Unit 5
When a corporate bond has a convertible feature, it means A. the owner of the bond may exchange it for a pre-determined number of shares of the issuer's common stock B. the corporation may redeem the bond before its maturity date C. the owner fo the bond my exchange it for a common stock of the issuer at a discount from the current market value D. the owner of the bond may exchange it for a bond paying a higher coupon rate
A. A convertible bond is usually a debenture that allows the owner to exchange it for a set number of shares of stock as stated in the bond indenture (or contract). This number will change only in response to the anti dilutive provisions that go into effect in the case of a stock split or stock dividend and has nothing to do with the market price of the stock.
A $1,000 bond with a nominal yield of 8% will pay how much interest each year? A. $40 B. $80 C. $160 D. There is no way to compute without knowing the current market price of the bond.
B. The nominal yield (or coupon rate) is the interest rate stated on the bond and is the annual rate the issue promises to pay on the bond until the bond matures. A $1,000 bond with an 8% nominal yield will pay $80 per year in interest. In all cases on the exam, the interest will be paid in two equal semi-annual installments, in this case, $40 each.
Corporate bonds are considered safer than common stock issued by the same company because A. the par value of bonds is generally higher than that of stock B. bonds and similar fixed-rate securities are guaranteed by SIPC C. bonds place the issuer under an obligation but stock does not D. if there is a shortage of cash, dividends are paid before interest
C. A bond represents a legal obligation to repay principal and interest by the company. Common stock carries no such obligation. SIPC insures broker-dealer client accounts, not bonds.
What would likely happen to the market value of existing bonds during an inflationary period couples with rising interest rates? A. the price of the bonds would increase B. the nominal yield of the bonds would increase C. the price of the bonds would decrease D, the price of the bonds would stay the same.
C. Bond prices fall when interest rates rise because bond prices have an inverse relationship with interest rates.
A method of valuing an investment, particularly debt securities, by calculating what future cash returns will be worth at the time they are received, based on estimate of future inflation and interest rates is known as A. net present value B. dividend discount model C. discounted cash flow D. Yield to maturity
C. This is the basic definition of discounted cash flow, a useful tool in determining the value of debt securities
Which of the following statements is TRUE of a corporate bond with a call feature? A. The owner of the bond may demand that the issuing corporation redeem the bond before it matures. B. The issuing corporation may change the coupon rate at any time by giving the owner of the bond written notice. C. The owner of the bond may exchange it for shares of stock. D. the issuing corporation has the option to redeem the bond before it matures.
D. A callable bond is one that may be redeemed by the issuing corporation before it matures. One reason a corporation might call a bond is because it can now borrow at a lower interest rate.
True or False: A resident of France is purchasing Eurodollar bonds does not incur currency risk.
F. As the name implies, Eurodollar bonds are denominated in U.S. dollars. That means that someone in France will have the risk that the Euro, the home currency in France, will rise against the dollar and, as a result, interest payments will be worth less as will the ultimate payback at maturity. Only U.S. residents have no currency risk with Eurodollar bonds.
True or False: In most cases, convertible securities sell right at their parity price.
F. B because of the perceived extra safety of the convertible security (either a preferred stock or debenture, both having senior claim over the common stock), the general case is that convertible securities sell at somewhat of a premium over their parity price.
When a bond with a 6% coupon is selling for 90 I. the current yield is approximately 6.67% II. the bond is selling at a discount III. the bondholder will receive two semi-annual interest payments of $27 each IV. the yield to maturity is slightly less than the current yield A. I and II B. I, II and IV C. II and III D. III and IV
A. The current yield on a bond is the coupon divided by the current market price. In this example 6 divided by 90. the price of 90 represents 90% of par. a discount of $100. Interest payments are base on the $1,000 face amount, so this investor would receive two semiannual payments of $30 each. On a discounted bond, the yield to maturity will always be higher than the current yield.
A client has TIPS with a coupon rate of 4.5%. The inflation rage has been 7% for the last year. What is the inflation-adjusted return? A. -2.5% B. 4.5% C. 7.0% D. 11.5%
B. Treasury Inflation Protection Securities (TIPS) adjust the principal value every 6 months to account for the inflation rate. therefore, the real rate of return will always be the coupon.
If your clients want to set aside $40,000 for when their child starts college, but do not want to endanger the principal, you should recommend A. corporate bonds with a high rates of interest B. zero-coupon bonds backed by the U.S. Treasury C. general obligation municipal bonds for their tax benefits D. common stock
B. Treasury STRIPS are guaranteed by the U.S. government so there is no chance of default. They are zero-coupon bonds and offer no current income, which is appropriate for a client who want 100% return paid at a future date for college expenses.
A corporate bond is currently selling in the market at a price of 120. The bond is convertible at $25. The parity price is A. $25 per share B. $30 per share C. $40 per share D. $48 per share
B. the first step is determining the number of shares upon conversion that would be dividing the $1,000 par value fo the bond by the $25 conversion price. this tells us that the bond is convertible into 40 shares. Then, we divide the current market price of the $1,200 by the 40 shares to arrive at the parity price (the price as which 40 shares is equal to $1,200).
Each fo the following debt securities would be considered investment grade EXCEPT A. corporate subordinated union unsecured debt ensures with an A rating B. municipal water authority revenue bonds with a Baa rating C. Corporate first lien mortgage bonds with a BB rating D. U.S. Treasury bills
C. Investment grade is defined as BBB (S&P) or Baa (Moody's) and higher. When giving the rating collateral, or lack of same, it taken into consideration. All you do is look at the letters.
