Chapter 2 - Debt Securities

Question 1

A bond that was yielding 3.65% yesterday is currently yielding 3.75%. Which two of the following statements are true?

I. The bond’s price went down since yesterday
II. The bond’s price went up since yesterday
III. The bond’s yield is 10 basis points more today.
IV. The bonds yield is 1/10th basis point more today.
A) I and IV
B) I and III
C) II and IV
D) II and III

Answer 1

Correct Answer:
B) I and III

Answer Explanation
There is an inverse relationship between bond prices and bond yields. Because the bond’s yield is more today, its price fell. Basis points measure the change in interest rate. Each basis point equals 1/100 of a percent. (A change of 1 percent = 100 basis points). A change from 3.65% to 3.75% is a change of 10 basis points.

Textbook Reference
Please see textbook section 2.1.7

Question 2

When a bond’s market price increases, what is the impact on its nominal yield?
A) Nominal yield will increase.
B) Nominal yield will decline.
C) There will be no change in nominal yield.
D) There will be increased volatility in the nominal yield.

Answer 2

Correct Answer:
C) There will be no change in nominal yield

Answer Explanation
Nominal yield is the bonds annual interest or coupon rate. It is a percentage of par value and fixed over the life of the bond.

Textbook Reference
Please see textbook section 2.2.1

Question 3

A corporate bond that is currently trading at 95 pays a semi-annual coupon of $25. What is the current yield?
A) 0.05
B) 0.0526
C) 0.025
D) 0.0263

Answer 3

Correct Answer:
0.0526

Answer Explanation
A bond’s current yield is calculated by dividing the annual interest income by the current market price. $50/$950 = 5.26%.

Textbook Reference
Please see textbook section 2.2.2

Question 4

Which of the following statements regarding debt securities are true?

I. A purchaser of a bond is a creditor of the corporation

II. The corporation is a creditor of a bondholder

III. Bonds are generally issued with a par value of $100

IV. Bonds are generally issued with a par value of $1,000
A) I and IV
B) II and IV
C) II and III
D) I and III

Answer 4

Correct Answer:
A) I and IV

Answer Explanation
Investors that purchase bonds are creditors of the corporation, because the corporation owes them principal and periodic interest for the use of their money. Bonds are usually issued with a par value of $1,000. The stated rate of interest is a percentage of the bond’s par value.

Textbook Reference
Please see textbook section 2.1

Question 5

An issuer is most likely to call a bond which has
A) a low coupon and a call premium when interest rates are rising
B) a high coupon and no call premium when interest rates are falling
C) a high coupon and a call premium when interest rates are falling
D) a low coupon and no call premium when interest rates are rising

Answer 5

Correct Answer:
B) a high coupon and no call premium when interest rates are falling

Answer Explanation
Issuers strive to keep their cost of borrowing as low as possible. To do this, they call bonds with high coupons when rates are have fallen. They can then issue new bonds at a lower rate and reduce borrowing costs. A call premium is an additional amount that must be paid to call the bonds. To keep costs as low as possible, the issuer would prefer to call a bond with no call premium.

Textbook Reference
Please see textbook section 2.1.9

Question 6

Which of the following is TRUE of the yield of a bond that is trading at a price that is $80 more than its face value?
A) Its current yield will be the same as its coupon yield
B) Its current yield will be higher than its coupon yield
C) Its coupon yield will be higher than its current yield
D) Its current yield will be $80 less than its coupon yield

Answer 6

Correct Answer:
C) Its coupon yield will be higher than its current yield

Answer Explanation
Coupon yield stays constant over the life of a bond while current yield changes with bond’s market price. If a bond is trading above face value, its current yield will be lower than its coupon yield. If a bond is trading below face value, current yield will be the greater of the two. Current yield goes up as bond prices decrease, and vice versa.

Textbook Reference
Please see textbook section 2.2.5

Question 7

Which of these bond features is the most attractive to a corporate issuer?
A) High sinking fund requirement
B) Nonrefundable
C) High interest rate
D) Low call premium

Answer 7

Correct Answer:
D) Low call premium

Answer Explanation
Low call premiums are attractive to issuers because it allows the issuer to call the bond away from investors for a lower price. High interest rates require a larger interest expense for issuers, nonrefundable bonds do not allow an issuer to reissue bonds if interest rates decrease, and a high sinking fund require an issuer to maintain a large reserve of cash to maintain the bond. Only the low call premium is beneficial to issuers.

Textbook Reference
Please see textbook section 2.1.9

Question 8

An assessment by an independent agency of an issuers ability and willingness to make full and timely payments of amounts due on its debt obligations is known as a
A) growth profile
B) stock rating
C) credit rating
D) assessment rating

Answer 8

Correct Answer:
C) credit rating

Answer Explanation
A credit rating is an assessment by an independent rating agency of a company’s ability and willingness to make full and timely payments of amounts due on its debt obligations. Credit ratings are typically required for companies seeking to raise debt financing in the capital markets as only a limited class of investors will participate in a corporate debt offering without an assigned credit rating on the new issue. The three primary credit rating agencies are Moody’s, S&P, and Fitch. Nearly every public debt issuer receives a rating from Moody’s, S&P, and/or Fitch. Moody’s uses an alphanumeric scale, while S&P and Fitch both use an alphabetic system combined with pluses (+) and minuses (-) to rate the creditworthiness of an issuer.

Textbook Reference
Please see textbook section 2.3.5.1

Question 9

A buyer is not responsible for paying a seller any accrued interest since the last coupon payment in a bond that trades
A) flat.
B) thin.
C) ex-coupon.
D) round lot.

Answer 9

Correct Answer:
A) flat

Answer Explanation
If a bond trades “flat,” the buyer is not responsible for paying interest that has accrued since the last interest payment.

Textbook Reference
Please see textbook section 2.4

Question 10

A municipal bond’s coupon rate is 3%. The same issuer is now issuing bonds of similar quality and maturity with a coupon rate of 3.5%. The 3% bond will
A) Trade at its par value because the issuer will increase the coupon on the 3% bond to ensure parity with newly issued bonds
B) Trade at a premium in the secondary market
C) Trade at a discount in the secondary market
D) Continue to trade in the secondary market at its par value with no adjustment to the coupon rate

Answer 10

Correct Answer:
C) Trade at a discount in the secondary market

Answer Explanation
A bond trades at a discount in the secondary market when its coupon rate is lower than prevailing interest rates.

Textbook Reference
Please see textbook section 2.1.6

Question 11

An investor should expect the greatest price increase in which of the following if interest rates decline?
A) Short-term bonds selling at a premium
B) Short-term bonds selling at a discount
C) Long-term bonds selling at a discount
D) Long-term bonds selling at a premium

Answer 11

Correct Answer:
C) Long-term bonds selling at a discount

Answer Explanation
Because of the inverse relationship between price and yield, when interest rates fall, bond prices rise. Longer maturities have more market risk, so their prices rise more than shorter maturities. Bonds selling at a discount also rise more sharply than those selling at a premium.

