UNIT 01.01 008 Flashcards
If your customer has two bonds, and one has a coupon of 5.1% and the other has a coupon of 5.3%, what is the difference in annual interest payments between the bonds?
$2
$1,000 × 0.053 = $53
$1,000 × 0.051 = $51
$53 − $51 = $2
Which of the following income investments would be most suitable if interest rates were expected to increase sharply within the next two years?
A) Treasury bonds
B) GNMAs
C) Treasury bills
D) AAA corporate bonds
Treasury bills
The recommendation of a short-term debt instrument is most suitable during a period of substantial interest rate risk, because they have the smallest price response. Of the instruments listed, Treasury bills would be the most suitable because of their maturity of less than one year.
An investor is considering purchasing a bond. He has settled on either a 6% municipal bond offered by the state in which he lives or an 8% corporate bond offered by a company with headquarters in his state. He would like you to help him decide which bond will get him the greatest return for his investment. Which of the following items of information must you obtain before you can make a specific recommendation?
His tax bracket
To make the recommendation, you must do a tax-equivalent yield or tax-free equivalent yield calculation, for which you need the investor’s tax bracket. The other items listed do not have a bearing.
The minimum face amount of a negotiable CD is
$100,000
Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are typically traded in blocks of $1 million.
An investor would like to make a long-term investment in a debt security whose duration is equal to its maturity. Which of the following AAA-rated bonds should her registered representative recommend?
A) ABC 8% 10-year bond maturing in 5 years
B) XYZ zero-coupon bond maturing in 5 years
C) MNO zero-coupon bond maturing in 8 months
D) DEF 10-year 8% bond maturing in 8 months
XYZ zero-coupon bond maturing in 5 years
Because they make no interim payments, zero-coupon bonds have duration equal to maturity. Of the choices offered, only XYZ is both long term (over one year to maturity) and zero coupon.
Ms. Garcia sold 500 shares of Small Corporation stock short at $25 a share. The stock rose to $28 and she covered 200 shares. The stock then dropped to $22 and she closed the remainder of the short position. What is the result of the transactions?
$300 gain
Ms. Garcia received $12,500 for selling the stock short (500 × 25 = 12,500). She then purchased 200 shares for 5,600 (200 × 28) and 300 shares for 6,600 (300 × 22) for a total of $12,200 for a gain of $300.
Corporations issue commercial paper with maturities ranging from as little as one day to as long as how many days?
270 days
Commercial paper has a maximum maturity of 270 days.
If a bond is nearing the end of its call protection, this will tend to
make the bond less attractive to investors because a call would terminate the interest payments.
Callability is unattractive to the investor. It is attractive to the issuer because, with a call, the bonds are bought back at par or a small premium, and interest payments end.
Mr. Garcia purchased 100 shares of the Sierra Verde Coffee Company at $37 a share. Over the course of a year the stock paid a $0.10 a share dividend and the shares dropped to $35 a share. What is the total return for this transaction?
-4.3%
The formula for calculating total return is income received plus gains (or minus losses) divided by cost basis equals total return. In this example, (0.4 – 2) / 37 = -1.6/37 = -4.3%.
An investor would like to make a long-term investment in a debt security whose duration is equal to its maturity. Which of the following AAA-rated bonds should his registered representative recommend?
A) MNO zero-coupon bond maturing in 8 months
B) ABC 8% bond maturing in 15 years, callable in 10 years
C) DEF 10-year 8% bond maturing in 8 months
D) XYZ zero-coupon bond maturing in 15 years
XYZ zero-coupon bond maturing in 15 years
The simplest definition of duration is that it is the time it takes for a bond’s cash flow (interest payments) to equal the maturity value. Because there is no cash flow from a zero-coupon bond, its duration is equal to its maturity. Because the question says “long-term,” we’re not going to choose an 8-month maturity over a 15-year one.
An electric company issued mortgage senior lien bonds, with an 8⅞ coupon, priced at 96. Each bond pays annual interest of
$88.75.
A coupon of 8⅞ represents an annual interest payment of 8⅞% of $1,000, or $88.75. Because the interest rate always applies to par, which is $1,000, the issue price does not have an effect.
Which of the following are characteristics of commercial paper?
A type of secured debt
Maximum maturity of 270 days
Issued by municipalities
Exempt from registration
Maximum maturity of 270 days
Exempt from registration
Commercial paper represents the unsecured debt obligations of corporations in need of short-term financing. Both yield and maturity are open to negotiation. Because commercial paper is issued with maturities of 270 days or less, it is exempt from registration under the Act of 1933.
Which of the following statements regarding interest rates and price fluctuations of debt securities are true?
Short-term prices fluctuate more than long-term prices.
Long-term prices fluctuate more than short-term prices.
Short-term interest rates fluctuate more than long-term rates.
Long-term interest rates fluctuate more than short-term rates.
Long-term prices fluctuate more than short-term prices.
Short-term interest rates fluctuate more than long-term rates.
Long-term bond prices move more in response to interest rate changes than short-term bond prices do because of the compounding effect of interest on bonds with longer maturities. Short-term interest rates fluctuate significantly in response to Federal Reserve Board actions and other changes in interest rates. Although long-term rates also respond and move in the same direction, their movements are not as large.
Your customer is a 66-year-old retired widower. He is seeking an investment of $50,000 that will keep pace with inflation. He currently survives on Social Security and a pension and is very risk averse. Which of the following do you recommend?
TIPS
TIPS is the only choice that keeps pace with inflation and also has the lowest default risk of the choices given. The biggest risk associated with a fixed annuity is that over time it won’t keep pace with inflation, and both the high-yield bond fund and the gold fund are too volatile for this risk-averse client.
Which of the following choices correctly ranks investment risk from lowest to highest?
A) Treasury bonds, municipal bonds, corporate bonds, common stock
B) Treasury bonds, corporate bonds, municipal bonds, common stock
C) Common stock, corporate bonds, municipal bonds, Treasury bonds
D) Common stock, municipal bonds, corporate bonds, Treasury bonds
Treasury bonds, municipal bonds, corporate bonds, common stock
Treasury bonds carry the lowest investment risk because they are backed in full by the U.S. government. Municipal bonds are next lowest because they are backed by the taxing authority and general revenues of issuing municipalities. Corporate bonds are the most risky debt instruments but are still backed by the full faith and credit of the issuer. Common stock has no promises associated with it, is junior in claim to all debt securities, and is, therefore, the riskiest investment.
