Bond Basics Flashcards
The bondholder of a municipal bond issue is the:
A. borrower of the bond proceeds
B. lender of the bond proceeds
C. guarantor of the payment of debt service on the bond issue
D. fiduciary acting for the benefit of the bondholders
The best answer is B.
The “bondholder” of a bond issue is the party that is owed the debt service on the bonds. This is the “legal” name for the lender or creditor.
A percentage of par quote is also known as a:
A. firm quote
B. yield quote
C. dollar quote
D. basis quote
The best answer is C.
Dollar Bonds - most corporate, government, and any municipal issues which are term bonds - are quoted on a percentage of par basis. Anytime a bond is quoted as a percentage of par, it is quoted on a dollar basis. In contrast, municipal serial issues are quoted on a yield basis.
A bond issue where the bonds have the same maturity but different dates of issuance is a:
A. term bond offering
B. series bond offering
C. serial bond offering
D. combined serial and term bond offering
The best answer is B.
A bond issue where the bonds have the same maturity but different dates of issuance is a series bond issue. These are rarely issued and are used to finance long-term construction projects where all of the money is not needed at once.
Zero coupon bonds:
A. do not pay interest
B. pay interest semi-annually
C. pay interest annually
D. pay interest at maturity
The best answer is D.
Zero coupon bonds do not make semi-annual interest payments. The bonds are bought at a deep discount and mature at par. The difference is the interest earned, so all of the interest is paid at maturity.
What is the benefit of a zero coupon bond?
A. Dividend income
B. Semi-annual payments
C. Amortization
D. Capital appreciation
The best answer is D.
Zero coupon bonds do not make period payments. The bond is purchased at a deep discount price and builds internally until maturity, at which point the bond is redeemed at par. They are often called capital appreciation bonds because of this and they are used to accumulate capital that will be used at maturity. For example, parents of young children might buy zero coupon bonds at a deep discount and use them at maturity to pay for the kid’s college expenses.
Zero coupon bonds:
A. pay interest semi-annually
B. pay interest annually
C. are bought at a discount and mature at par
D. are bought at a par and mature at a premium
The best answer is C.
Zero-coupon bonds are often called “capital appreciation bonds” since the bondholder does not receive annual interest payments from the issuer. Instead, the bonds are bought at a discount from par, and are redeemed at par at maturity (similar to savings bonds). The discount is earned over the life of the bond and is the “income” from this type of investment.
The amount by which the par value of a municipal bond exceeds the purchase price of the bond is termed the:
A. spread
B. discount
C. premium
D. takedown
The best answer is B.
If par value is higher than the purchase price, then the bond is selling for less than par. This is the bond’s discount.
An investor buys a bond at a premium. Later in the year, the bond is trading at a discount. This is termed:
A. Amortization
B. Depreciation
C. Accretion
D. Devaluation
The best answer is B.
When an asset decreases in value, this is termed depreciation.
How are corporate bonds quoted?
A. Coupon
B. Yield to Maturity
C. Whole and Fractional
D. Decimal
The best answer is C.
Corporate bonds are quoted as a percentage of par value, with each “whole” point movement representing 1% of $1,000 par or $10.
The minimum price increment is 1/8th of 1%, so it is a fraction of par. Thus, corporate bonds are quoted in whole and fractional points.
For example, a corporate bond quoted at 100 1/8 is priced at 100.125% of $1,000 par = $1,001.25.
Which of the following would be a quote for a railroad bond?
A. 101.25
B. 101-8
C. 101 1/4
D. 101 4/16
The best answer is C.
A railroad bond is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 101 1/4 = 101.25% of $1,000 par = $1,012.50 per bond.
Choice B is a U.S. Government bond quote in 32nds. 101-8 = 101 8/32nds = 101.25% of $1,000 par = $1,012.50 per bond.
Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.
Which of the following would be a quote for an airline bond?
A. 105.625
B. 105-20
C. 105 5/8
D. 105 10/16
The best answer is C.
An airline bond is a corporate bond. Corporate bonds are quoted on a percentage of par basis in 1/8ths. 105 5/8 = 105.625% of $1,000 par = $1,056.25 per bond.
Choice B is a U.S. Government bond quote in 32nds. 105-20 = 105 20/32nds = 105.625% of $1,000 par = $1,056.25 per bond.
Note that corporate, municipal and government bonds are not quoted in penny movements, as is the case with equities.
How are Treasury Notes quoted?
A. Coupon
B. Yield to Maturity
C. Whole and Fractional
D. Decimal
The best answer is C.
Treasury Notes and Bonds are quoted as a percentage of par value, with each “whole” point movement representing 1% of $1,000 par or $10. The minimum price increment is 1/32nd of 1%, so it is a fraction of par. Thus, Treasury Notes and Bonds are quoted in whole and fractional points.
For example, a Treasury Note quoted at 100-8 is priced at 100 and 8/32nds % of $1,000 par = 100.25% = $1,002.50.