Textbook Reference
Please see textbook section 2.3.1

Question 12

Which of the following factors affect a debt obligation’s coupon?

I. Ratings

II. Maturity

III. Covenants

IV. Security
A) I, II, and III only
B) I only
C) I and II only
D) I, II, III, and IV

Answer 12

Correct Answer:
D) I, II, III and IV

Answer Explanation
Coupon refers to the annual interest rate (“pricing”) paid on a debt obligation’s principal amount outstanding. It can be based on either a floating rate (typical for bank debt) or a fixed rate (typical for bonds). Bank debt generally pays interest on a quarterly basis, while bonds generally pay interest on a semiannual basis. There are a number of factors that affect a debt obligation’s coupon, including the type of debt (and its investor class), ratings, security, seniority, maturity, covenants, and prevailing market conditions.

Textbook Reference
Please see textbook section 2.1.6

Question 13

A 4% municipal bond is trading in the secondary market for 96. Which two of the following statements about the bond’s current yield are true?

I. The bond’s current yield is 4%
II. The bond’s current yield is 4.17%
III. The bond’s CY is less than its YTM
IV. The bond’s CY is greater than its YTM
A) I and IV
B) II and III
C) II and IV
D) I and III

Answer 13

Correct Answer:
B) II and III

Answer Explanation
Current yield is calculated by dividing the annual interest rate of the bond (4%) by the current price (96). Because the bond is trading at a discount its current yield is greater than the coupon rate, and its YTM is greater than its current yield.

Textbook Reference
Please see textbook section 2.2.5

Question 14

Retiring an outstanding bond issue at maturity by using money from the sale of a new offering is known as
A) Refunding
B) Serial Retirement
C) Restructuring
D) Redeeming

Answer 14

Correct Answer:
A) Refunding

Answer Explanation
When issuers sell new bonds to retire an outstanding bond issue they are engaged in refunding. Pre-refunding or advance refunding occur if the issuers sells the new bonds in advance of the first available call date, typically to lock in a lower interest rate.

Textbook Reference
Please see textbook section 2.1.9

Question 15

Who is the owner of a bearer bond?
A) The bearer of the bond certificate
B) The underwriter
C) The registered principal
D) The purchaser

Answer 15

Correct Answer:
A) The bearer of the bond certificate

Answer Explanation
Bearer bonds, which were issued in the U.S. for many decades, functioned much like cash in that the bearer of the bond certificate was considered the rightful owner. Unlike other investment securities, the ownership and transactions involving ownership of bearer bonds are not formally recorded. In 1982, Congress passed legislation that eliminated new bearer bonds. Now, there is only one form of note issued in the U.S. in bearer form – a Federal Reserve Note – i.e., the cash or currency in your wallet.

Textbook Reference
Please see textbook section 2.1.1

Question 16

If a bond declines in price, which of the following results in yield will occur?
A) Coupon yield will rise
B) Current yield will fall
C) Coupon yield will fall
D) Current yield will rise

Answer 16

Correct Answer:
D) Current yield will rise

Answer Explanation
Coupon yield, or nominal yield, doesn’t change over the life of the bond, so it isn’t sensitive to price changes. Current yield is the sum of annual coupon (interest) payments divided by the bond’s current price. It moves inversely with prices. As bond prices decline, the current yield rises; as bond prices increase, the current yield falls.

Textbook Reference
Please see textbook section 2.2.2

Question 17

A bond is selling at a price of 81 with all coupons since July of 2011 attached. This bond is said to be
A) Trading and interest
B) Trading with recall
C) trading flat with unpaid coupons attached
D) Trading short

Answer 17

Correct Answer:
C) trading flat with unpaid coupons attached

Answer Explanation
When coupons from previous interest payments are attached, the interest has not been paid. Such bonds are termed “trading flat”.

Textbook Reference
Please see textbook section 2.4

Question 18

When a municipal bond is sold, the amount of accrued interest
A) Includes the settlement date when calculated
B) Is calculated based on actual day months
C) Is added to the price paid to the seller
D) Is only included in the price if the bond is trading flat

Answer 18

Correct Answer:
C) Is added to the price paid to the seller

Answer Explanation
The calculation of accrued interest for municipal bonds is based on 360 day years and 30 day months. It is added to the price paid to the seller, and includes interest payable up to the settlement date only. Bonds that trade flat do not include accrued interest.

Textbook Reference
Please see textbook section 2.4

Question 19

The calculation of accrued interest for government bonds
A) Is subtracted from the price owed to the seller
B) Is based on 360 day years
C) Is not included on the confirmation
D) Includes the last interest payment date

Answer 19

Correct Answer:
D) Includes the last interest payment date

Answer Explanation
The accrued interest calculation for a government bond is based on actual day years and months. It is added to the price the seller receives at settlement and included in the total price. The calculation includes interest on the prior coupon date up to, but not including, the settlement date.

Textbook Reference
Please see textbook section 2.4

Question 20

An investor buys a 6.0% coupon bond to yield 6.1%. What will most likely happen to the price of the bond as maturity approaches?
A) The price will increase towards par.
B) The price will fall to zero.
C) The price will remain constant.
D) The price will decrease towards par.

Answer 20

Correct Answer:
A) The price will increase towards par

Answer Explanation
This bond has a coupon of 6.0% and a yield-to-maturity of 6.1%, indicating that the bond is trading at a discount. The price of a bond will always trend towards par as maturity approaches. Given that this bond is trading at a discount (e.g. 90% of par), the price would need to increase to arrive at par value.

Textbook Reference
Please see textbook section 2.1.8

Question 21

All of the following statements regarding variable rate bonds are true EXCEPT
A) the lender assumes interest rate risk
B) they typically have greater price volatility than fixed rate bonds
C) an index or other common base rate such as LIBOR is usually used to determine the rate payable for each period
D) the amount of interest paid varies over the life of the loan

Answer 21

Correct Answer:
B) they typically have greater price volatility than fixed rate bonds

Answer Explanation
The price of a variable rate bond remains relatively stable because the interest rate adjusts to prevailing conditions. As the name implies, the rate of interest paid will vary over the life of the bond. The amount of interest is tied to an underlying index; LIBOR + a spread is frequently used as the base rate. Lenders take on the interest rate risk because the interest payments they receive are subject to fluctuation.

Textbook Reference
Please see textbook section 2.1.4.1

Question 22

What is the nominal yield of a bond with par value of $1,000, market value of $800, and interest payments of $40 per year?
A) 4%
B) It depends on prevailing interest rates.
C) 2%
D) 5%

Answer 22

Correct Answer:
A) 4%

Answer Explanation
Nominal yield is the coupon rate, which is the annual interest paid divided by par value. It does not change over the life of a bond.

