Unit 2 Flashcards
(128 cards)
1
Q
T/F: Once issued, bonds are bought and sold in the secondary market.
A
True.
2
Q
The 2 primary factors affecting bond’s market price?
A
Interest rate and credit rating (financial stability of issuer)
3
Q
If issuers credit rating remains constant, what’s the only other impact on bond’s market price?
A
Interest Rates
4
Q
Bond price changes are quoted in: Points or Basis Points?
A
Bond price changes are quoted in Points - 1 point is 1% of 1000, or $10. There are 100 basis points in 1 point, so 1 point = 1/100 of 1%
100 basis points = 1%
1 basis point = .01%
5
Q
How much is 80 basis points in terms of $ and %?
A
A. $8, .8%
We know that 100 basis points = $10 = 1%. So 80 basis points = $8 = .8%
6
Q
What rating must a municipal bond be higher than to indicate “investment grade” quality?
A
BBB (S&P) or Baa (Moody’s)
7
Q
Generally, the (higher/lower) a bond’s rating, the lower the yield?
A
The higher a bond’s rating, the lower its yield. Safer bonds (less risk) yield lower returns.
8
Q
If a bond is callable at 102 (par being 100), what’s the value of the call premium, in points and dollars?
A
100 = par = $1000. So 102 = $1020 or $20 per bond or 2 points
9
Q
T/F: Nominal Yield = Coupon Yield
A
True: Nominal/Coupon yield is the fixed percentage of the bond’s par value.
10
Q
T/F: Current Yield is different than a nominal yield or a coupon yield.
A
True: Current Yield measures a bond’s coupon payment relative to its market price
Coupon Pmt/ Market Price = Current Yield
11
Q
Bond prices and yields have an ______ relationship.
A
Inverse relationship. As interest rates rise, bond prices fall. When a bond trades at a discount, its current yield increases. When a bond trades at a premium, its current yield decreases.
12
Q
What is the current yield of a 6% bond trading at $800?
A
CY = Coupon pmt ($) / Market Price
6% bond = $60/$800 = 7.5% current yield
13
Q
T/F: YTM (Yield to maturity) takes into account the premium paid or discount received by the bondholder to calculate a true yield or return to the investor at maturity.
A
True: if the investor buys the bond at a discount (below par), the YTM accounts for this increase in return. If the investors pays a premium, this loss is accounted for in the YTM.
14
Q
T/F: Under normal circumstances, the shorter the bond’s maturity, the greater the yield.
A
FALSE: The longer a bond’s maturity, the greater the yield. The increased yield attached to longer maturity reflects the potential for credit quality and inflation over time.
15
Q
The difference in yields between short-term and long-term bonds of the same quality is known as (and reflected in) what?
A
Yield Curve reflects the difference between short-term and long-term bonds of the same quality.
16
Q
There are 2 types of corporate bonds. When the issuer has identified specific assets as collateral for interest and principal payments, this is a ______ bond.
A
Secured bond. In default, bondholder of secured bond can lay claim to collateral.
17
Q
These types of bonds have no collateral backing them and are classified as either “Debentures” or “Subordinated Debentures”.
A
Unsecured bonds
18
Q
Convertible bonds are corporate bonds that can be exchanged for a fixed number of the issuing company’s _____ stock.
A
Convertible bonds can be exchanged for common stock.
19
Q
What is the “annualized return if a bond is held to maturity”?
A
YTM
20
Q
How do you calculate the numerator in the YTM calculation?
A
$ Annual Interest +/- (Premium or Discount/# of Years to Maturity), where premium or discount = (Par value - Market Price)
21
Q
How do you calculate the denominator in the YTM calculation?
A
Average Price, (Par value + Market Price)/2
22
Q
Which yield calculation takes into account the potential early redemption date, and the consequent acceleration of discount gained or premium lost?
A
Yield to Call. Think about it, an investor who buys a callable bond at a premium loses the premium faster if bond is called rather than held to maturity. Same idea for gaining the discount. So, YTC on a premium bond is always less than all other yields to account for the early payment of the premium (loss). YTC on discount is always more than all other yields to account for the early redemption of the discount (return).
23
Q
If YTC > YTM, bond is likely trading at: par, premium, or discount?
A
Discount. If YTC is greater than YTM, bond is trading at a discount bc the higher YTC reflects the early redemption of a discount (aka return or yield) on the bond.
