READING 47 FIXED-INCOME INSTRUMENT FEATURES Flashcards
(38 cards)
Which of the following best describes the key difference between loans and bonds in fixed-income markets?
A. Loans are issued by governments, while bonds are only issued by corporations.
B. Loans are private and nontradable, while bonds are standardized and tradable.
C. Loans typically have longer maturities than bonds.
Correct Answer: B
Explanation:
Loans are private agreements and not traded in markets, whereas bonds are standardized securities that can be traded.
(A) is incorrect because both loans and bonds can be issued by corporations; loans are not exclusively from governments.
(C) is incorrect because maturity depends on the agreement and is not a defining difference.
In a bond transaction, the term “principal” refers to:
A. The investor’s return from bond price appreciation.
B. The amount the issuer pays to purchase the bond back.
C. The amount of money the issuer borrows and must repay.
Correct Answer: C
Explanation:
The principal (also called par or face value) is the original loan amount that the issuer agrees to repay.
(A) is incorrect; return from price appreciation is capital gain.
(B) is not precise; the issuer repays the principal, not purchases the bond back.
Which of the following bonds would be classified as a money market security?
A. A 3-month U.S. Treasury bill
B. A 10-year corporate bond
C. A perpetual bond
Correct Answer: A
Explanation:
Bonds with maturities of one year or less are money market securities.
(B) is a capital market security.
(C) has no maturity and is a perpetual bond.
Which of the following would most likely be considered a capital market security?
A. A 270-day commercial paper
B. A 7-year government bond
C. A 6-month Treasury bill
Correct Answer: B
Explanation:
Bonds with maturities greater than one year are capital market securities.
(A) and (C) are both under one year and fall into the money market.
Which type of bond makes no interest payments until maturity?
A. Floating-rate note
B. Zero-coupon bond
C. Fixed-coupon bond
Correct Answer: B
Explanation:
Zero-coupon bonds pay no periodic interest. They’re sold at a discount and pay full par at maturity.
(A) pays interest tied to a market rate.
(C) pays regular fixed interest (coupons).
What is the main source of cash flow backing asset-backed securities (ABS)?
A. Issuer’s retained earnings
B. Interest and principal from underlying financial assets
C. Equity issued by a special purpose vehicle
Correct Answer: B
Explanation:
ABS are backed by cash flows from assets like mortgages, car loans, or credit card receivables.
(A) is unrelated to ABS.
(C) is incorrect—SPVs issue debt, not equity.
Which of the following is the best example of a special purpose entity (SPE)?
A. A central bank buying government debt
B. A firm set up to issue bonds backed by mortgage payments
C. A supranational entity like the IMF
Correct Answer: B
Explanation:
SPEs are created to hold financial assets and issue asset-backed securities.
(A) describes monetary policy.
(C) is a different type of issuer (not an SPE).
The term “tenor” of a bond refers to:
A. The yield at issuance
B. The type of coupon rate
C. The time remaining until maturity
Correct Answer: C
Explanation:
Tenor = time left until maturity.
(A) relates to yield, not tenor.
(B) refers to the structure of interest payments.
Which of the following best describes a floating-rate note (FRN)?
A. A bond that pays no interest and is issued at a discount
B. A bond with a coupon tied to a variable market reference rate
C. A bond with fixed annual interest payments
Correct Answer: B
Explanation:
FRNs have variable coupons linked to a reference rate + fixed spread.
(A) describes a zero-coupon bond.
(C) describes a fixed-rate bond.
A bond pays interest based on LIBOR + 100 basis points. If LIBOR is 3.5%, what is the bond’s coupon rate for the period?
A. 3.5%
B. 4.5%
C. 1.0%
Correct Answer: B
Explanation:
100 basis points = 1%. 3.5% + 1% = 4.5%.
(A) ignores the spread.
(C) reflects only the spread, not the full rate.
Which of the following statements about seniority is correct?
A. Senior debt has a lower claim on assets than subordinated debt.
B. Equity holders are paid before senior debt in liquidation.
C. Senior debt has priority over junior debt in bankruptcy.
Correct Answer: C
Explanation:
Senior debt is repaid before junior or subordinated debt in liquidation.
(A) is false—it’s the opposite.
(B) is false—equity holders are last.
What is a perpetual bond?
A. A bond with fixed coupons but no maturity date
B. A bond with coupons that grow over time
C. A bond that pays a lump sum at maturity and no interest
Correct Answer: A
Explanation:
Perpetual bonds pay interest forever but never mature.
(B) describes a step-up bond.
(C) describes a zero-coupon bond.
Which of the following best explains the inverse relationship between bond prices and yields for fixed-coupon bonds?
A. Higher bond yields require investors to pay a higher price for the bond.
B. Lower bond yields are caused by a decrease in coupon payments.
C. A higher yield can only result from a lower bond price, assuming fixed coupon payments.
Correct Answer: C
Explanation:
When coupon payments are fixed, the only way for a bond to offer a higher return (yield) is if the investor buys the bond at a lower price.
A is incorrect because higher yields require a lower purchase price, not a higher one.
B is incorrect because coupon payments are fixed and do not change in standard fixed-coupon bonds.
