Securities Products & Suitability Flashcards Preview

Series 7 Top-off Exam > Securities Products & Suitability > Flashcards

Flashcards in Securities Products & Suitability Deck (432)
Loading flashcards...
1

What describes the number of common shares for which a convertible bond may be exchanged?

conversion ratio

The conversion ratio is the number of common shares for which a convertible bond may be exchanged. 

2

Which of the following statements about the risk characteristics of a convertible bond are true? 

  1. A convertible bond is less risky than a similar straight bond
  2. A convertible bond is more risky than common stock
  3. A convertible bond is more risky than a straight bond but less risky than common stock
  4. A convertible bond is as risky as common shares

3 only

A convertible security provides more upside potential and risk than a straight bond, but less upside potential and less risk than the common stock.

3

You are the owner of a $1,000 convertible bond that was issued at par. The conversion option allows you to exchange the bond for 10 shares of common stock. What is the bond's conversion price?

$100

A convertible bond's conversion price is calculated by dividing its issue price by the conversion ratio (number of shares for which it may be exchanged). In this case the issue price of $1,000 is divided by 10 to obtain the conversion price of $100.

4

What is the purpose of a balance sheet?

A one-time snapshot of the company's assets and liabilities.

The formula for the balance sheet is:

Assets - Liabilities = Net Worth

5

What are assets or liabilities easily accessible or payable within one year called?

 

"Current" Assets and Liabilities

These assets include cash on hand, prepayments, and accounts receivable with terms less than one year. This also applies to short-term loans or accounts payable.

6

What is the purpose of separating short-term assets and liabilities?

Evaluate a Company's Liquidity

By separating short term assets and liabilities, we can create a set of ratios that give insight to the short term access to cash or the amount of upcoming liabilities that must be paid.

7
Define:

Acid Test

 

The acid test is an even more conservative analysis of the liquidity of a company. The formula is:

Acid Test = (Current Assets - Inventory) / Current Liabilities

The idea here is, inventory is considered a current asset but is not necessarily easily convertible into cash. By removing it from current assets, it gives a more conservative estimate of the cash available to pay liabilities.

8
Define:

Secured Bonds

What are the three major types?

  1. Collateral Trust Bonds -  secured by placing financial collateral with a trustee
  2. Mortgage Bonds - the bond is secured by property, such as real estate 
  3. Equipment Trust Bonds - backed by equipment

9

What is another name for a company's unsecured debt?

Debentures

10

How do zero coupon bonds differ from coupon bonds?

They are issued at a deep discount and make no regular coupon payments.

Their risk profile is also different: their market price is much more sensitive to rate changes than that of coupon bonds. 

11

Zero coupons pay no interest; how does the IRS capture taxes?

In a zero coupon bond, even though the investor does not receive any income until maturity, they are still required to pay taxes each year on the annual accretion.

12

Why are zero coupon bond prices so volatile? 

Because zero coupon bonds do not pay annual cash flows, they do not provide a buffer to changing rates and therefore are more volatile to changing rates.

13

What is a suitable use of zero coupon bonds from an investor's point of view? 

Since zeros mature at par, they are suitable for long term planning purposes where the investor wants a known lump sum available in the future. 

Example: A parent wants to have a $50,000 lump sum available in 20 years to pay for their child's graduate education. It would be suitable for them to buy $50,000 zero bonds now at a deep discount, knowing they will mature at $50,000. 

14

What are EuroDollar bonds?

EuroDollar bonds are US dollar demoninated bonds that are issued and/or traded outside of the US.

15

How does the money market differ from the bond market? 

Much Shorter Maturity

Although money markets have shorter maturities than the bond market, by defintion usually one year or less, they are just as important to funding the day-to-day operations of corporations and represent a very liquid, multi-billion dollar market. 

16

Who issues commercial paper?

Corporations

Commerical paper is issued by corporations as is used to raise short-term cash. These securities typically have a maximum maturity of nine months (270 days). 

17

For what purpose are bankers acceptance (BA) notes typically used? 

To Finance International Trade

 

18

What is a repo agreement and why do banks use them? 

To Raise Short Term Cash

If a broker-dealer needs to raise cash, it can sell collateral to another party with an agreement to repurchase that same collateral at a defined price at some point in the future. The difference between the original sale price and the repurchase price is the interest charged for this loan.

19

What are the specific tax benefits of U.S. government treasury bonds? 

U.S. Treasuries are exempt from state and local taxes. 

20

For what return objective are T-Bills unsuitable for some investors? 

T-Bills are very short term instruments sold at a discount and they provide no coupon payments. Because they have no cash flows, T-Bills, like zeroes, offer no current income. Investors seeking current income during a given period, such as retirement income, should avoid T-Bills.

21

Describe the auction process of T-Bills.

T-Bills are offered weekly at auction, where primary dealers bid for the bills using their own capital and orders from customers. T-Bills are bought at discount in amounts of $1,000 to $1 million and mature in 13 and 26 weeks. The purchase price of T-Bills at auction is expressed as a percentage: a bid of 10 means that dealer is bidding that auction at a 10% discount to par. 

 

 

22

Describe how Treasury notes differ from T-Bills.

  1. Notes mature between 2 and 10 years versus T-Bills, which mature in one year or less
  2. Notes are issued with coupons and pay interest, unlike T-Bills, which are zeros
  3. T-Bills are quoted as a discount off of par, while T-Notes are quoted as a percentage of par in increments of 1/32

23

Describe how Treasury bonds differ from T-Bills.

  1. Treasury bonds typically mature in 30 years whereas T-Bills have maturities of one year or less
  2. T-Bonds are issued with coupons and pay interest, unlike T-Bills, which are zeros

  3.  

    T-Bills are quoted as a discount off of par, while T-Bonds are quoted as a percentage of par in increments of 1/32

24

What are Treasury Receipts and how are they created?

Synthetic Zero Coupon Bonds

Treatury receipts are created by selling another security backed by the interest payments and principal of T-Bills and T-Notes. They are sold at a discount and pay no interim cash flows. Even though they are backed by treasuries, they do not carry any guarantee.

25

What are STRIPS and how are they created? 

Seperate Trading of Registered Interest and Principal of Securities (STRIPS)

STRIPS work almost exactly like treasury receipts. but are backed by the government. A simple bond is split into two parts, its interest payment and it's principal amount, and sold seperately. The principal-only security works just like a zero coupon bond and is sold at a discount. 

26

What are TIPS?

Treasury Inflation Protection Securities (TIPS)

TIPS are issued with a fixed coupon, but in order to protect against inflation, the notional is linked to the Consumer Price Index. 

Although the coupon is fixed, the interest payment will change as the notional changes and can both increase or decrease with inflation or deflation. 

27

What type of investor is suitable for TIPS?

Long-term investors

Investors who buy and hold TIPS usually are investing for things far into the future and are concerned about inflation eroding their purchasing power. 

 

 

28

Where do TIPS trade relative to other Treasury securities?

TIPS trade at lower yields

Anytime a fixed income instrument has some feature that will benefit the investor, it will trade at a lower yield relative to a nearly identical asset without that feature. So two-year TIPS always will trade with a lower yield than the two-year Treasury note.

29

What types of government securities have no secondary market?

U.S savings bonds

There is no secondary market for these bonds and to be sold must be redeemed with the U.S. Treasury. 

30

What are the two government-sponsored enterprises (GSE)?

  1. Freddie Mac - Federal Home Loan Mortgage Corporation (FHLMC)
  2. Fannie Mae - -Federal National Mortgage Association (FNMA)

As GSEs, they are not formally backed by the government but are presumed to carry government backing – a presumption tested during the financial crisis.