24
Q
If YTM > Coupon, bond is likely trading at: par, premium, or discount?
A
Discount. Since YTM takes into consideration the premium or discount, when YTM is greater than coupon, this means the bond is trading at a discount, thus providing a greater return or yield.
25
Bonds are considered a _____ security bc they are preferred (in terms of liquidity) over common and preferred shareholders.
Bonds are considered a "senior" security.
26
Bond interest (coupon) accrues (daily, monthly, annually) and is paid (monthly, semiannually, or annually)?
Interest accrues daily and is paid semiannually.
27
When is the final interest payment on a bond paid?
Final interest payment is paid at maturity with repayment of principal.
28
What does the following bond name mean?
| 5M ABC J&J15 8s of 21
```
5M = 5 bonds
ABC = Issuer
J&J15 = semiannual interest pmt dates (Jan 15 and July 15)
8s = annual coupon rate
21 = maturity year
```
29
If a bond is trading at 85, what is the market price?
$850 - bonds are priced in terms of percentage of par. 85% of $1000 = $850
30
Corporate bonds trade in what increments of par?
1/8% which equals $1.25
31
Why would an issuer use their call option?
Issuers use their call option to call the bonds before maturity if interest rates in the general market are lower than when the bonds were issued.
32
If CY > Coupon, bond is trading at (par, premium, discount)?
When CY > Coupon, bond is trading at a discount because current yield measures the bond's coupon pmt relative to market price. Recall, CY = $ coupon pmt/market price.
33
On the Yield Curve, what is on the Y axis and what is on the X axis?
Y axis = Yield, X axis = Years to Maturity
34
A NORMAL (rather than Inverted) Yield Curve predicts that interest rates will (rise or fall) in the future?
A normal yield curve predicts interest rates will rise in the future - indicates economic expansion.
35
What are the two primary types of Corporate Bonds?
Secured (backed by collateral) & Unsecured (no collateral - "debentures")
36
Is a Debenture a secured or unsecured corporate bond?
Unsecured Corporate Bonds are also called Debentures.
37
What are the 3 main types of Secured Corporate Bonds?
1) Mortgage Bonds: the mortgages that back them are the collateral
2) Collateral Trust Bonds - where securities of other companies are used as collateral
3) Equipment Trust Certificates - finances the purchase of capital equipment which = the collateral
38
What are the 2 main types of Unsecured Corporate Bonds?
1) Debentures - backed by general credit of the issuer.
| 2) Subordinated Debentures - paid last of all debt obligations
39
List the liquidation hierarchy starting with unpaid wages (total of 7).
1. Unpaid wages
2. Taxes
3. Secured debt (bonds and mortgages)
4. Unsecured debt and general creditors (debentures)
5. Subordinated debt
6. Preferred Stock
7. Common
40
What are "Guaranteed Bonds" backed by?
Company other than the issuer - i.e. parent company
41
When a company is reorganizing and coming out of bankruptcy, what types of bonds will they issue?
Income (aka Adjustment) Bonds
42
In which type of bonds, does interest not accrue if issuer doesn't have enough money to pay it?
Income Bonds - therefore, not suitable for investors seeking income.
43
What type of bonds do not pay interest?
Zeroes (Zero Coupon Bonds) - the fact that they do not pay interest means that their prices reflect the general interest rate environment.
44
Why types of bonds allow investors to speculate on the general interest rate environment?
Zeroes allow investors to speculate on interest rate movements.
45
Zero coupon bonds are issued at what, but mature at par? What can the difference between issue price and par considered?
Zero coupon bonds are issued at a deep discount, but mature at par. Difference can be considered the return.
46
What is unique about the taxation of zeroes?
Zeroes are taxed on their "accreted value" (the difference between what they purchased it at and par value) even if it has not yet matured. In addition, the cost basis of the investment increases each year by the amount of taxable income. If held to maturity, there will be no capital gain.
47
What is the accreted value of a zero-coupon bond if bought at $400, on which the investor will be taxed?
$600
48
If investor's accreted value in zero coupon bond is $600 with a 10 year maturity, on what amount will they be charged tax?
$60 annually. To find taxable income on zero: Accreted Value / Years to Maturity = $600/10 = $60
49
Each year, the cost basis on a zero coupon bond increases by what amount, for tax purposes?
Each year, the cost basis on a zero increases by the amount of taxable income, as calculated by accreted value divided by years to maturity. IE) If original cost basis was $400, meaning accreted value was $600 and 10 years to maturity, taxable income = $60. So, each year, cost basis increases by $60.