Textbook Reference
Please see textbook section 2.2.1

Question 23

Two bonds have relatively equal credit quality and terms to maturity. Which of the following statements is true?
A) The bonds will have equal coupon rates.
B) The bond with the higher coupon is more marketable.
C) The bond with the higher coupon will trade at a lower price.
D) The bond with the lower coupon is more liquid.

Answer 23

Correct Answer:
B) The bond with the higher coupon is more marketable

Answer Explanation
All other factors being equal, bonds with higher coupons are more marketable, and more attractive to investors than bonds with lower coupons. Investors will pay more for the bond with the higher coupon unless it is more risky. Bonds of equal credit quality and terms to maturity will likely have similar yields, but their coupon rates of interest may be very different.

Textbook Reference
Please see textbook section 2.1.4

Question 24

A bond with ten years to maturity is bought at a price of $860. The annual adjustment to its cost basis will be
A) amortization of $70.
B) amortization of $14.
C) accretion of $70.
D) accretion of $14.

Answer 24

Correct Answer:
D) accretion of $14

Answer Explanation
Bonds purchased at a discount are accreted, meaning adjusted upwards towards par value each year. The accretion is calculated on a straight-line basis, by dividing the discount off par ($140) by the number of years to maturity (10). Assume a bond’s par value is $1,000.

Textbook Reference
Please see textbook section 2.5

Question 25

Saving for the future is a primary investment goal for many people. Which of the following products may help an investor achieve this goal? A) Money-market mutual funds B) Defensive stocks C) High-yield bonds D) Zero-coupon bonds

Answer 25

Correct Answer: D) Zero-coupon bonds Answer Explanation Zero-coupon bonds may be beneficial to help people save for future events, such as a child's college education, or retirement. Textbook Reference Please see textbook section 2.1.5

Question 26

An investor holds a callable bond that has been called by the issuer. This investor now faces A) credit risk B) interest rate risk C) call risk D) reinvestment risk

Answer 26

Correct Answer: D) reinvestment risk Answer Explanation Issuers call bonds when interest rates decline, so they can refinance their debt at a lower rate. An investor who has a bond called away is subject to reinvestment risk, because the investor may have difficulty finding as good a deal for the money. Textbook Reference Please see textbook section 2.3.3

Question 27

A bond has a call provision, effective three years following the original issuance date. This call feature is likely to be utilized if A) Interest rates have gradually risen over the ensuing three- year period B) The issuer is not considering a refunding of its debt for the next few years C) The issuer's sinking fund commitment has not been fulfilled D) interest rates have declined since the original issuance date

Answer 27

Correct Answer: D) interest rates have declined since the original issuance date Answer Explanation An issuer would be inclined to exercise a call feature on a bond when interest rates have declined from what they were when the bond was originally issued. When the bond is called, the issuer can either retire that particular issue, thereby eliminating any further obligation to make interest payments, or may elect to do a refunding, which would effectively replace a higher coupon bond with a lower coupon bond, based on whatever level interest rates have declined to. Textbook Reference Please see textbook section 2.1.9

Question 28

A corporation will call in some of its outstanding bonds. When the bonds are called, the issuer A) will offer the investor another bond with a lower interest rate. B) must make one final interest payment to the bondholder. C) will pay the investor par value plus accrued interest to that date. D) will pay the investor the current market value of the bond plus accrued interest to that date.

Answer 28

Correct Answer: C) will pay the investor par value plus accrued interest to that date. Answer Explanation When an issuer calls in a bond, it will pay the bondholder the par value of the bond, plus any accrued interest to that date. Once the bond is called, there will be no further interest payments made on the bond. Textbook Reference Please see textbook section 2.4

Question 29

Which two of the statements below define settlement terms of U.S. government and municipal securities? I. Regular way settlement for U.S. Treasury securities is T + 3. II. Regular way settlement for municipal securities is T + 1. III. Cash settlement for municipal securities is the same day as the trade. IV. The terms of cash settlement for municipal securities and U.S. Treasury securities are the same A) III and IV B) II and IV C) I and III D) I and II

Answer 29

Correct Answer: A) III and IV Answer Explanation Regular way settlement for U.S. Treasury securities is trade date + 1 business day; for municipal securities regular way settlement is T + 2. Cash settlement for both U.S. Treasury and municipal securities is the same day as the trade date. Textbook Reference Please see textbook section 2.4

Question 30

On Monday, March 1st a customer purchases a Treasury bond for regular way settlement. The bond pays semi-annual interest on January 1 and July 1. How many days of accrued interest are added to the buyer's price? A) 61 days B) 63 days C) 60 days D) 59 days

Answer 30

Correct Answer: C) 60 days Answer Explanation Regular way settlement for government bonds is T+1, and the accrued interest calculation is based on actual day months. There are 31 days in January, 28 in February, and 1 day in March (the buyer's price includes interest that goes up to, but does not include the settlement date). Textbook Reference Please see textbook section 2.4

Question 31

Which of the following call dates would be LEAST beneficial for an investor? A) 10 years B) 15 years C) 5 years D) 20 years

Answer 31

Correct Answer: C) 5 years Answer Explanation Investors prefer a longer call date in order to better protect themselves from call and reinvestment rate risk. Textbook Reference Please see textbook section 2.1.9

Question 32

A corporate bond valued at "300 over" comparable treasury securities is A) less risky than treasury securities B) yielding 300 basis points more than treasury securities C) selling at $300 over the price of treasury securities D) trading at a premium

Answer 32

Correct Answer: B) less risky than treasury securities Answer Explanation The expression "300 over" refers to the yield of a bond being 300 basis points greater than that of a comparable security. Textbook Reference Please see textbook section 2.1.7

Question 33

The accrued interest that is added to the price the seller receives at settlement of a municipal bond that was purchased in a secondary market transaction A) Starts on the dated date. B) Is calculated based on actual day months. C) Starts on the day following the prior interest payment date. D) Does not include interest paid on the settlement date.

