debt per capita; as well as a consistent mill rate - meaning that property tax rates are not being raised too quickly, causing people to flee from the area.
Jumbo Certificates of Deposit are: I issued in amounts in excess of $10,000 II issued in amounts in excess of $100,000 III fully insured by the Federal Deposit Insurance Corporation IV not fully insured by the Federal Deposit Insurance Corporation A. I and III B. I and IV C. II and III D. II and IV
The best answer is D. Jumbo Certificates of Deposit are issued in minimum $100,000 amounts and many banks only offer them in $1,000,000 minimums. Any amount in excess of $250,000 does not get FDIC insurance ($250,000 is the FDIC coverage limit). They are backed solely by the faith and credit of the issuing bank.
The normal priority of the flow of funds for a revenue bond net revenue pledge, as found in the Trust Indenture, is: A. debt service, operation and maintenance reserve, operation and maintenance, debt service reserve B. debt service reserve, operation and maintenance reserve, operation and maintenance, debt service C. operation and maintenance reserve, operation and maintenance, debt service, debt service reserve D. operation and maintenance, debt service, debt service reserve, operation and maintenance reserve
The best answer is D. The normal order for the "flow of funds" under a net revenue pledge is to apply revenues first to operation and maintenance; then to debt service; followed by debt service reserve; and last to the operation and maintenance reserve. If there are still funds left over after these payments are made, the excess goes into the surplus fund.