50
Why is a zero coupon bond considered a security without reinvestment risk?
bc no interest payments to reinvest.
51
Which 2 parties are involved in the Trust Indenture?
Bond issuer & Trustee (on behalf of bondholders)
52
What is the Trustee's primary function within the Trust Indenture?
To monitor compliance with the covenants of the indenture.
53
Which types of governments are exempt from issuing a Trust Indenture?
Federal & Municipal Govs
54
What type of bond is a corporate bond that may be exchanged for a fixed number of shares of the issuing companies common stock?
Convertible Bond -> exchange debt for equity
55
Do convertible bonds pay a higher or lower interest rate (yield) than non-convertibles?
Lower due to the conversion feature.
56
Is there a tax liability associated with converting a convertible bond into common stock?
No, because it is not considered a purchase and sale.
57
Conversion Ratio = (calculation)?
Par/Conversion Price = Conversion Ratio
58
Due to antidilution covenants, conversion prices of convertible bonds are adjusted after what types of events?
Stock Splits & Dividends
59
What concept describes: When 2 securities (i.e. convertible bond and common stock into which it can be converted) are of equal value.
Conversion Parity
60
If the conversion price of a bond is $50, what is the conversion ratio? What is the parity price of the common stock for the same convertible bond that is selling at 104? If the common stock is selling below the parity price, what should the investor do? If selling above parity price, what should investor do? (keep the bond or convert and sell the shares)
1. Conversion Ratio = Par / Conv. Price so $1000/$50 = 20 shares.
2. Parity Price of Common Stock = Market Price (Bond) / Conversion Ratio, so, $1040/20 = $52
3. If common stock is selling below parity, this means the bond is worth more than the common stock - keep the bond.
4. If common stock is selling above parity, convert and sell the shares of common stock.
61
What are the parity price calculations for common stock and for convertible bond?
Parity Price of Common Stock = Market Price of Bond/Conversion Ratio.
Parity Price of Bond = Market Price of Common Stock x Conversion Ratio
62
What is the new conversion ratio and conversion price of convertible bond with conversion price of $25 after a 20% stock split? Think about it this way, in a stock split, the number of shares increases. In order to maintain ownership % due to antidilution convenants in the trust indenture, will the conversion ratio increase or decrease? will conversion price increase or decrease?
1. Find original conversion ratio: $1000/$25 = 40 shares
2. New conversion ratio after stock split = original conversion ratio x 1 + stock split, so 40 + 1.20 = 48 shares
3. New conversion price = $1000/48 shares = $20.83
After stock split, conversion ratio increases and conversion price decreases to maintain ownership %.
63
Since T-Bills do not pay a coupon, what is the return that an investor is getting?
T-Bills are issued at a discount from par - this difference is essentially the "return"
64
T-bills are quoted on a _____ basis? i.e. there's a bid of 1.15 and the ask is 1.12.
Yield basis - the bid is on the yield
65
How are T-Notes quoted? % of par of yield basis?
% of par in 1/32's i.e. 100:26 = 100 and 26/32
66
If a T-Note is trading at 98.24, what is the actual price?
98 + 24/32% of $1000:
98% = .98
24/32 = 0.75
98.75% of $1000 = $987.50
67
Which 2 of the three Treasury securities pay interest every 6 months and are both quoted in terms of % of par?
T-Notes & T-Bonds; T-Bills do not pay interest and are quoted in terms of yield.
68
What are the securities called when brokerage firms package T-Notes and T-Bonds, place them in trust at a bank and sell receipts against their principal and interest?
Treasury Receipts - NOT backed by govt
69
Form of govt-backed security that is stripped into principal and interest components and does not pay interest.
STRIPS - 1984 Treasury entered zero-coupon market
70
Form of gov security that protects investors against purchasing power risk because its principal is adjusted by CPI.
TIPS - Treasury Inflation Protection Securities
71
What levels are TIPS taxed at?
Federal. Interest is exempt from state and local taxes.
72
How are agency-issued bonds settled? Regular or book-entry?
Regular way - 3 business days
73
Which types of bonds have higher yields than government securities but lower than corporate?
Agency-issued bonds have higher yields than govt securities but lower yields than corp bonds.
74
Know that if Agency Issues are backed by mortgages, what levels of taxation?
Federal, state, and local. Without mortgages, just federal.