Answer 33

Correct Answer: D) Does not include interest paid on the settlement date. Answer Explanation Accrued interest for municipal bonds is calculated based on 30-day months, and starts on the date of the prior interest payment. It does not include interest payable on the settlement date. The dated date is only relevant for the calculation of accrued interest on newly issued municipal bonds. Textbook Reference Please see textbook section 2.4

Question 34

An investor purchases a 6% bond for 115. Rank the yield computations for this bond from highest to lowest. I. Current yield II. Nominal yield III.Yield to call IV. Yield to maturity A) II, I, IV, III B) II, IV, I, III C) II, IV, III, I D) II, I, III, IV

Answer 34

Correct Answer: A) II, I, IV, III Answer Explanation When a bond is trading at a premium, the nominal yield (i.e. coupon) is the highest rate, followed by the current yield, yield to maturity, and yield to call. Textbook Reference Please see textbook section 2.2.5

Question 35

The market perceives which two of the following to have the greatest risk? I. bonds with high credit ratings II. bonds with low credit ratings III. bonds with short terms to maturity IV. bonds with long terms to maturity A) II and IV B) I and IV C) II and III D) I and III

Answer 35

Correct Answer: A) II and IV Answer Explanation Bonds with low credit ratings have a higher degree of default risk. Bonds with long term maturities have a higher degree of interest rate risk. Textbook Reference Please see textbook section 2.3.5

Question 36

What does yield to maturity (YTM) measure in a bond, assuming the bond is held to its scheduled maturity? A) Yield discounted by time value B) Total return C) The value of interest payments D) Yield

Answer 36

Correct Answer: B) Total return Answer Explanation YTM measures the total return of a bond, held from the current date through scheduled maturity. It includes both scheduled interest payments and any capital gain or loss – i.e., the difference, if any, between the current price and maturity value. The denominator in YTM is the current bond price. So, YTM changes as current bond prices change. Textbook Reference Please see textbook section 2.2.3

Question 37

When does settlement normally occur for government securities? A) T B) T+2 C) T+3 D) T+1

Answer 37

Correct Answer: D) T+1 Answer Explanation Settlement for government securities usually occurs on the day after trade date (T+1). Textbook Reference Please see textbook section 2.4

Question 38

A 20-year U.S. Treasury bond was bought at a price of $945 in July. By the end of the year, its price had increased to $1,075. What most likely caused the price to rise? A) The U.S. Treasury called in older bonds B) The U.S. Treasury issued new bonds C) Interest rates rose D) Interest rates fell

Answer 38

Correct Answer: D) Interest rates fell Answer Explanation The most likely factor that caused a change in the trading value of a bond is a change in prevailing market interest rates. The inverse relationship between bond price and interest rates instructs that when interest rates go down, bond prices go up. Likewise, if rates go up, bond prices go down. Textbook Reference Please see textbook section 2.1.6

Question 39

A municipal bond that is offered at a yield to maturity higher than its coupon rate is recognized as trading A) At a premium B) flat C) At par D) At a discount

Answer 39

Correct Answer: D) At a discount Answer Explanation If a bond's yield to maturity is more than its coupon rate, the bond is trading at a discount. The YTM calculation reflects the impact on the investor's return of the amount of premium or discount paid when the bond is purchased. If the bond is purchased at a discount, the investor's rate of return on the bond at maturity is more than the stated rate, or coupon, of the bond when it was issued. Textbook Reference Please see textbook section 2.2.5

Question 40

An issuer may use LIBOR as a benchmark to A) Determine the tax liability of an interest payment to an investor B) Calculate the amount of new debt that it needs to issue to raise capital for the next fiscal year. C) Adjust the coupon rate that it will pay to an investor D) Calculate the capital gains tax from the sale of a bond

Answer 40

Correct Answer: C) Adjust the coupon rate that it will pay to an investor Answer Explanation LIBOR is sometimes used as the benchmark to set a new coupon rate on a bond. These are examples of variable rate bonds, as opposed to a fixed-rate instrument, where the coupon rate remains the same until maturity. Textbook Reference Please see textbook section 2.1.4.1

Question 41

What is accrued interest? A) The annual interest payments received by a bondholder B) The interest that has accumulated on a bond since the last interest payment C) The total amount payable on the bond's maturity date D) The total dollar value of interest paid on the bond to date

Answer 41

Correct Answer: B) The interest that has accumulated on a bond since the last interest payment Answer Explanation Accrued interest is the interest that has accumulated on a bond since the last interest payment. Interest accrues up to, but not including, the settlement date. The buyer of a bond will pay the seller of a bond any accrued interest at the time of the transaction. The buyer will then collect and retain the entire next interest payment as the seller of the bond has already received any interest owed prior to the sale. Textbook Reference Please see textbook section 2.4

Question 42

In a book-entry format, ownership of the security is recorded by A) Clearing house B) Central depository C) The issuer D) Corporate counsel

Answer 42

Correct Answer: B) Central depository Answer Explanation When a book-entry format is used, ownership is recorded by a central depository, rather than by the issuer. This has become the most common method of tracking ownership. Textbook Reference Please see textbook section 2.1.1

Question 43

Which of the following is NOT a primary responsibility of a broker-dealer's transfer agent? A) Acts as intermediary for the issuer B) Issues and cancels certificates on behalf of the issuer C) Guarantees the signature of the parties involved in the transfer D) Validates mutilated certificates and assists in tracking lost or missing securities

Answer 43

Correct Answer: C) Guarantees the signature of the parties involved in the transfer Answer Explanation The transfer agent reviews all information for accuracy and completeness. It checks to ensure signatures are authentic, but does not guarantee them. The guarantee of the signature is handled by the broker-dealer through the Medallion Stamp process. Textbook Reference Please see textbook section 2.1.1

Question 44

An issuer is most likely to call a bond which has A) a low coupon and a call premium when interest rates are rising B) a high coupon and no call premium when interest rates are falling C) a low coupon and no call premium when interest rates are rising D) a high coupon and a call premium when interest rates are falling

Answer 44

Correct Answer: B) a high coupon and no call premium when interest rates are falling Answer Explanation Issuers strive to keep their cost of borrowing as low as possible. To do this, they call bonds with high coupons when rates are have fallen. They can then issue new bonds at a lower rate and reduce borrowing costs. A call premium is an additional amount that must be paid to call the bonds. To keep costs as low as possible, the issuer would prefer to call a bond with no call premium. Textbook Reference Please see textbook section 2.1.9

Question 45

Which of the following securities carries the highest degree of purchasing power risk? A) Convertible cumulative preferred stock B) Long-term, high-grade bond C) Blue chip stock D) Short-term note

Answer 45

Correct Answer: B) Long-term, high-grade bond Answer Explanation Long-term debt carries the highest degree of purchasing power risk because the interest and principal received does not appreciate in value as inflation causes prices to increase. Thus, the purchasing power of the semi-annual interest payments decreases over time. Additionally, inflation causes interest rates to increase, subsequently lowering the price of outstanding bonds. Equity securities provide more protection against inflation. Textbook Reference Please see textbook section 2.3.4

Question 46

When a bond is called away by the issuer, the investor will likely face A) credit risk. B) holding period risk. C) interest rate risk. D) reinvestment rate risk.