10 basis points equals:
A. .01%
B. .1%
C. 1%
D. 10%
The best answer is B.
One basis point equals .01% movement in interest rates, so 10 basis points equals a .1% movement in interest rates.
The nominal yield on a bond is:
A. stated interest rate / bond par value
B. stated interest rate / bond market value
C. market interest rate / bond par value
D. market interest rate / bond market value
The best answer is A.
The nominal yield is the stated rate of interest on the bond, based on par value.
Annual Interest
———————– = Nominal Yield
Par
In 2019, a customer buys 5 GE 10% debentures, M ‘29, at 85. The interest payment dates are Feb 1st and Aug 1st. The bonds are callable as of 2024 at 103. The nominal yield on the bonds is:
A. 10.00%
B. 10.81%
C. 11.76%
D. 12.43%
The best answer is A.
The nominal yield is the stated rate of interest on the bond, based on par value.
Annual Interest
———————– = Nominal Yield
Par
$100
———- = 10%
$1,000
A corporation has issued 10% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 12%. Which statement is TRUE about the outstanding 10% issue?
A. The bond will trade at a discount and the current yield will be lower than the nominal yield
B. The bond will trade at a discount and the current yield will be higher than the nominal yield
C. The bond will trade at a premium and the current yield will be lower than the nominal yield
D. The bond will trade at a premium and the current yield will be higher than the nominal yield
The best answer is B.
The bond was issued with a coupon of 10%. Currently, yield for a similar issue is 12%. Therefore, interest rates have risen subsequent to the issuance of the bond or the credit quality of the bond has deteriorated. When interest rates rise, yields on bonds already trading must also rise. What causes this is a drop in the dollar price of the issue - the bond now trades at a discount.
An increasing market rate of interest would lead to:
A. higher bond prices and higher bond yields
B. higher bond prices and lower bond yields
C. lower bond prices and lower bond yields
D. lower bond prices and higher bond yields
The best answer is D.
A rising market rate of interest means that interest rates are increasing. If interest rates rise, then bond prices will drop, and yields on those bonds will rise.
If market rates of interest increase, bonds issued at par would trade at (a):
A. discount
B. premium
C. par
D. parity
The best answer is A.
A rising market rate of interest means that interest rates are rising. If market interest rates rise, then bond prices will decline to a discount below par, and the yields on those bonds will rise.
Which statements are TRUE regarding market risk for bondholders?
A. As interest rates rise, the price of long term bonds falls faster than that of short term bonds
B. As interest rates rise, the price of short term bonds falls faster than that of long term bonds
C. To avoid market risk, a customer would invest in bonds with long term maturities
D. To avoid market risk, a customer would invest in bonds with short term maturities
The best answer is B.
Market risk for a bondholder is the risk of rising interest rates forcing the price of a bond to drop. As interest rates rise, the price of a long term bond falls faster than that of a short term bond. To avoid market risk, a bondholder would want to invest in the shortest maturity possible.
Which statement is TRUE regarding bond price volatility?
A. High coupon, long maturity bonds have the lowest price volatility
B. High coupon, short maturity bonds have the lowest price volatility
C. Low coupon, long maturity bonds have the lowest price volatility
D. Low coupon, short maturity bonds have the lowest price volatility
The best answer is B.
The shorter the maturity, the lower the bond’s price volatility in response to interest rate movements. The longer the maturity, the greater the bond’s price volatility in response to interest rate movements. Bonds with low coupon rates exhibit greater price volatility than ones with high coupon rates.
If interest rates are rising, which statement about discount and premium bonds is TRUE?
A. Discount bonds will depreciate faster than premium bonds
B. Premium bonds will depreciate faster than discount bonds
C. Both bonds will depreciate equally
D. The rate of depreciation depends on the credit rating of the issuer
The best answer is A.
As a general rule, the longer the maturity on a debt issue, the greater the issue’s price volatility in response to interest rate movements.
Another general rule is that the lower the price of the issue (which would result from having a lower coupon), the greater the issue’s price volatility in response to interest rate movements.
As interest rates rise, bonds that are selling at a discount will fall proportionately more than bonds trading at an equivalent premium. This is true since the change in price as a percentage of the bond’s cost is greater for a discount bond than for a premium bond.
Which bond will exhibit the greatest price volatility?
A. 2% coupon bond with a 2 year maturity
B. 0% coupon bond with a 1 year maturity
C. 6% coupon bond with a 10 year maturity
D. 0% coupon bond with a 9 year maturity
The best answer is D.
The longer the expiration, the more volatile a bond’s price movements, which narrows the Choices to either C or D. The lower the coupon, the more volatile the bond’s price movements, with the lowest coupon being “0.” A 9-year zero coupon bond will actually be more volatile in price movements than a slightly longer maturity bond (10 years) with a fairly high coupon (6% in this case). The higher coupon means that more of the bond’s value is represented by the interest stream than comes in early and this stabilizes the bond’s price as market interest rates move.