75
Which agency is govt-owned and govt-backed, and supports HUD? (only agency security backed by govt)
Ginnie Mae
76
Interest earned on GNMA securities is taxable at what levels?
Fed State and Local
77
What are the 3 major risks associated with GNMA securities?
1) Interest Rate Risk: risk that interest rates rise causing the value of a mortgage to decrease
2) Prepayment Risk
3) Extended Maturity Risk
78
What levels are Farm Credit securities taxed?
Federal. Exempt from State & Local taxation
79
Which of the Agency Securities is a public corporation that is considered a nationwide secondary mortgage market?
Freddie Mac
80
Which of the agencies buys residential mortgages from financial institutions and package them into MBS to investors?
Freddie Mac
81
At what level is income from Freddie and Fannie Securities taxed at?
Fed, state, and local
82
Which of the agencies is publicly held, provides mortgage capital, and purchases mortgages from agencies like FHA and VA? (also publicly traded)
Fannie Mae
83
Which is the only agency backed by the US Government? (not publicly traded)
Ginnie
84
What does it mean that most bonds trade "and interest"?
Buyer pays the bond's market price PLUS any Accrued Interest since the last interest payment. Then, buyer recvs the full amount of the next interest payment including interest that accrued while the Seller owned the bond.
85
Accrued interest is calculated from the last interest payment date up to, but not including, the (settlement) or (dated) date.
Accrued interest is calculated from the last interest payment date up to, but not including, the SETTLEMENT date. The DATED date is the date at which interest accrcual begins.
86
Corporate and Muni Bonds use which interest accrual method to calculate accrued interest? (360 or 365)
Corp & Muni Bonds use the 360-day method. The 360 day method assumes each month has 30 days. i.e. an F&A muni bond trades regular way (3 days out) on March 5. # of days accrued would include the month of February (30 days) + March 1-5 (5 days) plus March 6th and 7th but not March 8th (settlement date)
87
An A&O corp bond trades cash (same day) on August 16th. How many days of interest has been accrued?
Last interest payment date was April. April (30), May (30), June (30), July (30), August 1st - 15th (not including the settlement date the 16th) = 135 days
88
Government bonds use which interest accrual method? (360 or 365)
Gov bonds use the 365 method (aka actual days elapsed).
89
If an F&A Bond trades regular way on Monday, March 5th, how many days of interest accrued?
Last int payment was Feb 1 so February (28) + 5 days in March = 33 days
90
Interest from CMO's (Collateralized Mortgage Obligations) is paid (monthly, semi annually, or annually)?
Monthly
91
If a bond is Trading Flat, what does that mean?
If a bond is trading flat, such as a zero or income bonds or bonds in default, they are trading without accrued interest.
92
With regard to CMO's, when interest rates decrease, homeowners typically refinance leading to what kind of risk?
If interest rates decrease, homeowners refi, meaning principal may be received earlier than expected, leading to pre-pmt risk.
93
With regard to CMO's when interest rates increase, homeowners may not be able to pay principal as quickly as anticipated, leading to what kind of risk?
Extension risk
94
What denominations are CMO's issued in?
$1000 denominations
95
T/F: CMO's are backed by the US Gov.
FALSE - Know this! CMO's not backed by the US GOV; they are corporate instruments
96
T/F: Interest on CMO's are taxed at all levels.
TRUE - Know this! Interest on CMO's is taxed at Fed, State, and local level
97
T/F: CMO's yield more than treasury securities.
TRUE - CMO's yield more than treasury securities
98
T/F: CMO's are NOT subject to interest rate risk.
FALSE - Know this! CMO's are absolutely subject to interest rate risk, along with prepayment risk and extension risk.
99
What is the difference between a CMO and a CDO?
Pool of MORTGAGES v. Pool of DEBT
100
What are the 2 types of "non-marketable govt securities" i.e. Savings Bonds that you can only buy directly from a bank on behalf of the govt?
Series EE Bonds & Series I Bonds
101
What's the difference between the capital market and money market?
Capital Market securities are long term instruments with maturities over 1 year. Money market securities are short term with maturities less than 1 year. Therefore they are highly liquid i.e. T-Bills, Repos, Reverse Repos, Bankers Acceptances, Commercial (Prime) Paper, CD's, Federal Funds
102
What type of money market security is it when a bank raises cash by temporarily selling securities with an agmt to buy it back at a later date?