Answer 46

Correct Answer: D) reinvestment risk Answer Explanation Bonds are typically called during periods of falling interest rates. This means that the investor will be forced to reinvest the proceeds from their bond at a time when interest rates are lower, thus exposing them to reinvestment rate risk. Textbook Reference Please see textbook section 2.3.3

Question 47

A municipal bond that is quoted with a yield to call that is higher than its coupon rate is recognized as trading A) flat B) At par C) At a discount D) At a premium

Answer 47

Correct Answer: C) At a discount Answer Explanation The yield to call reflects the impact on an investor's rate of return if the bond is called prior to maturity. The yield to call is higher than the coupon rate when a bond is trading at a discount because the bond holder receives the par value of the bond prior to its original maturity date if the bond is called. Textbook Reference Please see textbook section 2.2.5

Question 48

An investor buys an 8.0% coupon bond to yield 7.0%. What will most likely happen to the price of the bond as maturity approaches? A) The price will remain constant. B) The price will fall to zero. C) The price will increase towards par. D) The price will decrease towards par.

Answer 48

Correct Answer: D) The price will decrease towards par. Answer Explanation This bond has a coupon of 8.0% and a yield-to-maturity of 7.0%, indicating that the bond is trading at a premium. The price of a bond will always trend towards par as maturity approaches. Given that this bond is trading at a premium (e.g. 105% of par), the price would need to decrease to arrive at par value. Textbook Reference Please see textbook section 2.1.8

Question 49

The price of which of the following bonds will be most adversely affected by a sharp increase in interest rates? A) Money market instrument B) 5-year bond C) 10-year bond D) 30-year bond

Answer 49

Correct Answer: D) 30-year bond Answer Explanation The longer a bond's maturity, the more sensitive its price will be to a change in interest rates. A rate change normally has a greater impact on long-term bond prices than on short-term. Textbook Reference Please see textbook section 2.3.1

Question 50

An investor who has purchased a new municipal bond issue notices a “dated date” of June 15. This is the date that A) the bond will first become available for investors to purchase. B) represents the first semi-annual intertest payment date for the bond, the other being December 15. C) all future interest payments will be made on the bond. D) interest begins to accrue for a new issue, and will only be important for the first interest payment on the bond.

Answer 50

Correct Answer: D) interest begins to accrue for a new issue, and will only be important for the first interest payment on the bond. Answer Explanation The “dated date” is the date when interest begins to accrue on a new municipal bond issue. This date is used in determining the amount of the first interest payment only. Subsequent interest payments will be based on the semi-annual interest (coupon) payment dates for the bond. The dated date will no longer be relevant at this point. Textbook Reference Please see textbook section 2.4

Question 51

An investor owns a 9% coupon bond with par value of $1,000. The bond can be called after 5 years for a call premium of 104.5. Assuming the bond is called away at the earliest possible date, how much money will the investor receive upon redemption? A) 1045 B) 1090 C) 1135 D) 1000

Answer 51

Correct Answer: B) 1090 Answer Explanation When a bond is called away, an investor receives the call premium (104.5 percent of par, or $1,045) plus the final semi-annual coupon payment: 9% x $1,000 par / 2 = $45. Therefore, $1,045 call premium + $45 interest = $1,090 Textbook Reference Please see textbook section 2.1.9

Question 52

Regarding Treasury securities, they A) are exempt from purchasing power risk, but are subject to credit risk and interest rate risk. B) are subject to all of the same risks as any other fixed-income security. C) are subject to credit risk and purchasing power risk, but not interest rate risk. D) carry no credit risk but are subject to purchasing power and interest rate risk.

Answer 52

Correct Answer: D) carry no credit risk but are subject to purchasing power and interest rate risk Answer Explanation Treasury bonds do not carry credit risk (as the US Government can print money), but they do carry purchasing power (inflation) and interest rate risk. Textbook Reference Please see textbook section 2.3.5

Question 53

All of the following statements are true about bonds that trade flat EXCEPT A) No accrued interest is added at settlement. B) The issuer may be in default. C) The bond is settled on an interest payment date. D) The bond is trading "and interest".

Answer 53

Correct Answer: D) The bond is trading "and interest" Answer Explanation Bonds that trade flat do not include accrued interest in their settlement price. This could be because the issuer is in default and interest is not being paid, or because the bond is settling on an interest payment date. "And interest" means that accrued interest is included in the settlement price. Textbook Reference Please see textbook section 2.4

Question 54

For a bond trading at a discount, how does yield to call (YTC) compare to yield to maturity (YTM)? A) YTC is greater B) YTC and YTM are equal C) YTM is greater D) It depends on the size of the discount.

Answer 54

Correct Answer: A) YTC is greater Answer Explanation For a bond trading at a discount, yield to call is higher than yield to maturity, as the investor receives the discount back at an accelerated rate (at the first call date rather than waiting until the maturity date). Textbook Reference Please see textbook section 2.2.4

Question 55

When interest rates fall in the marketplace, there is a(n) A) Reduced incentive for borrowers in general to refinance their loans, such as mortgages B) Increasing likelihood that an issuer will call in its outstanding bonds C) Decreasing fear of credit downgrades D) Expectation that inflation will become more prominent

Answer 55

Correct Answer: B) Increasing likelihood that an issuer will call in its outstanding bonds Answer Explanation When market interest rates decline, there will be an increased probability that an issuer will call in its outstanding bonds, especially if those bonds carry higher interest rates. Textbook Reference Please see textbook section 2.1.9

Question 56

If the price of a long-term municipal bond increases over a period of one week, what is the likely impact on yield to maturity (YTM)? A) A decrease in YTM B) No change in YTM C) It depends on the bond's coupon yield. D) An increase in YTM

Answer 56

Correct Answer: A) A decrease in YTM Answer Explanation Bond yields move inversely to bond prices. Therefore, if prices increase, that indicates falling yields. Textbook Reference Please see textbook section 2.2.3

Question 57

Which of the following call dates would be MOST beneficial for an investor? A) 15 years B) 10 years C) 5 years D) 20 years

Answer 57

Correct Answer: D) 20 years Answer Explanation Investors prefer a longer call date in order to better protect themselves from call and reinvestment rate risk. Textbook Reference Please see textbook section 2.1.9

Question 58

An investor holds a bond containing a put feature. This provision A) Requires the issuer to return an investor's principal should the investor decide to sell his bond prior to maturity. B) Can only be exercised if interest rates declined C) Requires the investor to sell his bond back to the company prior to the maturity date of the bond. D) Enables either the issuer or the investor to redeem the bond prior to maturity.

Answer 58

Correct Answer: A) Requires the issuer to return an investor's principal should the investor decide to sell his bond prior to matruity. Answer Explanation A put feature allows an investor to demand early repayment of their principal, based on the occurrence of some predetermined event. For example, a put feature might be exercised if interest rates were to increase. Textbook Reference Please see textbook section 2.1.9.1

Question 59

An investor is evaluating the purchase of a corporate bond with 12 years to maturity. Under a call feature, it can be called in 8 years. Another feature that can impact the amount of call risk is A) any penalty the investor will pay for calling the bond early. B) any premium to par payable on the call date. C) the amount of common stock into which the bond may convert. D) the credit standing of the issuer.

