Chapter 12 Part 5

Question 1

Corporate zero-coupon bonds arc taxed a bit differently. Each year the bond’s

Answer 1

cost basis (the amount that the investor originally paid for the bond) is increased (accreted) for tax purposes. This process is called accretion and the investor must pay taxes on the increase even though he has not actually received any money. This is a disadvantage of zero-coupons for investors in high tax brackets

Question 2

U.S. government securities are direct obligations of the

Answer 2

federal government.

Question 3

Agency securities are issued by

Answer 3

agencies of the federal government such as the Federal National Mortgage Association. Although most agency securities are not direct obligations of the United States government, they are usually considered very safe investments, since it is unlikely that the federal government would permit a default on these securities

Question 4

U.S. government securities are divided into two major groups

Answer 4

marketable securities (Treasuries) and nonmarketable securities (savings bonds)

Question 5

Marketable securities are

Answer 5

negotiable. This means that investors can sell their securities to other investors after they are issued

Question 6

nonnegotiable

Answer 6

Savings bonds are nonrnarketable-they may only be sold back to the U.S. government

Question 7

Treasuries are much more important of the two groups, since they may be freely transferable after issuance. These securities include

Answer 7

Treasury bonds; Treasury notes; Treasury bills; Treasuiy STRIPS; Treasury TIPS

Question 8

Key advantages of treasury securities for investors include

Answer 8

Safety, Liquidity, Interest exempt fro1n state and local income taxes

Question 9

Treasury notes (t notes) andtreasury bonds (t bonds) are like most corporate bonds. They pay a

Answer 9

fixed rate of interest semiannually (twice a year) and the investor receives the face value of the security when it matures. For this reason, t notes and t bonds are referred to as interest-hearing securities

Question 10

treasury notes mature in

Answer 10

2 to 10 years

Question 11

Treasury bonds can take up to

Answer 11

30 years to mature

Question 12

Treasury Notes and Bonds are sold in denominations of

Answer 12

$100

Question 13

Prices for Treasury notes and bonds are quoted as

Answer 13

a percentage of their par value, the same way as for most corporate bonds

Question 14

The difference between government bonds and other bonds is that government securities are

Answer 14

quoted in increments of 1 /32, while the prices for most other bonds are expressed in increments of 1 /8th.

Question 15

For example, a Treasury bond quoted as 101 24/32 would appear in the paper as 101.24 or 101 :24. Anything to the right of the decimal is a fraction with 32 as its denominator. In order to translate this quote into the bond’s dollar price, you need to do the following

Answer 15

Step 1: Express the quote as a fraction. (Put everything that is to the right of the decimal over 32.) 101.24 = 101 24/32. Step 2: Change the fraction to a decimal. 24/32 =. 75 Thus, 101 24/32 = 101. 75%. Step 3: Change the percentage to a decimal. 101.75% becomes 1.0175 (Move the decimal two places to the left.). Step 4: Multiply the result by the par value ($1,000). 1.0175 x $1,000 = $1,017.50 The dollar price of a Treasury bond quoted as 101.24 is $1,017.50.

Question 16

Treasury Inflation-Indexed Securities

Answer 16

Often referred to as Treasury Inflation-Protected Securities (TIPS), the principal value of these securities is inflation-adjusted, based on the Consumer Price Index (CPI). With TIPS the rate of interest is fixed. However, the principal amount on which that interest is paid may vary

Question 17

Treasury Bills

Answer 17

Currently an investor can purchase T-bills with maturities of one month (4 weeks), three months (13 weeks), six months (26 weeks), and one year (52 weeks). They are sold with a minimum denomination of $100, and in multiples of$100. T-bills are only issued in book-entry form

Question 18

T-bills are always sold

Answer 18

at a discount from their face value. Unlike Treasury bonds and notes, T-bills do not make interest payments to investors. The difference between what the investor pays for the T-bill and what he receives when the T-bill matures is his interest. Consequently, T-bills are referred to as discount securities and noninterest-bearing securities

Question 19

T-Bill Prices

Answer 19

the prices of T-bills are not quoted as a percentage of their par value. T-bills are quoted on a discounted yield basis. This means that their prices represent the yield that the buyer will earn on the T-bill. Since T-bills are always sold at a discount and do not make interest payments to investors, their yield refers to the size of the discount from the T-bill’s face value

Question 20

Treasury STRIPS are

Answer 20

zero-coupon bonds issued by the United States government. As with other zero-coupon bonds, the investor does not receive periodic interest payments. He receives a lump sum when the bond matures