Repurchase Agmt (Repo)
103
Which of the money market securities pays for goods and services in a foreign country to finance international trade?
Bankers Acceptance. Secured by the goods and services through a lien in the event the bank fails. Sold at discount and matures at par; quoted in yield.
104
Which type of money market security is similar to BA and is used to finance A/R and seasonal inventory?
Commercial Paper (aka prime paper aka promissory note)
105
T/F: Non-negotiable CD's are not traded in the secondary market and are not considered money market securities.
TRUE. Only negotiable cd's considered money market.
106
What is the rate banks charge each other for overnight loans in excess of $1mm? It is a barometer of short-term interest rates.
Federal Funds Rate - considered most volatile rate in the economy; Lowest of the 4 money market int rates
107
What is the rate banks charge their most CREDITWORTHY corporate borrowers for unsecured loans? This rate is lowered by banks when the Fed eases the money supply and raised when Fed contracts the money supply.
Prime Rate - highest of the 4 money market int. rates
108
What is the rate the FED charges member banks for short-term loans? This rate indicates the direction of money supply, so if the fed decreases this rate, they are easing the money supply. If they increase this rate, they are contracting the money supply.
Discount Rate
109
What is the rate the banks charge broker/dealers on money they borrow to lend to margin acct customers?
Broker Loan Rate
110
Name the 4 Money Market Interest Rates from highest to lowest yield.
Prime, Broker, Discount, Fed (PBDF)
111
T/F: Freddie Mac issues securities under the Federal Farm Credit System, along with Co-Op Banks, Federal Land Bank, and Federal Intermediate Credit Banks.
False, Freddie Mac does not. It issues securities backed by residential mortgages.
112
Defeasement can also be considered _____ which is issuing one bond to call another at a future date, where the funds are escrowed and the issuer no longer has to show these bonds as a debt obligation.
Pre-refunding
113
Which of the 4 yields is highest when a bond is trading at a premium?
Coupon Rate will be highest if premium bond.
114
CMO's can be purchased from as little as $? but typically trade in minimum amounts of $25,000
$1000
115
T/F: Put options can be exercised immediately after issue.
False: Put options can only be exercised after the put protection period has passed.
116
T/F: Put options protects the holder from depreciation associated with rising interest rates.
True
117
T/F: Put options ensures that the holder will never recieve less than par for the bond.
True
118
T/F: Put options protect the holder from a loss of principal when bond prices fall.
True
119
What is the parity price of the common stock associated with a 10% bond with a conversion price of $25 per share that is currently quoted at 90?
$22.50
1) Find conversion ratio by dividing $1000 by conversion price of $25 = 40 shares
2) Divide market value of bond ($900) by conversion ratio (40 shares) to find the parity price of common stock.
120
T/F: Agency debt (associated with govt) is not an obligation of the U.S. govt, aside from GNMA.
True. GNMA is the only "agency" thats securities are direct obligations of the U.S. Govt
121
T/F: Agency debt has slightly higher yields than govt debt.
True: since agency debt isnt backed by U.S. Govt, slightly more risky --> higher yield
122
If a bond is trading at 104.24, what is the actual value in dollars?
1) 104 = 1040
2) 24 = 24/32% of $10 --> 24/32 = 0.75 x $10 = $7.50
3) 1040 + 7.50 = $1047.50
123
What is the current yield of an 8-1/4% bond trading at 104.24?
Current Yield = coupon pmt/market price
1) coupon pmt = $82.50
0. 08 x 1000 = $80
0. 25% = 0.0025 x $1000 = $2.50
2) market price = $1047.50
104: 1000 x 1.04 = $1040
24: 24/32% = 0.0075 x 1000 = $7.50
3) $82.50/$1047.50 = 7.87%
124
Which association uses historical data and projections of mortgage prepayments to estimate yield and maturity of different CMO tranches?
PSA The Public Securities Association
125
T/F: PAC's have more certain maturity dates than TAC's
True
126
T/F: TAC's have lower prepmt risk than PAC's and therefore have (lower/higher yields).
False - PAC's have lower prepmt risk than TAC's and therefore have lower yields.
127
At what level(s) is the accreted interest income on Treasury STRIPS taxed?
Federal only
128
Which of the agencies is a government-owned corporation who approves private lending institutions to originate loans, pool them, and then sell them as "agency-name mortgage-backed securities"?
GNMA. Do not originate loans or issue/sell securities