Answer 59

Correct Answer: B) any premium to par payable on the call date Answer Explanation A call is always at the option of the issuer, never the investor. Normally, a call feature creates extra risk by shortening the investor's holding period, especially in times of falling rates. Issuers may agree to pay an additional price (call premium) above par for the call option. Textbook Reference Please see textbook section 2.3.2

Question 60

A refunding occurs when A) Interest rates have increased since the issuer's last bond offering was made. B) The issuer of the bond repays the principal prior to its maturity date. C) The issuer replaces a high coupon bond with a low coupon bonds in the wake of falling interest rates. D) An investor sells his bond prior to its maturity date.

Answer 60

Correct Answer: C) The issuer replaces a high coupon bond with a low coupon bonds in the wake of falling interest rates. Answer Explanation An issuer might engage in a refunding when interest rates have declined. The issuer will sell a bond with a lower coupon now that rates have fallen, and redeem the bond with the higher coupon. Textbook Reference Please see textbook section 2.1.9

Question 61

An investor purchases a T-Bond in the open market, paying 3% interest. The next day, the fed increases the discount rate. In this scenario, the investor would be immediately concerned with A) reinvestment rate risk B) market risk C) credit risk D) inflationary risk

Answer 61

Correct Answer: B) market risk Answer Explanation When interest rates increase, the immediate impact will be a decline in bond prices. Interest rate risk is also referred to as market risk. It is possible that higher rates could also lead to higher inflation, but that would be a longer term concern. Textbook Reference Please see textbook section 2.3.1

Question 62

An investor should expect the greatest price increase in which of the following if interest rates decline? A) Long-term bonds selling at a premium B) Long-term bonds selling at a discount C) Short-term bonds selling at a discount D) Short-term bonds selling at a premium

Answer 62

Correct Answer: B) Long-term bonds selling at a discount Answer Explanation Because of the inverse relationship between price and yield, when interest rates fall, bond prices rise. Longer maturities have more market risk, so their prices rise more than shorter maturities. Bonds selling at a discount also rise more sharply than those selling at a premium. Textbook Reference Please see textbook section 2.3.1

Question 63

The inputs for calculating yield to call (YTC) include the bond's current market price, par value, and what else? A) First call date and any call premium B) First call date C) Maturity date D) Maturity date and call premium

Answer 63

Correct Answer: A) First call date and any call premium Answer Explanation YTC is calculated the same as yield to maturity (YTM) with two exceptions. First, the first call date is used instead of maturity date. Second, any call premium on the first call date must be added to par value. Textbook Reference Please see textbook section 2.2.4

Question 64

Which of these bond features is the most attractive to a corporate issuer? A) Low call premium B) High sinking fund requirement C) Nonrefundable D) High interest rate

Answer 64

Correct Answer: A) Low call premium Answer Explanation Low call premiums are attractive to issuers because it allows the issuer to call the bond away from investors for a lower price. High interest rates require a larger interest expense for issuers, nonrefundable bonds do not allow an issuer to reissue bonds if interest rates decrease, and a high sinking fund require an issuer to maintain a large reserve of cash to maintain the bond. Only the low call premium is beneficial to issuers. Textbook Reference Please see textbook section 2.1.9

Question 65

Which statement is true when a bond is in default? A) It is trading at par. B) The bond trades flat. C) The price of the bond remains relatively stable regardless of market conditions. D) There is no commission payable on the transaction.

Answer 65

Correct Answer: B) The bond trades flat. Answer Explanation Bonds in default trade flat, meaning they do not trade with accrued interest. Textbook Reference Please see textbook section 2.4

Question 66

An investor purchased a 5 1/2% bond to yield 6 1/2%. If the company calls the bond at par before maturity, the investor's return would be A) 5.50% B) less than 5 1/2% C) greater than 6 1/2% D) 6.50%

Answer 66

Correct Answer: C) greater than 6 1/2% Answer Explanation For this bond, NY = 5.5% and YTM = 6.5%. With YTM>NY, this indicates that the bond is sold at a discount, and for a discount bond, YTC > YTM. Textbook Reference Please see textbook section 2.2.5

Question 67

An investor purchased a 5 1/2% bond to yield 6 1/2%. If the company calls the bond at par before maturity, the investor's return would be A) 5.50% B) less than 5 1/2% C) greater than 6 1/2% D) 6.50%

Answer 67

Correct Answer: C) greater than 6 1/2% Answer Explanation For this bond, NY = 5.5% and YTM = 6.5%. With YTM>NY, this indicates that the bond is sold at a discount, and for a discount bond, YTC > YTM. Textbook Reference Please see textbook section 2.2.5

Question 68

An investor would most likely buy a floating rate security issued by the U.S. Treasury for which of the following reasons? A) To hedge a portfolio from systemic risk B) To receive interest that is tax exempt at the federal level. C) To benefit from interest rate arbitrage D) To protect against interest rate volatility

Answer 68

Correct Answer: D) To protect against interest rate volatility Answer Explanation Floating rate securities feature an interest rate that varies or "floats" based on the performance of an underlying benchmark rate. Investors purchase them to protect against volatile interest rates, as these securities can help reduce the risk of locking in a low rate for a long period of time. Textbook Reference Please see textbook section 2.1.4.1

Question 69

During a period of falling interest rates which of the following is likely to occur? A) Callable bonds will appreciate more than the noncallable bond B) Both callable and noncallable bonds will fall in value C) Both callable and noncallable bonds will appreciate in value equally D) Noncallable bonds will appreciate more than callable bonds

Answer 69

Correct Answer: D) Noncallable bonds will appreciate more than callable bonds Answer Explanation Bond prices increase during periods of falling interest rates. Callable bonds are likely to be called when interest rates are falling so issuers can refinance at lower rates. An investor will lose future interest payments when the bonds are called and face reinvestment risk, so this is not favorable to the investor. Therefore, callable bonds will trade at less of a premium than noncallable bonds when interest rates are falling. Textbook Reference Please see textbook section 2.1.9

Question 70

On Friday September 1st a customer purchases a municipal bond for regular way settlement. The bond pays semi-annual interest on December 1 and June 1. How many days of accrued interest are added to the buyer's price? A) 93 days B) 95 days C) 96 days D) 94 days

Answer 70

Correct Answer: D) 94 days Answer Explanation Regular way settlement for municipal bonds is T+2 business days, and the accrued interest calculation is based on 30-day months. There are 30 days in June, 30 days in July, 30 days in August, and 4 in September due to the weekend (settlement date is Tuesday September 5th). The buyer's price includes interest that goes up to, but does not include the settlement date. Textbook Reference Please see textbook section 2.4

Question 71

An investor is evaluating the purchase of a corporate bond with 12 years to maturity. Under a call feature, it can be called in 8 years. Another feature that can impact the amount of call risk is A) any premium to par payable on the call date. B) the credit standing of the issuer. C) any penalty the investor will pay for calling the bond early. D) the amount of common stock into which the bond may convert.