A bond offered at par has a coupon rate A. less than its yield to maturity B. less than its current yield C. equal to its current yield D. greater than its yield to maturity
C. When a bond is selling on par, it's coupon or nominal rate, current yield, and yield to maturity are all the same.
True or False: One of the benefits of holding convertible debentures is the option to convert into the corporation's common or preferred stock
F. Convertible debentures are convertible into the issuer's common, not preferred stock.
What happens to outstanding fixed-income securities when interest rates decline A. Coupon rates increase B. No change C. Prices increase D. Yields increase
C. When interest rates drop, prices will rise, decreasing effective yield. Thus there is an inverse relationship between interest rates and bond prices.
An investor is considering the purchase of $100,000 maturity value of zero-coupon AAA rated corporate bonds scheduled to mature in 20 years. Among the risk that this investor will be assuming are I. Default risk II. interest rate risk III. Pre-payment risk IV. Reinvestment risk A. II and III B. III and IV C. I and II D. I and IV
C. Even through these bonds are rated AAA, 20 years is a long time and it is possible that the corporation may not even exist when the maturity date arrives. Adding to the risk is the fact that there are no interest payments in the interim. That is why most commonly recommend zero-coupon bonds are those issued or guaranteed by the U.S. Treasury. Since zero-coupon bonds have the longest duration for their maturity of any bonds, they have the greatest exposer to interest rate changes. Pre-payment risk is only found with the mortgage-backed securities and on o the benefits of zeroes is that there is no reinvestment risk.
Which of the following statements about municipal bonds is NOT true? A. the interest on municipal bonds is usually not subject to federal income tax. B. Municipal bonds are bonds issued by governmental units at level other than the federal. C. Municipal bonds are generally considered riskier than corporate bonds. D. Municipal bonds generally carry lower coupon rates than corporate bonds of the same quality
C. Municipal Bonds are generally considered second only to U.S. Treasury instruments in relative safety. Because of their tax-free yield, their coupon rates are lower than corporate bonds of the same quality.
An investor in the 25% federal income tax b racket purchasing an unrated public works revenue bond issues by State A that carries a 3% coupon would have a tax equivalent yield of A. 2.25% B. 3.00% C. 4.00% D. Non of these because it is unlikely that an unrated bond will be able to make timely interest payments
C. Tax equivalent yield is computed by dividing the coupon rate of the municipal bond by (100% tax bracket). In this case the calculation is 3% divided by 75% ( or 0.75)and result in a TEY of 4%. You can always work backward to check by deduction the 25% tax from each answer to see with one results win the 3% coupon. The fact that the bond is unrated has little or nothing to do with the ability of the issuer to pay the interest.
In the Event of a company's insolvency, which of the following has first claim on assets? A. Bondholder B. Preferred stockholders C. Common stockholders D. Members of the board of directors
A. Bondholders have contractual rights to the assets of a business that must be honored on insolvency before claims of stockholders or directors.
All of the following debt instruments pay interest semiannually EXCEPT A. Ginnie Mae pass-through certificates B. U.S. Treasury notes C. U.S. Treasury bonds D. TIPS
A. Ginnie Ma4s pay interest on a monthly basis, not semiannually.
A customer wishes to buy a security providing periodic interest payments, safety of principal, and protection form purchasing power risk. The customer should purchase A. TIPS B. TIGRS C. CMOs D. STRIPS
A. TIPS offer inflation protection and safety of principal because they are backed by the U.S. government
Which of the following statements ab out zero-coupon bonds are TRUE? I. Zero-coupon bonds are sold at a deep discount from face value. II. Zero-coupon bonds pay periodic interest payments. III. the owner of a zero-coupon bond receives the face value only at maturity. A. I and II B. I and III C. II and III D. I, II and III
B. A zero-coupon bond is a type of de bt security that pays no periodic interest payments. Instead, they are sold at a deep discount from the maturity value and the investor receives return of that value only when the bonds mature.
An unsecured bond is also know as a(n): A. Equipment trust certificate B. debenture C. collateral trust bond D. mortgage bond
B. An unsecured bond is also known as a debenture. Mortgage bonds, collateral trust bonds and equipment trust certificates are all types of secured bonds.
What would likely happen to the market value of existing bonds during an inflationary period coupled with rising interest rates? A. the nominal yield of the bonds would decrease B. the Price of the bonds would increase C. the price of the bonds would decrease D. the price of the bonds would stay the same.
C. The market price of outstanding bonds falls when interest rates rise because bond prices have an inverse relationship with interest rates. that is, when an investor can get a higher nominal (coupon) yield on a new bond, the old one paying a lower rate of interest just isn't worth as much sot the price goes down. remember, the nominal yield is the coupon rate state on the face of the bonds and that never changes.
An investor purchase 5 bonds priced at 102 each would expect to pay total of (disregard commissions) A. $102 B. $510 C. $1,020 D. $5,100
D. A bond price of 102 represents a 102% of the $1,000 par value or $1,020. With 5 bonds, the investor would pay a total of 5 x $1,020 or $5,100.
A bond, preferred stock, or debenture exchangeable at the option of the holder (for common stock of the issuing corporation) is a: A. collateral-backed equity security B. synthetic security C. non dilutive stock, D. convertible security
D. A bond, preferred stock or debenture exchangeable at the option of the holder for common stock of the issuing corporation is convertible security.
In the Secondary market, Treasury bond prices are most influenced by the: A. Treasury department B. prime rate C. Primary dealers D. inflation rate
D. In the secondary market, the rate of inflation has the greatest influence on all bond prices.
True or False: A country wishing to restructure its debt using Brady bonds would do so to save on debt servicing costs.
T. One of the benefits of Brady bonds is the ability of the sovereign government to borrow at a lower cost because of the collateral behind the bond.
True or False: Call protection is of greatest benefit when interest rates are falling.
T. When interest rates fall, issuers can borrow at a lower rate so they will be highly motivated to call in the old debt and replace it with debt at a lower interest rate.
