Unit 3: Debt Securities

Question 1

term bonds

Answer 1

principal of the whole issue matures at once

Question 2

serial bonds

Answer 2

schedule for portions of the principal to mature at intervals over a period of years until the entire balance has been repaid

Question 3

balloon bonds

Answer 3

issuer repays part of the bond’s principal before the final maturity date but pays off the major portion of the bond at final maturity

Question 4

bond pricing points

Answer 4

each point = $10

bond trading at 90 is worth $900

Question 5

relationship between bond prices and interest rates

Answer 5

inverse

Question 6

nominal yield

Answer 6

coupon or stated yield

fixed percentage of bond’s par value

Question 7

current yield

Answer 7

CY = annual income / CMV

measures bond’s annual coupon payment relative to market price

Question 8

yield to maturity (YTM)

Answer 8

annualized return of bond if held to maturty

bond trading on 5.83 basis has YTM of 5.83%

Question 9

yield to call (YTC)

Answer 9

reflect the early redemption date and the acceleration of the discount gained or the premium lost

for callable bonds

Question 10

inverse relationship of price and yields

Answer 10

discount:
coupon < CY < YTM < YTC

par:
coupon = CY = YTM = YC

premium:
coupon > CY > YTM > YTC

Question 11

call feature

Answer 11

allows an issuer to redeem a bond before maturity

usually done when interest rates fall

Question 12

put feature

Answer 12

allows the investor to force the issuer to pay off the bond before it matures

usually done when interest rates rise

Question 13

convertible feature

Answer 13

allows the investor to convert the bond into shares of the issuer’s common stock

issuer pays lower coupon rate as feature compensates for lower return

Question 14

zero-coupon bonds

Answer 14

debt obligations that do not make regular interest payments

issued at a deep discount to their face value and mature at par

still pay taxes on interest annually

Question 15

volatility

Answer 15

bond’s sensitivity to changes in interest rates

Question 16

benefits of debt investments

Answer 16

• income
• safety

Question 17

risks of debt investments

Answer 17

• default risk
• interest rate risk
• inflation/purchasing power risk

Question 18

how accrued interest is calculated

(calendar)

Answer 18

corporations + munis:
30 days month / 360 days year

govt agencies:
30 days month / 365 days year

Question 19

types of secured debt

Answer 19

• mortgage bonds
• equipment trust certificate
• collateral trust bonds

Question 20

types of unsecured debt

Answer 20

• debentures
• guaranteed bonds
• income bonds
• subordinated debt

Question 21

mortgage bonds

Answer 21

Mortgage bonds are backed by real estate that is owned by the corporation

Question 22

equipment trust certificate

Answer 22

secured by equipment the corporation uses in its operations

“rolling stock”

Question 23

collateral trust bonds

Answer 23

backed by a portfolio of securities held in trust to secure the loan

treasury issues often used as collateral

Question 24

income bonds

Answer 24

only make interest payments when the company has enough income and the board authorizes the payments

adjustment bonds

Question 25

treasury bills (T-bills)

Answer 25

**short-term** debt obligations of US govt issued with maturities of 4, 8, 13, and 26 weeks | do not pay periodic interest, all interest paid at maturty

Question 26

treasury notes (T-notes)

Answer 26

** intermediate-term** direct debt of the federal government | pay interest semiannually ## Footnote at maturity investor receives the final semi-annual interest payment and the par value

Question 27

treasury bonds (T-bonds)

Answer 27

** long-term** direct debt of the federal government | pay semiannual interest ## Footnote at maturity investor receives the final semi-annual interest payment and the par value

Question 28

treasury receipts

Answer 28

BDs buy Treasury securities, place them in trust at a bank, and sell separate receipts against the principal and coupon payments | BD-issued, not backed by full faith and credit of US govt ## Footnote zero-coupon bond

Question 29

treasury STRIPS

Answer 29

Treasury Department designates certain issues as suitable for stripping into interest and principal components Banks and BDs perform the actual separation of the interest coupon from the principal and trading of the STRIPS | zero-coupon bond