Answer 71

Correct Answer: A) any premium to par payable on the call date Answer Explanation A call is always at the option of the issuer, never the investor. Normally, a call feature creates extra risk by shortening the investor's holding period, especially in times of falling rates. Issuers may agree to pay an additional price (call premium) above par for the call option. Textbook Reference Please see textbook section 2.3.2

Question 72

The accrued interest that is calculated for settlement of a newly issued municipal bond A) Is based on actual-day months. B) Is subtracted from the price that will be paid by the purchaser. C) Starts on the dated date. D) Includes interest paid on the settlement date.

Answer 72

Correct Answer: C) Starts on the dated date Answer Explanation For newly issued municipal bonds, the issuer designates a date that interest starts accruing. This date is the dated date. Municipal bond interest is based on 30 day months. The calculation does not include the settlement date, and is added to the purchase price. Textbook Reference Please see textbook section 2.4

Question 73

A zero coupon municipal security is most appropriate for which of the following investors? A) A retired individual who would like a regular income stream to supplement pension income B) A middle aged investor in a high tax bracket who is looking to generate as much tax-free income as possible C) A parent who is planning a college education fund for a child and wants access to funds that will not be taxed if used for qualified education expenses D) A working adult who would like funds available to pay off her mortgage in 10 years so that she can retire

Answer 73

Correct Answer: D) A working adult who would like funds available to pay off her mortgage in 10 years so that she can retire Answer Explanation Zero coupon bonds are purchased at a discount and mature to face value. They are most suitable for investors that would like to plan for a lump sum to be available at a defined date in the future. Textbook Reference Please see textbook section 2.1.5

Question 74

An investor purchased a City of Seattle 4% municipal bond that matures 3-25-2019, at 98 3/8. From this information you can tell that the bond A) Is trading at par value B) Will yield less than 4% if it is called. C) Has a yield to maturity that is greater than its nominal yield. D) Is priced at $980.38

Answer 74

Correct Answer: C) Has a yield to maturity that is greater than its nominal yield Answer Explanation Municipal bonds are priced in points, and 1 point is equal to $10. The price of this bond is $980 plus $3.75 (3/8 x $10) or $983.75. The bond is trading at a discount, so if it was called, its YTC would be greater than 4%. Bonds trading at a discount have YTM that is greater than their coupon, or nominal, yield. Textbook Reference Please see textbook section 2.2.5

Question 74

Which of the bonds listed below would have the greatest price volatility? A) A long-term zero coupon bond B) A variable rate bond C) A short-term investment grade bond D) A Treasury note

Answer 74

Correct Answer: A) A long-term zero coupon bond Answer Explanation Because zero coupon bonds pay no interest until maturity, their prices fluctuate more than other types of bonds in the secondary market. Variable bonds have little price fluctuation because their rates adjust to current interest rates. Also, long term bonds are generally more volatile than short term bonds. Textbook Reference Please see textbook section 2.3.1

Question 75

A type of bond that has no reinvestment rate risk is A) a high-coupon bond. B) a zero-coupon bond. C) a municipal bond. D) a low-quality bond.

Answer 75

B) a zero-coupon bond Answer Explanation Zero-coupon bonds do not have reinvestment rate risk because, since they do not pay a coupon, there is no interest to reinvest. Textbook Reference Please see textbook section 2.3.3

Question 76

A 20-year municipal bond, callable in 5 years, is trading at 101 ¼. Which two of the following statements are true? I. The bond's YTC is higher than its YTM. II. The bond's YTC is lower than its YTM. III. The bond's CY is greater than its nominal yield. IV. The bond's CY is lower than its nominal yield. A) II and IV B) I and IV C) I and III D) II and III

Answer 76

A) II and IV Answer Explanation When a bond is trading at a premium, YTC is lower than YTM, and its current yield is lower than nominal yield. Textbook Reference Please see textbook section 2.2.5

Question 77

A bond has annual coupons totaling $60. What is the highest price that can be paid for the bond to generate at least a 5% current yield? A) 1000 B) 1200 C) 1133 D) 900

Answer 77

B) 1200 Answer Explanation Current yield is calculated as the annual coupons divided by current price. One way to solve this problem is to divide $60 by 5% = $1,200 current price. Alternatively, a 5% current yield means an investor can afford to pay up to 20 times total annual coupons = $60 X 20 = $1,200. Textbook Reference Please see textbook section 2.2.2

Question 78

An investor purchases a 5% bond for 90. Rank the yields for this bond from lowest to highest I. Current Yield II. Coupon III. Yield to call IV. Yield to maturity A) II, I, III, IV B) I, II, III, IV C) I, II, IV, III D) II, I, IV, III

Answer 78

A) II, I, III, IV

Question 79

The calculation of accrued interest for government bonds A) Is not included on the confirmation B) Includes the last interest payment date C) Is based on 360 day years D) Is subtracted from the price owed to the seller

Answer 79

Answer Explanation The accrued interest calculation for a government bond is based on actual day years and months. It is added to the price the seller receives at settlement and included in the total price. The calculation includes interest on the prior coupon date up to, but not including, the settlement date. Textbook Reference Please see textbook section 2.4

Question 80

DEF Corporate debenture is quoted at 103 and pays a $10 semiannual coupon. What is the current yield of this bond? A) 0.9% B) 1.9% C) 9.7% D) 19.4%

Answer 80

Answer Explanation The current yield of a bond is found by dividing the annual interest by the bond’s market price. In this case, we divide the annual interest, which is $20 ($10 semiannual coupon x2), by the market price of $1,030, to arrive at the current yield of 1.9%. Note that bonds are quoted as a percentage of par, which is $1,000. Therefore, a quote of 103, means 103% of par or $1,030. Textbook Reference Please see textbook section 2.2.2

Question 81

A bond's par value is lower than its market price. This bond A) Is trading at a discount. B) Has a nominal yield that is greater than its yield to maturity. C) Has a current yield that is more than its coupon rate of interest. D) Has a yield to maturity that is greater than its current yield.