A fixed-coupon bond is currently trading below par. This most likely implies:
A. The bond’s yield is above its coupon rate.
B. The bond is offering a lower yield than comparable bonds.
C. Interest rates have decreased since issuance.
Correct Answer: A
Explanation:
When a bond trades below par, it means its yield is higher than the coupon rate to compensate investors for paying less than face value.
B is incorrect because trading below par typically means it offers a higher yield.
C is incorrect because a decrease in interest rates would lead bond prices to rise, not fall.
Which of the following best describes a normal yield curve?
A. A downward-sloping curve indicating short-term bonds yield more than long-term ones.
B. A flat curve where all maturities yield the same.
C. An upward-sloping curve where yields increase with maturity.
Correct Answer: C
Explanation:
A normal yield curve is upward-sloping, indicating that longer maturities yield more to compensate for risk over time.
A is the definition of an inverted yield curve.
B is incorrect because a flat yield curve suggests the market expects little change in interest rates or economic conditions.
An investor compares a 5-year U.S. Treasury bond yielding 5% with a 5-year corporate bond yielding 6%. The 1% difference is referred to as:
A. Risk premium
B. Yield spread
C. Real yield
Correct Answer: B
Explanation:
The difference in yield between two bonds of similar maturity but different credit quality is called a yield spread.
A is broader and may refer to various types of premiums (e.g., equity risk premium).
C refers to the yield after adjusting for inflation, not for comparing credit risk.
Which of the following is most likely true during a period of an inverted yield curve?
A. Investors expect higher inflation and stronger economic growth.
B. Long-term bonds yield less than short-term bonds.
C. The Federal Reserve is easing monetary policy aggressively.
Correct Answer: B
Explanation:
An inverted yield curve means long-term yields are lower than short-term yields, typically signaling expectations of an economic slowdown or recession.
A is incorrect—an inverted yield curve usually reflects expectations of lower inflation and growth.
C may happen in reaction to inversion, but it is not what defines it.
Which of the following most accurately explains why government bonds are considered low risk?
A. They are insured by commercial banks.
B. Their prices do not fluctuate with interest rates.
C. They are backed by the tax-raising ability of the government.
Correct Answer: C
Explanation:
Government bonds are considered low credit risk because governments can raise taxes to repay debt.
A is incorrect; government bonds are not insured by banks.
B is incorrect; government bond prices do fluctuate with interest rates, often significantly.
Which of the following statements best describes the role of the government bond yield curve?
A. It determines the coupon payments of all bonds in the market.
B. It is used as a benchmark to measure the credit risk of corporate bonds.
C. It eliminates interest rate risk in bond portfolios.
Correct Answer: B
Explanation:
The government bond yield curve is used as a benchmark to assess how much more risky (and rewarding) corporate bonds are.
A is incorrect—bond coupon payments are set at issuance and vary by issuer, not by the curve.
C is incorrect—yield curves help manage interest rate risk, but do not eliminate it.
Which of the following best describes the primary purpose of a bond indenture?
A. To outline the rights and obligations of both the bond issuer and bondholders, including sources of repayment and restrictions on the issuer.
B. To grant bondholders voting rights in the issuer’s corporate decisions.
C. To specify the exact interest rate and maturity date of the bond only.
Correct Answer: A
Explanation:
The bond indenture is a legal contract that defines the obligations and restrictions on the borrower, including how repayment will be made, forming the basis of future interactions.
Option B is incorrect because bonds generally do not confer voting rights.
Option C is incorrect because while interest rate and maturity are included, the indenture also covers much broader terms including covenants and repayment sources.
The source of repayment for sovereign bonds is primarily:
A. The operating cash flow of government-owned corporations.
B. Taxes on economic activity and the government’s ability to create currency.
C. Revenues from local infrastructure projects such as toll roads.
Correct Answer: B
Explanation:
Sovereign bonds are repaid mainly from government tax revenues and sometimes by printing new currency, which reduces credit risk perception.
Option A is incorrect as sovereign repayment is not tied to specific corporations.
Option C refers to local government bonds, not sovereign bonds.
A secured corporate bond differs from an unsecured corporate bond in that:
A. It is repaid only from operating cash flow without any collateral.
B. It includes a legal claim on specific company assets in case of default.
C. It cannot be issued by a corporation but only by governments.
Correct Answer: B
Explanation:
Secured bonds have collateral backing that bondholders can claim if the issuer defaults.
Option A describes unsecured bonds.
Option C is incorrect because corporations can and do issue secured bonds.
Which of the following statements about affirmative covenants is TRUE?
A. They restrict actions such as additional borrowing or asset sales.
B. They require the issuer to fulfill certain actions, such as providing timely financial reports.
C. They allow bondholders to vote on corporate matters.
Correct Answer: B
Explanation:
Affirmative covenants require the issuer to perform specific actions, like financial disclosure and specifying use of proceeds.
Option A describes negative covenants.
Option C is incorrect because bondholders typically have no voting rights.
A cross-default clause in a bond indenture means:
A. The bond issuer can never default on any debt obligation.
B. Default on any other debt obligation automatically triggers default on this bond.
C. Bondholders have priority over all other creditors in case of default.
Correct Answer: B
Explanation:
The cross-default clause links defaults across debts, so defaulting elsewhere causes this bond to be in default too.
Option A is an unrealistic expectation, not a clause.
Option C refers to seniority, not cross-default.