Answer 81

Correct Answer: B) Has a nominal yield that is greater than its yield to maturity Answer Explanation When a bond is priced higher than par, it is trading at a premium. Its nominal yield is then more than its current yield, which is more than its YTM. This is a good one to make up some numbers for. Par value ($1,000) is lower than market value ($1,200), which means a premium bond. Textbook Reference Please see textbook section 2.2.5

Question 82

A customer purchased a Treasury bond in a regular way transaction on Monday, April 4th. The bond is a J&J bond. How many days of accrued interest will the seller receive? A) 94 B) 79 C) 80 D) 96

Answer 82

Answer Explanation Treasury bonds accrue interest on an actual days basis and use a 365 day year. They settle T+1, in this case on Tuesday, April 5th. Interest accrues from the last interest payment date (January 1st), up to, but not including the settlement date: January – 31 days February – 28 days March – 31 days April – 4 days 94 days Textbook Reference Please see textbook section 2.4

Question 83

A zero coupon municipal security is most appropriate in which two of the following situations? I. A middle aged investor in a high tax bracket who is looking to generate as much tax-free income as possible II. A grandmother who would like to have a specified amount of money available to pay for her grandchild's college education in 10 years III. A retired investor who holds a diversified portfolio of growth security and wishes to receive tax free income from 20% of his portfolio IV.A head of household who is saving money to purchase a vacation home in 15 years A) I and IV B) I and III C) II and III D) II and IV

Answer 83

Answer Explanation Zero coupon bonds are purchased at a discount and mature to face value. They are most suitable for investors that would like to plan for the availability of a lump sum at a defined date in the future. They do not pay interest income regularly; the interest is considered the difference between the purchase price and the par value. Textbook Reference Please see textbook section 2.1.5

Question 84

An investor purchases a T-Bond in the open market, paying 3% interest. The next day, the fed increases the discount rate. In this scenario, the investor would be immediately concerned with A) inflationary risk B) reinvestment rate risk C) market risk D) credit risk

Answer 84

Answer Explanation When interest rates increase, the immediate impact will be a decline in bond prices. Interest rate risk is also referred to as market risk. It is possible that higher rates could also lead to higher inflation, but that would be a longer term concern. Textbook Reference Please see textbook section 2.3.1

Question 85

All of the following are covered under T+2 settlement dates EXCEPT A) Municipal securities B) Corporate bonds C) Mutual funds D) Government securities

Answer 85

Answer Explanation Government securities settle T+1. Textbook Reference Please see textbook section 2.4

Question 86

A corporation will call in some of its outstanding bonds. When the bonds are called, the issuer A) must make one final interest payment to the bondholder. B) will pay the investor the current market value of the bond plus accrued interest to that date. C) will pay the investor par value plus accrued interest to that date. D) will offer the investor another bond with a lower interest rate.

Answer 86

Answer Explanation When an issuer calls in a bond, it will pay the bondholder the par value of the bond, plus any accrued interest to that date. Once the bond is called, there will be no further interest payments made on the bond. Textbook Reference Please see textbook section 2.4

Question 87

A municipal bond that is quoted with a yield to call that is higher than its coupon rate is recognized as trading A) flat B) At a discount C) At a premium D) At par

Answer 87

Answer Explanation The yield to call reflects the impact on an investor's rate of return if the bond is called prior to maturity. The yield to call is higher than the coupon rate when a bond is trading at a discount because the bond holder receives the par value of the bond prior to its original maturity date if the bond is called. Textbook Reference Please see textbook section 2.2.5

Question 88

A corporate bond is trading "with" interest. This means that A) there is heightened demand for the bond. B) accrued interest is deducted from the price of the bond. C) accrued interest is included in its price. D) the seller of the bond makes an additional interest payment to the buyer of the bond.

Answer 88

Answer Explanation A bond is said to be trading "with" interest or "and" interest when accrued interest is included in its price. Textbook Reference Please see textbook section 2.4

Question 89

In the fixed income market, the risk that is created by a downward trend in interest rates is referred to as A) reinvestment rate risk B) interest rate risk C) market risk D) principal risk

Answer 89

Answer Explanation Downward trends in interest rates cause reinvestment risk because it may be difficult to find comparable yields for reinvestment of principal or interest payments. Interest rate risk occurs as interest rates increase, causing a subsequent decline in bond prices. Textbook Reference Please see textbook section 2.3.3

Question 90

Which of the following is a characteristic of a corporate zero-coupon bond? A) They generally have short-term maturities B) Prices generally fluctuate more than other types of bonds in the secondary market C) Imputed interest is not taxable at the federal level D) They typically pay interest semi-annually

Answer 90

Answer Explanation Zero-coupon bonds are generally long-term bonds that are purchased at a deep discount and mature to their face value. Because of the deep discount, their prices generally fluctuate more than prices of other bonds that are traded in the secondary market. They pay interest only at maturity, although imputed interest must be reported for tax purposes each year. Textbook Reference Please see textbook section 2.1.5

Question 91

If the price of a bond decreases, what will happen to its current yield? A) impossible to determine B) decrease C) increase D) no change

Answer 91

Answer Explanation If the price of a bond decreases, which means that the bond is trading at a discount to par, its current yield will increase. For example, if a bond with a 7.5% coupon that is issued at par trades down to a price of 98, its current yield will be 7.653%. This is calculated as $75/$980. Even though the price has decreased, the investor still receives the 7.5% coupon on the par amount. Textbook Reference Please see textbook section 2.2.2

Question 92

What is the main difference between yield to maturity (YTM) and yield to call (YTC)? A) Premiums and discounts are ignored in YTC but not in YTM. B) The time at which the bond terminates are different. C) Premiums and discounts are ignored in YTM but not in YTC. D) The current market price is relevant when calculating YTM but not YTC.

Answer 92

Answer Explanation Yield to maturity reflects the yield earned if the investor holds the bond until maturity, while yield to call reflects the yield earned assuming the issuer calls the bond back prior to maturity. Textbook Reference Please see textbook section 2.2.4

Question 93

The accrued interest that is calculated for settlement of a Treasury bond A) Is based on actual-day months. B) Is subtracted from the purchase price. C) Starts on the dated date. D) Includes interest paid on the settlement date.

Answer 93

Answer Explanation For government bonds, interest starts accruing on the interest payment date before settlement. Interest payable on the settlement date is not included. Dated date applies only to new issues of municipal bonds. Government bond interest is based on actual-day months. Accrued interest is added to the price paid by the purchaser and received by the seller. Textbook Reference Please see textbook section 2.4

Question 94

Market interest rates have declined since ABC Co. issued a $100,000,000 debenture. To benefit from the change in interest rates, ABC might consider a A) Reorganization B) Repurchase agreement C) Leveraged buy out D) Refunding

Answer 94

Answer Explanation A refunding is a refinancing strategy that an issuer might utilize when interest rates have declined following the issuance of a bond. The issuer would sell a new bond at the new lower rates and use the proceeds of the sale to redeem the outstanding bonds which are carrying a higher interest rate. The end result is lower financing costs for the issuer. Textbook Reference Please see textbook section 2.1.9